Startups to benefit from expansion and extension of tax incentives

Even as the Economic Survey 2022-23 highlighted the multi-fold growth in registered startups, Finance Minister Nirmala Sitharaman, in her Budget speech, touched upon the government’s focused attention on the startup ecosystem.

“We have taken a number of measures for startups and they have borne results,” said Sitharaman. “India is now the third largest ecosystem for startups globally, and ranks second in innovation quality among middle-income countries.”

The FM proposed to extend the date of incorporation for income tax benefits to startups from March 31, 2023, to March 31, 2024. She further proposed to provide the benefit of carrying forward losses on change of shareholding of startups from seven years of incorporation to ten years.

However, the key term which applies to both proposals is ‘eligible’ startups. The primary condition for being an eligible startup is to get registered with the Department for Promotion of Industry and Internal Trade (DPIIT) as a private limited company, partnership firm, or limited liability partnership firm. A DPIIT-registered entity is eligible to be called a startup for ten years from the date of its incorporation or registration.

Secondly, the annual turnover of such a registered entity cannot exceed Rs 100 crore in the financial years since incorporation or registration.

And thirdly, the entity is working towards innovation, development, or improvement of processes, products, or services, or is a scalable business model with a high employment generation potential.

One of the proposals is aimed at offering relief to startups in carrying forward and offsetting losses. At present, the condition of continuity of at least 51% shareholding for setting off of carried forward losses is relaxed for an eligible startup if all the shareholders of the entity continue to hold those shares.

Currently, the relaxation applies for losses incurred during the period of seven years from the incorporation of such a startup. The FM proposed to increase this period to 10 years.

“Increasing the tax relief period from 7 years to 10 years is a big announcement,” hailed Anil Joshi, Managing Partner, Unicorn India Ventures–an early-stage technology-focused venture fund. “It will help startups redeploy earnings on growth of the business."

The other startup-centric measure is aimed at the extension of the date of incorporation for eligible startups for exemption. As per the last dispensation, registered startups and those that get registered before April 1, 2023, were meant to be considered as startups ‘eligible’ for various incentives and relaxations offered by the government.

The FM has now proposed to extend the period of incorporation by one year to startups registered before April 1, 2024.

A finer reading of the memorandum explaining the provisions in the Finance Bill, 2023, reveals that non-resident investors are proposed to be brought within the ambit of section 56(2)(viib) of the Income-tax Act 1961 to eliminate the possibility of tax avoidance.

This particular section applies when a closely held company issues shares at a premium over the face value, and the consideration for such shares exceeds the fair market value (FMV) of such shares.

In effect, Angel Tax (Section 56(2)(viib)), which taxed the issue of shares at a premium to a resident investor in the hands of the company, has now been amended to include non-residents as well with effect from April 1, 2024. “The only exemption to angel tax is investment from SEBI-registered Alternative Investment Funds (AIFs),” said Siddarth Pai, Founding Partner at 3one4 Capital, an early-stage venture capital firm based in Bengaluru.

Hailing the Budget as favourable, especially for FM’s measures for startups and MSMEs, Aparna Thyagarajan, Co-founder and Chief Product Officer of Shobitam, a D2C ethnic fashion brand, said that a decade ago, talk of startups in Budget was unheard of. “Really liked the fact that the tax holiday for startups was extended for 10 years enabling us to reinvest and drive innovation from India," she added.

According to Vyom Shah, Founder and CEO of FOODISM, a food community platform, these measures will help create more jobs, stimulate economic growth, and encourage innovation in the country.

“There shall be more incentives for investors and venture capitalists who are willing to invest in startups,” said Vyom. “It is a major step towards providing a much-needed boost to SMEs and startups in the country.”

Prerna Kalra, Co-founder and CEO of Daalchini Technologies, which is building an intelligent retailing network through smart vending machines, opines that the proposal for extension of the date of incorporation for income tax benefits will indeed encourage budding entrepreneurs and startup founders.

(With inputs from Thimmaya Poojary)