Income from Business/Profession - Taxation of Start-ups

Start-ups in India can avail of several tax benefits designed to encourage entrepreneurship and support the growth of small businesses. These benefits are subject to certain conditions and are only available to start-ups that are recognised by the government. These tax incentives provide a much-needed boost to start-ups, helping them to overcome the challenges of setting up and running a business in the competitive marketplace.

Start-up India Initiative

The Start-up India Initiative, which was launched on January 16, 2016, is focused on promoting entrepreneurship and supporting the growth of start-ups in India. To achieve this goal, the initiative has implemented several programs to build a strong and supportive ecosystem for start-ups. A dedicated team manages these programs within the Department of Promotion of Industry and Internal Trade (DPIIT), which oversees the initiative's operations and progress. The Start-up India Initiative aims to transform India into a country where entrepreneurs and start-ups thrive, creating new jobs and contributing to the country's economic growth.

What is DPIIT?

DPIIT is the Department of Promotion of Industry and Internal Trade. DPIIT is a Central Government department under the Ministry of Commerce and Industry. It has been constituted to promote internal trade, including retail trade, the welfare of traders and their employees, and matters relating to facilitating ease of doing business. Additionally, policies for the promotion and benefit of Start-ups are also dealt with by the DPIIT.

Why should a Start-up be recognized by DPIIT?

Certain benefits flow to an entity if it is an 'Eligible Start-up', and to become an eligible Start-up an entity has to satisfy various conditions prescribed under Notification No. GSR 127(E), Dated 19-2-2019, issued by the DPIIT. Although there are additional conditions to claim certain benefits or relief under the Income-tax Act, but recognition by the DPIIT is mandatory for claiming such benefits.

What is the meaning of a Start-up?

As per the notification issued by the DPIIT, an entity is considered as a Start-up up to a period of 10 years from the date of its incorporation/registration if the following conditions are satisfied:

• It is incorporated as a private limited company, partnership firm, or LLP in India;
• Turnover of the entity for any of the financial years since incorporation does not exceed Rs. 100 crores;
• It is working towards innovation, development, or improvement of products or processes or services or business model of the entity is scalable with high potential of employment generation or wealth creation; and
• It is not formed by splitting up or reconstructing an existing business.

Tax Benefits to Start-ups

The following benefits shall be available to an eligible start-up recognised by the DPIIT:

• Exemption to the company from levy of angel tax under Section 56(2)(viib)*
• Deductions under Section 80-IAC to the start-up
• Liberalised regime of Section 79 to carry forward and set off the losses of start-up

The list of different forms of entities eligible for benefits under various sections recognised with DPIIT:

* The provisions of Section 56(2)(viib) are not applicable with effect from Assessment Year 2025-26

What is angel tax?

Angel tax is a term used for the tax payable by a closely held company under Section 56(2)(viib). This tax is payable in respect of any excess premium received by a company from the issue of shares provided the following conditions are satisfied:

  i.  Shares (equity or preference shares) are issued by a closely held company;

 ii.  The consideration for the issue of shares is received from any person; and

iii.  The consideration received for the issue of shares exceeds the face value and fair market value of shares.

If the above conditions are satisfied, the consideration received exceeding the fair market value of the share shall be taxable in the hands of the issuer company. However, this provision does not apply to an eligible start-up that fulfils the conditions prescribed in the Notification issued by the DPIIT. So a company registered with DPIIT shall get an exemption from the angel tax if it fulfils the prescribed conditions.

Conditions prescribed by the DPIIT

A Start-up recognised by DPIIT shall get immunity from the provisions of Section 56(2)(viib) if it fulfils the following conditions:

Condition as to the 'paid-up share capital'

The aggregate amount of paid-up share capital and share premium of the start-up, after the issue or proposed issue of shares, should not exceed Rs. 25 Crores. While calculating this threshold limit, the issue of shares to the following persons shall not be included:

  i.  A non-resident person;

 ii.  Venture Capital Company;

 iii.  Venture Capital Fund; and

 iv.  Listed Company whose net worth exceeds Rs. 100 Crores or turnover exceeds Rs. 250 Crores for the financial year preceding the year in which shares are issued.

Condition as to the 'utilisation of funds'

The eligible start-up should not invest in any of the following assets for a period of 7 years from the end of the latest financial year in which the shares are issued at a premium:

  i.  Land or building, being a residential house, other than that used for the purposes of renting or held as stock-in-trade in the ordinary course of business;

 ii.  Land or building, not being a residential house, other than that occupied by a start-up for its business or renting purposes or held as stock-in-trade in the ordinary course of business.

 iii.  Loans and advances, if a start-up is not engaged in the ordinary business of lending of money;

 iv.  Capital contributions to any other entity;

 v.  Shares and securities;

 vi.  Motor vehicle, aircraft, yacht, or any other mode of transport, if the cost of such an asset exceeds Rs. 10 lakhs other than that held by the Start-up for the purpose of plying, hiring, leasing, or as stock-in-trade in the ordinary course of business;

 vii.  Jewellery held otherwise than as stock in trade; and

viii. Archaeological collections, drawings, paintings, sculptures, any work of art or bullion.

How to claim the exemption from angel tax?

The exemption from applicability of angel tax shall be available in respect of all shares issued by the start-up from the date of its incorporation, except for the shares issued in respect of which an addition under section 56(2)(viib) has been made in an assessment order made before the date of issue of the notification.

To claim this exemption, the start-up has to file a declaration in Form 2 with the DPIIT along with the details of the company, such as name, date of incorporation, registration/ incorporation no., contact details, etc. Within the form, a self-declaration form has to be attached in PDF format, and it should be printed on the company's letterhead and digitally signed by the authorised signatory. The DPIIT shall forward the self-declaration form to the CBDT for approval. The start-up can issue the shares after successfully submitting the self-declaration form. The CBDT, thereafter, shall assess the application, and it can either accept it or reject it after giving an opportunity of being heard.

Withdrawal of exemption

In case the start-up invests in any of the assets specified above before the end of 7 years from the end of the latest financial year in which the shares are issued at a premium, the exemption provided under section 56(2)(viib) shall be revoked with retrospective effect.

When the exemption is withdrawn, the consideration received from the issue of shares, as exceeding the fair market value of such shares, shall be deemed to be the income of the company chargeable to tax for the previous year in which such failure occurs. Such income arising on withdrawal of exemption shall be deemed to be under-reported by the company in consequence of the misreporting and, consequently, a penalty of an amount equal to 200% of tax payable on the under-reported income (i.e., the difference between issue price and fair market value of shares) shall be levied as per Section 270A.

How to file Form 2 with DPIIT?

Step 1: Log in to https://www.startupindia.gov.in/

Step 2: Go to Recognition>Apply for Tax Exemptions

Step 3: Click on apply for Angel Tax Exemption.

Step 4: Fill in the details, and attach the declaration. Click on 'Submit'.

Deduction under Section 80-IAC is allowed to an eligible start-up to the extent of 100% of profits and gains for 3 consecutive assessment years out of the 10 years beginning from the year of incorporation or registration. The meaning of an eligible start-up under this provision differs from the meaning assigned to it in the DPIIT's notification.

Reference to the meaning of an eligible start-up

The meaning of an eligible start-up is defined differently in the notification issued by DPIIT and in Section 80-IAC, which has been explained in the below table.

The definition of an eligible start-up as per DPIIT notification and as per Section 80-IAC is used for different provisions as explained below:

* The provisions of Section 56(2)(viib) are not applicable from Assessment Year 2025-26.

The losses incurred by a closely held company in any year prior to the previous year shall not be carried forward and set off against the income of the previous year unless the shares of the company carrying at least 51% of the voting power are beneficially held by the same persons on the following two dates:

  ♦  On the last day of the previous year in which loss was incurred;

  ♦  On the last day of the previous year in which such brought forward loss has to be set off.

In case of an eligible start-up

Meaning of eligible start-up

This provision makes a reference to Section 80-IAC for the meaning of an eligible start-up. It means a company which fulfils the following conditions:

  ♦  It is incorporated between 01-04-2016 and 31-03- 2030;

  ♦  The total turnover of its business does not exceed Rs. 100 Crores in any of the previous years during April 1, 2016, and March 31, 2030; and

  ♦  It holds a certificate of eligible business from the Inter-Ministerial Board of Certification.

'Eligible business' means a business which involves in innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property.

If a company does not fulfil any of the conditions as mentioned above, it will not be regarded as an eligible start-up for Section 80-IAC. Thus, if the turnover of a company exceeds the threshold limit, it becomes ineligible not only for Section 80-IAC but also for Proviso to Section 79. Consequently, such companies, if they are closely held companies, can claim the set-off of losses in accordance with general provisions.

When losses can be carried forward and set off?

The losses incurred by an eligible start-up shall be allowed to be carried forward and set off against the income of the previous year on the satisfaction of any of the two conditions specified below:

Condition 1: Continued 51% shareholding

In the year of set-off of losses, at least 51% of voting power is beneficially held by the same persons who held them as on the last day of the year in which loss was incurred; or

Condition 2: Continued 100% shareholders

100% of shareholders, on the last day of the previous year in which the loss was incurred, should continue to hold their shares on the last day of the previous year in which the loss is to be set off. Further, such losses should have been incurred during the period of 10 years beginning from the year of incorporation of the company.

For example: Suppose a company was incorporated in April 2019 and incurred losses in the financial year 2021-22. Suppose it issued additional equity shares in the financial year 2022-23; as a result, the aggregate shareholding of the original shareholders fell below 51% as on 31-03-2023. Should the company be allowed to set off the losses incurred in the financial year 2021-22 against the profits of the financial year 2022-23 assuming it is an eligible start-up and original shareholders continued to hold their shares as on 31-03-2023?

In this case, the company is not complying with Condition 1 as 51% of the shareholding of the company was not held by the same persons. However, as the company is an eligible start-up, it would still be allowed to carry forward and set off the losses as original shareholders had continued to hold their shares as on 31-03-2023. Thus, the company is satisfying condition 2 in this case.