Startup Ecosystem in India

Eligibility Criteria for Startup Recognition as per DPIIT:

1. Entity Structure: The Startup should be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership (LLP).
2. Turnover Threshold: Turnover should be less than ₹ 100 crores in any of the previous financial years.
3. Age of Entity: An entity shall be considered as a Startup up to 10 years from the date of its incorporation.
4. Innovation & Scalability: The Startup should be working towards innovation/improvement of existing products, services and processes and should have the potential to generate employment/create wealth.

Definition of “Eligible Startup” and “Eligible Business” under the Income-tax Act, 1961:

“Eligible Startup” means a company or a limited liability partnership engaged in “eligible business” which fulfils the following conditions namely:

1. Incorporated on or after 01^st April, 2016 but before 01^st April, 2021.
2. The total turnover of the business doesn’t exceed ₹ 100 Crores⁴ in the previous year relevant to the Assessment Year for which deduction is being claimed.
3. It holds a certificate of eligible business from the Inter-Ministerial Board of Certification as notified in the Official Gazette by the Central Government.

“Eligible business” means a business carried out by an eligible startup engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation.

1. Section 80-IAC: 100% Tax Holiday for Three Consecutive Years

The gross total income of an eligible startup from an eligible business will be allowed a deduction of 100% for a period of three consecutive assessment years from any of the 10 assessment years⁵ starting from assessment year relevant to the previous year in which the company was first incorporated.

This period of three assessment years would be at the option of the assessee. It has to be noted by the assessee that only gross total income relating to the eligible business will be allowed as deduction under this section. Any income other than income from eligible business would not be allowed as deduction.

2. Section 54GB: Capital Gains Exemption on Transfer of Residential Property Invested in Eligible Startups

When the eligible assessee (being Individual or HUF) transfers any residential property (being a house or a plot of land and should qualify as a long term capital asset) and out of the net consideration⁶ received, subscribes for the shares of an eligible company before furnishing return of income before due date u/s 139(1) and the eligible company within one year from date of subscription by the assessee, purchases a new asset, then the capital gains arising on such residential house property will be exempted from tax.

However, the capital gains will be exempted on a proportionate basis i.e. if amount of cost of acquisition of new asset is less than consideration, then only that proportion of capital gains which bears to the amount invested in new asset as divided by net consideration will be exempt from tax and the balance would be taxable. However, if amount of cost of acquisition of new asset equals to or exceeds net consideration, then the entire capital gains will be exempt.

The eligible assessee should have at least 25% shareholding or 25% voting power in the company⁷. However, the shares subscribed to by the eligible assessee in the new company have to be held for a minimum period of five years and the new asset acquired by the new company also have to be held for a minimum period of five years. If the shares are sold by assessee before five years or new asset acquired by the company is sold within a period of five years, then the capital gains exempted earlier will become taxable.

3. Section 56(2)(viib): Angel Tax Exemption for Investments in Startups

This section provides for taxation of income of such amount received for issue of shares to a Resident which exceeds the fair market value of such shares. However, for such amount to be taxed as income, the fair market value of the share should be more than its face value. However, such excess amount would not be taxable as such if such amount is received by a venture capital undertaking⁸ from a venture capital company or a venture capital fund.

1. Partnership Firms: DPIIT recognises a partnership firm as a Startup whereas the Income-tax Act, 1961 (“the Act”) doesn’t recognise a partnership firm as a startup.
2. Foreign LLPs: DPIIT recognises foreign LLPs as startups as well. However, the Act is silent on whether foreign LLPs too would be eligible to be recognised as startups if other conditions are satisfied.

“Differences in policies adopted by Income tax Department and DPIIT for this flagship initiative of the Government of India be streamlined so that startup as per the Income-tax Act, 1961 and as well as DPIIT are at the same page. Uniformity in criteria in terms of startup recognition would be more beneficial overall including tax benefits.”

“All the above measures taken by the Government only emphasise the Government’s belief in the Startup ecosystem and in the minds, ideas and capabilities of Indians to create wonders. Undoubtedly, India will be instrumental in upspring of unicorns in the years to come.”