Startups in India - Tax and Regulatory Insight

Step-by-Step Process for DPIIT Startup Recognition:

1. Register on www.startupindia.gov.in as a “Startup”.
2. Initiate an online application for recognition as an “Eligible Startup” on the portal.
3. Submit a write-up highlighting how the business is working towards innovation, development, or improvement of products/services or scalability in terms of employment generation or wealth creation.
4. Submit the online application along with the Certificate of Incorporation/Registration and other relevant corporate details.
5. Receive the DPIIT Recognition Certificate over registered email ID (or rejection letter providing detailed reasons).

“Angel Tax” is levied on consideration received by unlisted closely held companies from resident investors towards the issue of shares exceeding the fair market value (taxable as income from other sources). Under CBDT rules, an Eligible Startup is granted exemption from Section 56(2)(viib) provided:

Exclusions from the INR 25 Crore Limit (Shares issued to following persons are excluded):

• Non-resident investors;
• Venture Capital Company (VCC) or Venture Capital Fund (VCF);
• Specified Company: A company whose shares are frequently traded [under SEBI (SAST) Regulations, 2011] and whose Net Worth on the last date of the preceding FY exceeds INR 100 Crores, or Turnover exceeds INR 250 Crores.

2. 100% Tax Holiday on Profits [Section 80-IAC]

Eligible Startups can claim a deduction of 100% of profits and gains derived from an eligible business involving innovation, development, deployment, or commercialization of new products, processes, or services driven by technology or IP.

Inter-Ministerial Board (IMB) Certification Process (Form 1):

Startups must file Form 1 with MOA, 3 years’ audited financials and tax returns, pitch deck, and video link. As on 15th December 2022, 990 startups have been granted 80-IAC IMB Certification.

(A) Companies Act, 2013 Statutory Exemptions:

• Cash Flow Statement Exemption: Exempted from preparing cash flow statements as part of annual financial statements (G.S.R. 583(E) dated 13.06.2017).
• Board Meetings Frequency: Need hold only one Board Meeting in each half of a calendar year with a minimum gap of 90 days between meetings, rather than quarterly meetings (G.S.R. 583(E)).
• Acceptance of Member Deposits: Allowed to accept deposits from members without complying with stringent limits under Section 73(2) (G.S.R. 639(E) dated 29.06.2016).
• Convertible Notes: Under Rule 2(c)(xvii) of Companies (Acceptance of Deposits) Rules, 2014, an instrument receiving minimum INR 25,00,000 in a single tranche from a single person repayable/convertible within 10 years is not treated as a deposit.
• Sweat Equity Limit: Can issue sweat equity shares up to 50% of paid-up capital for up to 10 years from incorporation (normal limit is 25%) under Rule 8(4).
• ESOPs to Promoters: Permitted to issue ESOPs to promoters and director-shareholders holding >10% equity during their first 10 years of existence (G.S.R. 704(E) & G.S.R. dated 16.08.2019).
• Annual Return (MGT-7) Certification: No certification by a Practicing Company Secretary (PCS) is required; signature of directors is sufficient compliance under Section 92.

(B) Foreign Exchange Management Act (FEMA) & RBI Relaxations:

• Optionally Convertible Notes (FEMA NDI Rules 2019): Eligible startups can issue convertible notes for INR 25 Lakhs or more in a single tranche to foreign investors with a 10-year repayment/conversion period. No company valuation is required at the time of note issuance, avoiding immediate dilution of control.
• Relaxed ECB Guidelines (RBI Circular No. 13 dated 27.10.2016):
  1. No all-in-cost ceiling: Cost of borrowing mutually agreed between parties.
  2. No end-use restrictions on funds raised via ECB.
  3. Minimum Average Maturity Period is 3 years for all purposes.
  4. Can borrow from any recognized lender in a FATF-compliant country.
  5. Removal of restrictions on borrowing solely from Foreign Equity Holders and removal of debt-to-equity ratio caps.
• Overseas Foreign Currency Accounts (RBI Circular No. 77 dated 23.06.2016): Startups with overseas subsidiaries may open bank accounts abroad to credit export proceeds, with export earnings repatriated to India, and permissible foreign currency credits into domestic EEFC accounts.
• SEBI Registered FVCI Investments: FVCIs permitted to invest in Indian startups regardless of industry vertical (RBI Circular No. 7 dated 20.10.2016).

SIDBI Fund of Funds for Startups (FFS) — INR 10,000 Crore Corpus

Managed by the Small Industries Development Bank of India (SIDBI), the government contributes capital to SEBI-registered Alternative Investment Funds (AIFs), which deploy venture equity into high-growth innovation startups.