A startup is typically a venture that is floated by entrepreneurs, often those who are inexperienced and young, who have innovative ideas that can grow into significant business opportunities. Prime Minister Narendra Modi announced the ‘Startup India Scheme,’ in the year 2016 to provide an ecosystem that nurtured entrepreneurship, technology, and innovation. The startup scheme was formulated by the Department for Promotion of Industry and Internal Trade (DPIIT).

The Startup India scheme aims to improve on areas like handholding and funding support and incentives, in addition to providing government funding for startups in India. The scheme also offers industry-academia partnership and incubation. So far the Startup India scheme has recognized 26,619 startups. Of these, the maximum startups fell under the IT services umbrella followed by life sciences and education.

What defines an eligible startup?

The criteria for being an eligible startup are as follows:

  1. The entity has to be less than ten years old since its incorporation or registration in the country.
  2. The turnover of the entity must not exceed ₹100 crores in any of the prior years.
  3. The entity should be working toward the innovation, development, and improvement of products or services with a potential for wealth creation or employment generation

The entity should be formed without the splitting up, reconstruction, of a business that is already in existence.

Tax benefits for startups in budget 2020

In her Budget speech on February 1, Finance Minister Nirmala Sitharaman announced tax incentives for startups to encourage entrepreneurship in India. The speech included an extension of tax holidays for start-ups in addition to tax benefits on ESOPs. The following incentives and benefits are available to any eligible startups in India.

1. Waiver from income tax at the initial stage

Before Budget 2020, startups with turnover up to ₹25 crores were permitted a deduction of 100% of their profits for 3 consecutive assessment years out of 7 years, provided their total turnover did not exceed ₹25 crores. Under Budget 2020, Finance Minister Nirmala Sitharaman increased the turnover limit from the existing ₹25 crores to ₹100 crores so larger startups can also benefit from this income tax waiver. To add to this, Budget 2020 also proposed to extend the period of eligibility for one to claim a deduction from the existing seven to ten years since startups may not have the requisite profit to avail of an income tax deduction within the first seven years since their incorporation.

Hence, a company that meets the criteria for an eligible startup in India that has been incorporated between April 1st, 2016 and April 1st, 2021 can avail of a deduction of 100% of the profits for a block of three years within the first seven years it was incorporated. This deduction would be available upon filing an application with the DPIIT and satisfying certain conditions. Moreover, within the first three years, eligible startups will not be required to pay any tax on profits except for their minimum alternate tax or MAT. MAT is calculated on the startup’s book profits.

2. Waiver from ‘Angel tax’

A second tax exemption for startups in India 2020 is a waiver from angel taxation. A domestic company is required to issue its shares at FMV — or fair market value — which is determined on the net assets value or determined by the merchant banker on a discounted cash flow basis. Any amount that is received by the company from Indian residents in excess of the fair market value is liable to be taxed at the hands of the company. This form of taxation is known as Angel tax. Once the requisite declaration with DPIIT has been filed, subject to certain conditions, eligible startups are exempted from angel tax.

3. Relaxation for carrying forward losses and set-off

The income tax law provides for the carrying forward and set off of business losses. This set off will be denied for any private companies if there is a 50% or more change in the shareholding pattern of that company from the year in which they saw losses. An eligible startup is not hit by the condition for the losses that are incurred within the first seven years, provided the shareholders holding these years in the year they saw losses continue to hold shares in the year they experience a set-off.

4. Exemption from long-term capital gains tax to investors of startups

From the transfer of a residential property that arises to a HUF or an individual, one is exempted from paying tax on their long-term capital gain where the net consideration is invested in the equity shares of any eligible startups.

5. Relaxation in the taxation of Employee Stock Options (‘ESOP’) for startups’ employees

As of now, ESOPs are one of the better options to attract highly skilled employees to one’s company. The startup will be provided with certain relaxations on tax deductions for such ESOPs. This is the case where any eligible startup issues Employee Stock Options (ESOP) to its employees on or after April 1st, 2020. Right now, ESOPs are taxable as perquisites at the time of exercise. Startups stand to benefit immensely in attracting talent to themselves as ESOPs grow tax-friendly.

Other key benefits and tax exemption for startups in India 2020

1. A simple process of registering one’s startup

2. Easy access to funds through Alternative Investment Funds and eligibility to raise ECB’s as per relaxed norms.

3. Fast track one’s patent application with a rebate of upto 80% in filing patents.

4. Self-certification of compliance under six labor laws and three environmental laws.

5. The company can be easily wound up within 90 days as per the insolvency and bankruptcy code of 2016.

The Bottom Line

Companies in India have the benefit of availing a host of tax benefits for startups in budget 2020. Keep in mind, however, that the preferred form of a sole proprietorship, partnership firm, or LLP (limited liability partnership) is how the startup should be established. As per the Companies Act  of 2013 or the LLP Act of 2008, the startup has to be incorporated as a private company to qualify as an eligible startup.