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21 Jan 2016

India’s new Start-up action plan offers tax breaks

Recognising the role that start-ups around the world (and in India) have played in bringing innovation (and often technology-enabled social change), the government promised to formulate policies aimed at creating and promoting a robust ecosystem for start-ups in India.

On January 16, 2016, PM Modi announced the broad contours of the “action plan” for the “Start-up India” initiative. At the core of the action plan are three “pillars” that reflect perhaps the most important aspects of getting a start-up off the ground during its fragile, early days. These pillars are:

  1. Simplification and Handholding;
  2. Funding support and incentives; and
  3. Industry-Academia partnership for incubation.

The essence of the plan

The action plan defines what constitutes a “start-up” and only those entities that meet the specified criteria will be eligible for the various benefits offered under the “Start-up India” program.

The eligibility criteria include:

  • Place of registration and age of the entity (in India, less than five years ago)
  • Turnover/Revenue (not exceeding INR250 Million in any of the preceding five financial years)
  • Scope of work (innovation, development, deployment or commercialization of new products, processes or services driven by technology or IP that adds incremental value to customers)
  • Evidence of innovation could be certification by an incubator in a PG college/institute in India or support by a government-funded incubator or SEBI-registered Incubation Fund/Angel Fund/ Private Equity Fund/ Accelerator/Angel Network
  • Grant of a patent by the Indian Patent and Trademark Office in areas affiliated with the nature of business being promoted

For details of what constitutes a “start-up”, please read our blog http://www.foxmandal.in/startup-india-action-plan-intellectual-property-outlook/

Simplification

To simplify regulatory formalities and compliance with various laws and compress the associated timelines, the action plan introduces a Mobile App to provide on-the-go access for Registering Startups with relevant agencies of the Government and for collaboration with other startup partners.

Access to capital

Access to seed and early-stage funding is a huge challenge for most entrepreneurs. To provide impetus to start-ups, the action plan envisions setting up a ‘Fund of Funds’ fund with an initial corpus of INR 2,5000 Million and a total corpus of INR 10,0000 Million (INR 10 Billion) over the next four years (i.e. infusion of an additional INR 2,5000 Million per year for the next four years).

The action plan also provides for subsidies and tax breaks to facilitate financial scaling up of start-ups and make them attractive to providers of private capital in shorter time-scales than may otherwise be feasible.

Tax benefits

  1. Capital Gains Exemption

To attract and sustain investments in Startups, the action plan envisions capital gains exemption on investments in the Fund of Funds recognized by the Government.  Capital gain tax exemption for investment by individuals in newly formed manufacturing MSMEs are to be extended to Startups.

Under the applicable mechanism of availing exemption of capital gains, the investment must be in “new assets”. Under the action plan, investments in ‘computer or computer software’ (as used in core business activity) are also to to be considered as ‘new assets’, with a view to promote technology driven Startups.

 ‘Tax Holiday’ for 3 Years

The profits of startups are to be exempt from income-tax for a period of 3 years with a view to making it easier for startups to meet their working capital requirements during these initial years of operations and facilitate their growth. The tax exemption shall be available only if the startup does not distribute any dividends.

Tax Exemption on Investments above Fair Market Value

Investment by venture capital funds in Startups by way of subscribing to shares on a value exceeding the Fair Market Value (FMV) of such shares will not be taxed in hands of Startups under Section 56 of the Income Tax Act, 1961 which assesses taxability of Income under the Head “Income from Other Sources”. In the context of Startups, it is often difficult to determine the FMV of such shares as business is still in early stages of conceptualization. Such consideration received by way of subscription will be tax free in hands of the Startups.

Conclusions

From a tax benefits perspective, the government has taken a good first step to encourage investments in startups. However, it remains to be seen if and to what extent the intended beneficiaries- entrepreneurs, startups and investors- and in the broader sense, the Indian economy- will be galvanized. It also remains to be seen if unscrupulous people seek to misuse the benefits, thus forcing the government to revisit the action plan after one year (the plan is a pilot at this time, subject to review after one year). Sustained success of the tax breaks offered will depend on trust, high levels of voluntary compliance and greater collaboration between the government and startups.

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