Startups Can Continue to Enjoy their Tax Holiday! - Vakilsearch

9 August 2024

1,959 5 mins read

The coronavirus pandemic dealt a heavy blow to businesses across the country, leading to the government working overtime to provide support to such companies. One of the most prominent schemes enacted has been the tax holiday for startups.

Businesses of all sizes and types have been having a tough year courtesy of the coronavirus pandemic. Throughout the past year, the government has enacted various schemes to provide tax holidays for startups as a form of relief during these troubled times. This has proved to be quite successful.

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Let us now take a closer look at the Startup India campaign launched by Prime Minister Narendra Modi in 2016 and the start-up tax holiday facility offered by the government.

What is the Startup India Campaign?

The Startup India campaign was an initiative launched to boost commerce and entrepreneurship in India. The initiative helped young businesses by providing them with the required finance and simplifying the process of incorporation. Additionally, such startups received various monetary benefits such as tax breaks and subsidies.

During the past year, the government also proposed a tax holiday for startups in India to ensure they get some financial relief.

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Eligibility For Startup India

Not all benefits and exemptions are available to all Startup in India. Here is a quick look at the eligibility criteria that the startups have to meet to receive benefits under the Startup India Program.

The startup must have their registration or incorporation in India
Been operational for less than seven years for normal companies and up to ten years for biotechnology companies
Annual turnover must not have exceeded ₹25 crores in any financial year
Must be working towards commercialisation, development, deployment, or innovation of new products, intellectual property, technology, or services
Additionally, must not have been formed as a reconstitution, reshuffle, or split up of a business in existence
Must obtain certification from the concerned Inter-Ministerial Board
The startup may be incorporated as a limited liability partnership, partnership firm, or Private limited company.

Tax Holidays and Exemptions for Startups

The Startup India program offers the following tax holidays and extensions to eligible startups in India:

1. Three-year Tax Holiday

Startups incorporated between 1 April 2016 and 31 March 2021 are eligible for a 3-year tax holiday within seven years of incorporation. Budget 2021 further extended the eligibility for this tax holiday for startups to 31 March 2022.

The eligible startups will receive a 100% tax rebate on whatever profit they have made for three years as long as their annual turnover does not exceed ₹25 crores. This will make it easier for startups to meet their working capital requirements and ensure fluid cash flows.

2. Long-term Capital Gains Tax Exemption

As per the new Section 54EE which was inserted into the Income Tax Act: https://incometaxindia.gov.in/pages/acts/income-tax-act.aspx, certain eligible startups will be exempt from paying tax on a long-term capital gain. To avail of this benefit, the long-term capital gain or at least a part of it must have an investment as stated by the central government within six months of receiving it.

The maximum amount which can be saved in this way is ₹50 lakhs. Additionally, the invested sum must remain in the fund for at least three years. Withdrawal within that period will lead to the exemption being revoked.

3. Exemption on Investments Exceeding the Fair Market Value

The Indian government has also exempted startups from having to pay taxes on investments valued above the fair market price. These may include investments made by family or any other angel investor. However, it does not include the funds received through registered venture capitalists. Similarly, investments received from incubators at a price above the fair market value are also exempt.

4. Exemption Under Section 54GB

Under Section 54GB of the Income Tax Act, individuals or Hindu Undivided Families (HUFs) can avoid paying long-term capital gains tax if they sell a residential property and reinvest the proceeds. The reinvestment must be in Small and Medium Enterprises (SMEs) or by purchasing at least 50% of shares in eligible startups. For the exemption to apply, these shares must not be sold within five years from the date of purchase.

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Additionally, the startups that receive this investment must use the funds to buy assets and must not sell or transfer these assets within five years. If these conditions are met, the investor will benefit from the capital gains tax exemption.

5. Setting off Carry Forward Losses and Gains

Shareholders can set off carry forward losses if they held voting power when the loss occurred and still possess their shares by March 31st of the year the loss is being carried forward. Additionally, the loss must have been incurred within the first seven years of the company’s incorporation.

Extension of Tax Holiday for Startups in India

Finance Minister Nirmala Sitharaman announced that startups would receive extended tax holidays as a means to help them amid the coronavirus pandemic. The tax holiday for startups has been extended by an additional year till 31 March 2022 as per Budget 2021. The extension on capital gains extents for an additional year.

The definition of ‘small companies’ as per the Companies Act, 2013 will undergo a revision to include those with paid-up capital. Additionally with an annual turnover below ₹2 crores and ₹20 crores. This update will benefit over 2 lakh companies, making it easier for them to receive investments and maintain compliance.

Additionally, the government has empowered one-person company by allowing them to grow without restrictions on paid-up capital and turnover. Such companies will also have the power to convert into any other legal entity at any time.

The extension of the startup tax holiday for an additional year will be crucial for startup growth in India. This move provides startups with an opportunity to grow sustainably and enrich the economy during such troubling times. The government has lowered the residency limit for NRIs from 182 days to 120 days to further incentivise investments.

Impact of a Tax Holiday For Startups in India

The proposed tax holiday will be available only to around 500 startups in India as per financial experts. To be eligible for such benefits, startups must be certified by the Department for Promotion of Industry and Internal Trade. As a result, over 40,000 recognised startups that require such aid will not receive the benefits as they are not certified by the DPIIT.

Under the Startup India Program, only startups that meet all the criteria prescribed under GSR notification 127 (E) will receive recognition and certification. After receiving recognition under the program, startups may apply for exemption as per Section 80 IAC. However, financial experts have praised the move to extend tax holiday for startups as an effective method of reinvigorating the economy.

Conclusion

The Startup India campaign and the tax exemptions introduced by the government have been crucial in supporting new businesses during the pandemic. These measures have provided financial relief, helping startups maintain cash flow and meet capital needs.

By offering incentives like tax holidays and long-term capital gains exemptions, the government has fostered an environment that encourages innovation and growth. The recent extensions of these benefits further show the government’s commitment to entrepreneurship, helping startups thrive and contribute to India’s economic development.

FAQs

What is a tax holiday granted for startups in India?

A tax holiday for startups in India is a period during which eligible startups are exempt from paying income tax on their profits. This incentive is part of the Startup India initiative and allows startups to enjoy a 100% tax rebate on profits for three consecutive years within their first ten years of operation.

What is the tax issue of startups?

Startups often face challenges with high taxation rates, which can strain their limited financial resources. Additionally, complex tax compliance requirements can be burdensome, potentially diverting focus from core business activities and innovation.

Is startup funding taxable in India?

Yes, startup funding is generally taxable in India. However, certain exemptions exist, such as investments from registered venture capitalists and specific funds that qualify under government schemes. It's important for startups to be aware of these exemptions to minimise their tax liabilities.

Who is eligible for a tax holiday?

To be eligible for a tax holiday under the Startup India initiative, a startup must be incorporated in India, have an annual turnover of less than ₹25 crores, and work towards innovation, development, or improvement of products or processes. Additionally, the startup should not be older than ten years and must be certified by the Inter-Ministerial Board (IMB).

How to get tax benefits for a startup?

To obtain tax benefits, a startup must first register with the Startup India initiative and meet the eligibility criteria. After registration, the startup can apply for various tax exemptions and incentives, such as the three-year tax holiday, by submitting the necessary documentation and obtaining certification from the Inter-Ministerial Board (IMB).