corporate law
As India commemorates 75 years of independence, it proudly hosts 75,000 recognized startups. These startups can opt for recognition from the Department of Promotion of Industry and Internal Trade (‘DPIIT’) under the Startup India initiative. Below is an overview of the tax, intellectual property, and compliance benefits available to recognized startups.
Under section 80-IAC of the Income-tax Act, 1961 (‘Act’), eligible startups may enjoy exemptions from tax on profits for three consecutive financial years within their first ten years of incorporation.
Typically, if a closely held company issues shares at a premium exceeding the fair market value, the excess (i.e., Issue Price minus Fair Market Value) is considered taxable income under section 56(2)(viib) of the Act. The fair market value is determined according to Rule 11UA(2) of the Income-tax Rules, 1962, which uses a formula based on book value or discounted cash flow method. Due to common practices in startup funding where angel investors invest based on future valuations, the Government offers exemptions from section 56(2)(viib) under the following conditions:
Generally, the difference between the fair value of shares and the exercise price of ESOPs is taxed as a perquisite at the time of option exercise. This could lead to cash flow issues for employees. To alleviate this burden, the deduction of tax on ESOPs for eligible startups is deferred. Tax must be deducted at source no later than 14 days before the earliest of the following dates:
According to section 79 of the Act, a closely held company cannot carry forward and set off losses if there is a change in 51% or more of its shareholding in the year when losses are set off. However, startups may carry forward and set off such losses if all shareholders holding voting rights on the last day of the year the loss was incurred still hold those shares at the end of the previous year, provided the loss occurred within seven years of the company's incorporation.
Startups are often owners of innovative intellectual property. Traditionally, filing patents has been costly and time-consuming, presenting challenges to many startups. Recognition as a startup allows for expedited patent applications and up to an 80% reduction in filing fees compared to other companies. Additionally, the government has introduced a funded panel of facilitators to advise startups on various intellectual property matters.
To foster experimentation and mitigate risks for entrepreneurs, startups with a straightforward debt structure can be wound up within 90 days of application. This process involves appointing an insolvency professional and liquidator responsible for swiftly closing the business, selling assets, and repaying creditors.
Government and state-owned enterprises are significant markets for startups, purchasing a wide range of goods and services through public procurement. Recognition as an eligible startup allows for listing products on the Government e-Marketplace for sales to government entities. Furthermore, startups in the manufacturing sector can benefit from exemptions regarding prior experience or turnover requirements. DPIIT-recognized startups are also exempted from submitting Earnest Money Deposits (EMD) or bid security when participating in government tenders.
The relaxations and benefits provided to startups under various provisions of the Act offer substantial advantages that startups should consider. As per section 80-IAC of the Act, an eligible startup includes entities incorporated before 1st April 2023. Startups meeting the recognition criteria should assess available benefits and seek recognition promptly to maximize their potential.