Tax incentives play a pivotal role in fuelling and nurturing the exponential growth of startups in India. The government, recognising the transformative potential of startups as catalysts for economic expansion and job creation, has unveiled a diverse range of tax benefits and incentives. These dynamic measures aim to alleviate the financial burden on startups, encourage investment spirit and foster an ecosystem primed for innovation and entrepreneurial ability.
By offering tax exemptions, capital gains perks and research and development encouragements, the government seeks to propel startups to new heights, bring in investment capital and help a culture of risk-taking. These tax incentives not only bolster individual startups but also aid the overarching startup landscape, propelling economic growth and providing a range of employment opportunities across the nation.
Difference Between Recognized and Non-Recognized Startups
Recognised startups are those that have obtained a certificate of eligibility from the DPIIT. This certification grants them certain benefits and exemptions. On the other hand, non-recognised startups refer to businesses that have not yet received the official recognition but still operate within the startup ecosystem. While non-recognised startups may not be eligible for specific incentives reserved for recognised startups, they can still avail themselves of general tax provisions applicable to businesses in India. It is important for startups to seek recognition to access the exclusive tax incentives and benefits tailored specifically for their growth and development.
Tax Incentives for Recognised Startups
To understand tax incentives for startups in India, the following must be taken into consideration:
Income tax exemption under Section 80-IAC:
Eligibility criteria and conditions
Under Section 80-IAC of the Income Tax Act, recognised startups in India are eligible for income tax exemption. The eligibility criteria include:
- The startup must be incorporated as a private limited company, partnership firm or LLP.
- It should have obtained a certificate of eligibility from the DPIIT.
- The business should be engaged in innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property.
Certain conditions apply to avail this exemption, such as maintaining continuity of operations and fulfilment of specified turnover thresholds.
Duration and quantum of the exemption
The income tax exemption under Section 80-IAC is available for a period of three consecutive years out of ten years from the date of incorporation. Startups can enjoy this exemption on the profits and gains derived from eligible business activities for the specified duration.
Angel tax exemption:
Angel tax refers to the taxation of capital raised by unlisted companies, including startups, through the issuance of shares at a price exceeding their fair market value. This provision had created challenges for startups, as they were subject to taxation on the premium received on shares issued to resident investors.
Angel tax exemption under Section 56(2)(viib)
To address the concerns of startups, the government introduced an exemption for angel tax under Section 56(2)(viib) of the Income Tax Act. Under this provision, recognised startups are exempted from the angel tax if they fulfil certain conditions:
- The aggregate amount of paid-up share capital and share premium after the issue of shares does not exceed INR 25 crores.
- The valuation of the startup is done by a merchant banker registered with the Securities and Exchange Board of India (SEBI).
This exemption provides relief to startups by ensuring that they are not subjected to undue taxation on the funds raised from angel investors.
Capital gains tax benefits:
Exemption on long-term capital gains under Section 54GB
Introduced under the Income Tax Act, Section 54GB emerges as an important provision in stimulating investments in startups. This provision empowers individuals/HUF to avail an exemption on long-term capital gains originating from the sale of residential property, provided that the proceeds are invested in eligible startups. By offering this incentive, the government aims to incentivise individuals to channel their capital gains towards fostering the growth and development of promising startups.
Other Tax Related Benefits for Startups
Some other tax related benefits that accrue to startups are:
Research and development (R&D) tax incentives:
Under the guise of the Indian government, recognition has been given to the significant importance of R&D activities in driving innovation and technological advancements. The said R&D benefits for startups include not only deductions on eligible expenses incurred for scientific research, experimentation, but also for the development of new products or processes.
Deductions under Section 35(2AB) of the Income Tax Act
Section 35(2AB) of the Income Tax Act provides deductions to startups for expenses incurred on scientific research and development. Startups can claim a weighted deduction of 100% (earlier 150% before 2020-2021) on qualifying expenditure incurred on in-house R&D activities. This deduction is available over and above the regular business expenses, contributing to significant tax savings for startups.
Tax holiday for startups:
To promote entrepreneurship and incentivise startups, the government introduced a tax holiday scheme. Under this scheme, eligible startups can avail themselves of a complete exemption from income tax for a specific period.
Eligibility criteria and conditions for availing the tax holiday
Startups can avail themselves of the tax holiday for a consecutive period of three out of their first ten years since incorporation. To be eligible, a startup must meet the criteria defined by the DPIIT, including:
- Being incorporated as a private limited company, partnership firm or LLP.
- Obtaining a certificate of eligibility from the DPIIT.
- Being engaged in innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property.
Carry-forward and set-off of losses:
- Loss carry-forward and set-off provisions
Startups often face initial losses during their early stages of operation. The Indian tax system allows startups to carry forward and set off these losses against future profits. Loss carry-forward allows startups to offset their losses against future income, thereby reducing their tax liability in subsequent years.
- Benefits for startups in terms of tax planning
The provision of carrying forward losses provides startups with flexibility in tax planning. It helps them mitigate tax liabilities during periods of growth by utilising losses incurred in the initial years. This benefit allows startups to focus on scaling their operations and encourages risk-taking and innovation without the immediate burden of taxes.
Challenges and Limitations of Tax Incentives for Startups
Several challenges of tax incentives for the startup landscape include:
Complexity and compliance issues:
Challenges faced by startups in understanding and availing tax incentives
One significant challenge for startups is the complexity of understanding and navigating the tax incentive landscape. The eligibility criteria, documentation requirements and compliance procedures can be overwhelming, particularly for early-stage entrepreneurs who may not have expertise in tax matters. Startups often struggle to interpret the intricate provisions and ensure compliance, leading to potential errors or missed opportunities to avail tax benefits.
Suggestions for simplifying the process
To address these challenges, it is essential to simplify the process of availing tax incentives for startups. The government can focus on providing clear and concise guidelines, offering easily accessible resources and support for startups. Simplified application procedures, online portals and guidance through interactive platforms or dedicated helplines can help streamline the process and improve compliance rates.
Limited applicability and exclusions:
Restrictions on eligible sectors or activities
Tax incentives for startups may have certain restrictions on eligible sectors or activities. Some sectors, such as real estate, non-innovative businesses and speculative activities, may be excluded from availing specific incentives. This limitation can hinder startups operating in excluded sectors from accessing the full benefits of tax incentives.
Areas for expansion and inclusion
To ensure a more inclusive and comprehensive approach, there is a need to identify areas for expansion and inclusion of startups in different sectors. Regular reviews and assessments of the startup ecosystem can help identify emerging sectors, technologies and business models that can be eligible for tax incentives. Expanding the scope of tax incentives to encompass a broader range of sectors and activities will foster innovation and encourage startups across various domains.
Final Thoughts
Tax incentives play a vital role in fostering the growth and success of startups India. These incentives provide relief from income tax, angel tax and capital gains tax, reducing the financial burden on startups and encouraging investments. Additionally, benefits such as R&D deductions, tax holidays and loss carry-forward provisions further support their innovation-driven activities.
However, challenges related to complexity, compliance and limited applicability need to be addressed to maximise the benefits for startups. By simplifying processes, expanding eligibility criteria and providing support, the government can ensure that tax incentives effectively promote the startup ecosystem, driving economic progress and creating a thriving environment for entrepreneurship and innovation in India.
For further details, connect with our team of trained professionals at StartupFino.
