INDEX
Eligibility for Startup India
Tax Exemptions for Eligible Startups under the Startup India Program
Exemption from Tax on Long-term Capital Gains
Tax Exemption on Investments Above Fair Market Value
Tax Exemption to Individual/HUF on Investment of Long-Term Capital Gains in Equity Shares of Eligible Startups under Section 54GB
Set-Off of Carry-Forward Losses and Capital Gains in Case of Change in Shareholding Pattern
Tax Exemption For a Startup
Eligibility for Startup India
According to the Startup India Action Plan, the following conditions must be met for an entity to be recognized as a startup:
- Age of the Entity: The entity must not have completed 10 years from the date of incorporation or registration.
- Legal Structure: The entity must be a private limited company, partnership firm, or a limited liability partnership (LLP).
- Turnover Limit: The entity should have an annual turnover not exceeding INR 100 crore in any of the financial years since its incorporation or registration.
- Purpose and Innovation: The entity must focus on innovation, development, or improvement of products, processes, or services. Alternatively, it can have a scalable business model with the potential for significant employment generation or wealth creation.
- Formation: The entity must not be formed by splitting or restructuring an existing business.
Tax Exemptions for Eligible Startups under the Startup India Program
Eligible startups under the Startup India program can enjoy the following tax exemptions:
1. 3-Year Tax Holiday
Startups incorporated between April 1, 2016, and March 31, 2021, were initially eligible for a tax holiday. The Budget 2021 extended this eligibility until March 31, 2022.
2. Tax Rebate
Eligible startups can avail a 100% tax rebate on their profits for three consecutive years within a block of seven years, provided their annual turnover does not exceed INR 25 crores in any financial year. This tax exemption helps startups manage their working capital during the early stages.
Exemption from Tax on Long-Term Capital Gains
Under Section 54EE of the Income Tax Act, eligible startups can claim an exemption from tax on long-term capital gains if they invest the gains in a fund notified by the Central Government. The investment must occur within six months from the date of transfer of the asset.
- Maximum Investment: The maximum investment allowed is Rs. 50 lakh.
- Lock-in Period: The invested amount must remain in the specified fund for at least three years.
- Revocation of Exemption: If the amount is withdrawn before the completion of three years, the exemption will be revoked, and tax will apply in the year of withdrawal.
Tax Exemption on Investments Above Fair Market Value
The government offers a tax exemption on investments made above the fair market value in eligible startups. This applies to:
- Investments by Resident Angel Investors: Angel investors residing in India can invest in eligible startups even if the investment exceeds the fair market value, without attracting any tax.
- Investments by Family or Unregistered Funds: Investments from family members or unregistered funds will also be exempt from tax, even if the investment exceeds the fair market value.
- Investments by Incubators: If an incubator invests in a startup and the investment exceeds the fair market value, it is also exempt from tax.
This exemption encourages more investments in startups, especially from individuals or entities outside traditional venture capital funding.
Tax Exemption to Individuals/HUF on Investment of Long-Term Capital Gains in Equity Shares of Eligible Startups under Section 54GB
Section 54GB of the Income Tax Act allows individuals or Hindu Undivided Families (HUFs) to claim a tax exemption on long-term capital gains from the sale of residential property if the gains are reinvested in eligible startups.
Key Points of Section 54GB:
Eligibility: Previously, this section applied to investments in small or medium enterprises (SMEs), as defined by the Micro, Small, and Medium Enterprises Act, 2006. The section now extends the exemption to eligible startups, encouraging investment in the startup ecosystem.
Conditions for Tax Exemption:
- The individual or HUF must invest long-term capital gains from the sale of residential property into equity shares of eligible startups.
- The investment must be in at least 50% of the equity shares of the eligible startup.
- The startup must use the invested funds to purchase assets, which cannot be sold or transferred within five years from the date of purchase.
Holding Period: The individual or HUF must hold the equity shares for a minimum period of five years from the date of acquisition. If the shares are sold or transferred before the completion of five years, the tax exemption will be revoked.
Purpose of the Amendment: This amendment encourages individuals and HUFs to invest in startups, providing a tax-efficient way to support the growth of innovative businesses. It helps startups secure funds for growth and acquire necessary assets.
Benefits of the Exemption:
- The tax exemption allows individuals and HUFs to invest in startups without paying capital gains tax on the reinvested amount.
- This encourages wealth creation while helping startups expand and secure the funding necessary for growth.
- The five-year holding period ensures long-term support for the startup ecosystem, providing stability for new businesses.
Set-Off of Carry-Forward Losses and Capital Gains in Case of Change in Shareholding Pattern
Under Section 79 of the Income Tax Act, a company cannot generally carry forward its losses if there is a change in its shareholding pattern. However, this restriction has been relaxed for eligible startups.
Key Provisions for Eligible Startups:
Carry Forward of Losses: Eligible startups can carry forward their business losses even if there is a change in their shareholding pattern. The usual requirement of 51% unchanged voting rights does not apply to eligible startups.
Conditions for Carrying Forward Losses:
- The startup must meet the criteria of an eligible startup as defined under the Startup India program.
- Shareholding Continuity: All shareholders who held shares carrying voting power at the end of the year in which the loss occurred must continue to hold those shares at the end of the year in which the loss is carried forward.
Benefit of Relaxation: This relaxation provides flexibility for startups to raise capital or change their shareholding structure without losing the ability to carry forward losses.
Purpose of Relaxation: The relaxation encourages investment and expansion by allowing startups to modify their ownership structure without jeopardizing their tax benefits related to carried-forward losses. It supports greater operational flexibility for startups.