Page1 ANGEL TAX ANALYSIS 16th January, 2016 marked a significant milestone for startups in India, with the Government of India announcing the Startup India Action Plan amidst much fanfare in the presence of the Prime Minister Mr. Narendra Modi, some of his cabinet colleagues, key representatives from the bureaucracy and select startup promoters. Thereafter, the Government did take action to boost startups by relaxing several provisions and introducing new ones in the Companies Act, 2013, FEMA, 1999, IT Act, 1961, Labour and IP laws. However, the so-called startup benefits have not reached a majority of the enterprises due to conditions that are difficult and impractical for startups to fulfill. While it is good not to extend benefits across the board without proper in-built checks and balances, some of the conditions in the DIPP notification No. G.S.R. 364(E) dated 11th April, 2018 read with CBDT notification no 24/2018 dated 24th May, 2018 make it too taxing for startups in their formative years. The purpose of the tax exemptions seems to be lost in the overbearing provisions. This article aims to deconstruct the import of the said notifications read together with the relevant sections and rules of Income Tax. Not all startups are eligible to get the benefits under various laws as announced under the Startup India Action Plan. If a startup founder applies online and gets a registration certificate from DIPP, it does not naturally entitle them to tax exemptions, unless they apply for it and get approval from the Inter-Ministerial Board (IMB) constituted for the said purpose. Most startups wrongly assume that a DIPP number gives them a seven year tax break and concessions in patent registration costs. This is a myth as is clear from an analysis of the DIPP notification. The taxes referred to here are corporate tax on the profit earned by the startups and the share premium received from investors, popularly known as angel tax. Para 3 and 4 of the notification dealing with S.80-IAC and S.56 (2)(viib) of the IT Act, 1961 are critical and to be read carefully to understand what is the tax exemption available, who is eligible for the same and the procedure to be followed.
Page2 1. What is a Startup? Startup is defined as a business entity organized as a Partnership firm (under the Partnership Act, 1932), or Limited Liability Partnership firm (under the LLP Act, 2008), or Private Limited Company (under the Companies Act, 2013) having a turnover not exceeding Rs. 25 cr in a financial year. The startup status shall be available only for a period of 7 years from the date of registration / incorporation 10 years in the case of Biotechnology sector or till the time the startup reaches a turnover of Rs. 25 cr, whichever is earlier. The emphasis is on a new entity which means any business formed by splitting up or reconstruction of an existing business shall not be considered a Startup. The entity must be working towards innovation, development or improvement of products or processes or services, or have a high potential of employment generation or wealth creation (Eligible Business). This is evaluated and certified by an Inter-Ministerial Board. Note: - For the purpose of Tax exemptions only an LLP and a Private Limited Company incorporated after 1 st April, 2016 are eligible. The application must be made between 2016-2021. 2. What is an Inter-Ministerial Board? The IMB referred to as Board under the DIPP notification is a high level, multi-disciplinary group consisting of representatives from : Department of Industrial Policy and Promotion Ministry of Corporate Affairs Ministry of Electronics and Information Technology Department of Biotechnology Department of Science & Technology Central Board of Direct Taxes Reserve Bank of India Securities and Exchange Board of India
Page3 The Board is empowered to do the following : Issue a recognition certificate Isue a certificate under S.80-IAC (Income Tax exemption on profits made) Grant approval under S.56 (2)(viib) of the IT Act, 1961, (Income Tax exemption on share premium received in respect of certain investments) Reject the applications or revoke the certificate / approval if the prescribed terms and conditions are not met with by a startup 3. What is a recognized startup? An entity as defined above must make an online application to DIPP along with proof of Incorporation / Registration documents and a brief write-up about its business (focusing on innovation, improvement of products or services or employment generation etc. as explained above) to obtain recognition as startup. A certificate with a unique number is issued by the DIPP recognizing the eligible entity as a startup. Visit : https://startupindia.gov.in/startup-recognition.php for applying. It may be noted that mere recognition does not entitle a startup to tax exemptions, which is a separate process. 4. How to obtain a 7 year Tax exemption? The provisions of S.80-IAC of the IT Act, 1961 read with Para 3 of DIPP Notification No. G.S.R. 364(E) dated 11 th April, 2018 are relevant. S.80-IAC states that the profits and gains derived from an Eligible Business by a recognized startup (only LLP & Private Limited Company) will not be subject to income tax for 3 consecutive assessment years out of 7 years from the date of incorporation / registration. The startup has the option to choose the 3 consecutive years. The exemption is available only if certain terms and conditions specified are fulfilled and the IMB issues a certificate to the startup Startup must be recognized by DIPP and carrying on an Eligible Business It should be incorporated on or after 1 st April, 2016 It should not be formed by reconstructing an existing business It should not be using any previously used plant and machinery (Specific conditions provided in the Explanation u/s 80-IAC (3) to be fulfilled) Application in Form-1 (refer DIPP notification dated 11.04.2018) to be made to the IMB between 1 st April, 2016 and 1 st April 2021 Form-1 asks for some basic details of the startup,i.e., name, incorporation date, place of business, nature of business, PAN, etc.
Page4 Copy of Partnership Deed / MOA and AOA, annual accounts and IT returns of last 3 financial years to be submitted Application u/s 80-IAC can be made only once by the startup The Board may also ask for any additional information required before granting the certificate or rejecting the application along with reasons. Considering that startups in their early stages cannot realistically project employment generation and wealth creation figures, it is not clear on what basis the Board may approve / reject the 80- IAC application, in case the products or services are not innovative or developmental in nature. However, in the latest IMB meeting dated 27 th April, 2018 a Standard Operating Procedure (SOP) has been defined for processing Certificate of Eligibility u/s 80-IAC and 56 of the IT Act, 1961. 5. How to obtain Angel Tax exemption? S.56 (2)(viib) of the IT Act, 1961 states that share premium received by a Private Limited Company in excess of the fair market value (arrived at by a SEBI registered Category-I Merchant Banker) towards issue of shares to certain class of investors (only resident) is to be treated as Income from Other Sources and subject to payment of Income Tax. This tax is commonly referred to as Angel Tax. Such Angel Tax shall not apply if the consideration for issue of shares is received (i) by a venture capital undertaking from or (ii) by a company from a class or classe of persons as may be notified by the Central Government in this behalf. a venture capital company or a venture capital fund; Company here means a Recognized Startup carrying on Eligible Business. Class or classes of persons means certain type of investors approved by the IMB as notified vide CBDT Notification No. 24/2018 dated 24 th May, 2018 (effective from 11 th April, 2018 aligned with the DIPP notification) Para 4 of the DIPP Notification provides for exemption from such Angel Tax if a startup gets approval from the IMB, subject to fulfillment of certain terms and conditions.
Page5 Recognized startup (only Private Limited Company) carrying on Eligible Business can apply in Form-2 (refer DIPP notification dated 11.04.2018) to the IMB for approval It should be incorporated on or after 1 st April, 2016 Paid up share capital + share premium of the startup after the proposed issue of shares (equity & preference) does not exceed Rs. 10 cr the investor/ proposed investor must have (a) an average returned income of Rs. 25 Lakh or more for the preceding 3 financial years; or (b) a net worth of Rs. 2 cr or more as on the last date of the preceding financial year The valuation for the issue of shares must be obtained from a SEBI registered Category-I Merchant Banker (Chartered Accountant is omitted vide CBDT Notification No. 23/2018 dated 24 th May, 2018) in terms of Rule 11U and 11UA of the Income Tax Rules, 1962 Form-2 contains a lot of details about the startup company, its business, S.80-IAC Certificate, proposed issue of shares, investment amount, fair market value, premium, investor details, his returned income and net worth, audited accounts of the startup from incorporation, valuation report from a Merchant Banker as well as details of existing shareholders along with shareholding IMB may ask for further details and either issue the approval or reject the application with reasons. The approval will state the details of investor, amount of premium on which shares are to be issued and the latest date by which the shares are to be issued. It appears that in order to avail the Angel Tax exemption, the startup must plan the investment well in advance taking care to receive the investment only from certain type of qualified investors (as explained above) and after getting IMB approval. On paper these tax exemptions look attractive but in reality the startups hardly have the bandwidth in terms of time and money to comply with the rather demanding requirements both by DIPP and the IT Department during fund raising. Denying Angel Tax exemption to startups beyond a threshold capital of Rs. 10 cr also does not help much. The whole exercise to obtain recognition, certificate u/s 80-IAC and approval u/s 56 (2)(viib) does not seem to be in tune with the ease of doing business initiative claimed of the government. So also the quiet dropping of the word accountant from Rule 11U and 11UA of the Income Tax Rules which only increases the cost of fund raising, given that the fees charged by Merchant Bankers is definitely higher than a CA. It would auger well for the government to review all these notifications and make the startup ecosystem more tax friendly and usher in the spirit of Minimum Government Maximum Governance and ease of doing business. - S.C.Sharada, Founder - Ashwin G K, Executive 31 st May, 2018