In the year 2016, Prime Minister Narendra Modi initiated the Startup India campaign with the explicit aim of catalysing entrepreneurship within the nation. This strategic blueprint sought to facilitate easier access to financial resources from banks for startups, streamline the intricate startup registration procedures, and confer a spectrum of tax exemptions and additional advantages upon these nascent business ventures.
However, it is imperative to note that the entirety of these incentives and exemptions is accorded solely to those startups that conform to the delineated criteria of an ‘Eligible Startup.’ In this blog, we shall see how startups can save taxes using the Startup India scheme.
Eligibility Criteria for Startup India Registration to Save Taxes
To learn about how startups can save taxes, it is first needed to know that to qualify for Startup India registration, specific eligibility conditions must be met. These conditions are outlined in the Startup India Plan, and they include:
1. Ten-Year Limitation
Startups can save taxes if they have not surpassed ten years from its date of incorporation or registration.
2. Legal Structure
Startups can save taxes if the startup has one of the following legal structures:
3. Annual Turnover
The annual turnover of the startup should not exceed Rs. 100 crore for any financial year since its incorporation or registration by which startups can save taxes.
4. Innovation and Scalability
Startups can save taxes is the startup demonstrates a focus on:
- Innovation
- Development or improvement of products, processes, or services
- Scalable business model with high potential for:
- Employment generation
- Wealth creation
5. Not a Result of Reconstruction
The startup must not be formed through the splitting up or reconstruction of an existing business entity.
By satisfying these criteria, startups can save taxes by becoming eligible for the benefits and support offered under the Startup India initiative.
How Startups Can Save Taxes under Startup India Program
The Startup India Program, initiated to foster the growth of startups in India, offers several tax exemptions to eligible startups using which startups can save taxes easily. These exemptions play a crucial role in reducing the financial burden on startups during their initial years of operation and promoting investment in the sector. In this comprehensive guide, we will delve into the various tax exemptions provided to eligible startups under this program.
3-Year Tax Holiday
One of the most significant tax incentives offered to eligible startups is the three-year tax holiday within a seven-year block. Initially applicable to startups incorporated between April 1, 2016, and March 31, 2021, the eligibility was extended to March 31, 2022, through the Budget 2021. This scheme grants startups a 100% tax rebate on their profits for three years within a seven-year timeframe, provided their annual turnover does not exceed Rs. 25 crores in any financial year. This tax holiday helps startups meet their working capital requirements during their formative years.
Exemption from Tax on Long-term Capital Gains
Under the Startup India Program, eligible startups can also benefit from an exemption on long-term capital gains. Section 54 EE was introduced in the Income Tax Act to facilitate this exemption. Startups can avoid taxation on long-term capital gains if they invest a portion of these gains in a fund notified by the Central Government within six months from the date of asset transfer. The maximum amount eligible for investment in the specified asset is Rs. 50 lakh, which must remain invested in the specified fund for a period of three years. If the investment is withdrawn before three years, the exemption will be revoked in the year of withdrawal.
Tax Exemption on Investments Above Fair Market Value
Another valuable tax exemption for eligible startups pertains to investments made above the fair market value. The government has eliminated the tax on investments exceeding the fair market value in eligible startups. These investments can come from resident angel investors, family members, or funds not registered as venture capital funds. Incubators’ investments above the fair market value are also exempted. This exemption encourages funding and investment in startups, facilitating their growth and expansion.
Tax Exemption for Individuals/HUF on Investment of Long-term Capital Gain in Equity Shares of Eligible Startups
A recent amendment has expanded the scope of tax exemptions under section 54GB. Initially designed to provide tax exemptions on long-term capital gains invested in small or medium enterprises as per the Micro, Small and Medium Enterprises Act, 2006, this section now includes eligible startups. Individuals or Hindu Undivided Families (HUFs) who sell a residential property and invest the capital gains in 50% or more equity shares of eligible startups can benefit from tax exemptions. To qualify, these shares must not be sold or transferred within five years from the date of acquisition. Additionally, the capital gains must be used to purchase assets that cannot be transferred within five years. This exemption aims to boost investment in startups and foster their growth and expansion.
Set-off of Carry Forward Losses and Capital Gains
Eligible startups can carry forward their losses under specific conditions. The key requirement is that all shareholders holding shares with voting power on the last day of the year in which the loss was incurred must continue to hold shares on the last day of the previous year in which the loss is to be carried forward. Notably, the restriction of maintaining a 51% voting rights threshold, as per section 79, has been relaxed for eligible startups. This provision eases the process of carrying forward losses and capital gains in cases of changes in shareholding patterns.
The tax exemptions provided under the Startup India Program are instrumental in fostering a favorable environment for startups to thrive and innovate. These incentives encourage entrepreneurship, attract investments, and contribute to the growth of the startup ecosystem in India.
Final Thoughts
The Startup India initiative, launched in 2016 by Prime Minister Narendra Modi, plays a pivotal role in promoting entrepreneurship by simplifying registration processes and offering exclusive tax incentives to eligible startups, using which these startups can save taxes. These startups must adhere to specific criteria outlined in the Startup India Action Plan.
The tax exemptions provided under this program are instrumental in reducing financial burdens and attracting investments. The three-year tax holiday extension, exemptions on long-term capital gains, and investments above fair market value encourage funding and growth. Recent amendments also allow individuals and Hindu Undivided Families (HUFs) to benefit from tax exemptions on long-term capital gains when investing in eligible startups, provided certain conditions are met. Overall, the Startup India Program’s tax incentives foster a conducive environment for startups to flourish, driving innovation, entrepreneurship, and investment in India’s dynamic startup ecosystem.
