INTRODUCTION
During her Budget speech, Finance Minister Nirmala Sitharaman emphasised the government’s dedicated focus on nurturing the startup ecosystem in India. Sitharaman highlighted that the government’s measures for startups have yielded positive results, positioning India as the third-largest startup ecosystem worldwide and the second-highest-ranking middle-income country regarding innovation quality. As part of her proposals, the Finance Minister suggested extending the deadline for income tax benefits to startups from March 31, 2023, to March 31, 2024. Additionally, she recommended extending the period for carrying forward losses in the event of a change in shareholding, from seven years after incorporation to ten years. Additionally, the government has increased the limits for micro-enterprises and professionals when it comes to availing the benefits of presumptive taxation. A deduction for payments made to Micro, Small, and Medium Enterprises (MSMEs) shall only be permitted when the payment is made. (see here).
Tax incentives play a significant role in promoting the growth and sustainability of startups and MSMEs and by reducing the tax burden and providing financial relief, these incentives encourage entrepreneurial activities, attract investments, and facilitate business expansion. Tax benefits not only improve cash flow for these enterprises but also enable them to allocate resources towards research and development, technology adoption, and talent acquisition. Team YLCC is here to give you a comprehensive guide on the tax benefits for startups & MSMEs in India!
DEFINITION & CLASSIFICATION
To provide targeted support to startups and MSMEs, the Indian government has established specific criteria and parameters for their classification.
Startups in the Indian context are typically defined as businesses that are innovative, and scalable, and offer new products, processes, or services driven by technology or intellectual property. The Department for Promotion of Industry and Internal Trade (DPIIT) sets the guidelines (see here) for identifying startups based on factors such as the age of the company, turnover, and incorporation structure. The respective business must be registered as a private limited company, partnership firm, or limited liability partnership. Additionally, the turnover in any previous financial year should be below INR 100 Crores. The startup status can be retained for up to 10 years from the date of incorporation. Furthermore, the startup should be focused on innovating or improving existing products, services, or processes and have the potential to generate employment or create wealth. It is important to note that entities formed through the splitting up or reconstruction of an existing business will not be considered as startups, as per the definition given by DPIIT.
Startups can be categorized into different stages, including early-stage startups that are in the ideation or development phase, and growth-stage startups that have demonstrated scalability and market potential.
On the other hand, MSMEs are classified based on their investment in plant and machinery or equipment and annual turnover. As per the Micro, Small, and Medium Enterprises Development (MSMED) Act, micro-enterprises have investments of up to INR 1 crore and a turnover of up to INR 5 crore, small enterprises have investments of up to INR 10 crore and a turnover of up to INR 50 crore, while medium enterprises have investments up to INR 50 crore and a turnover of up to INR 250 crore. (see here)
TAX BENEFITS FOR STARTUPS
The Startup India initiative, launched by the Government of India (see here), is a flagship program designed to foster a conducive ecosystem for startups in the country. With a vision to promote entrepreneurship, innovation, and job creation, the initiative aims to accelerate the growth of startups and transform India into a global startup hub. The following are the tax benefits provided by this programme to the start-ups:
- Startups incorporated between April 1, 2016, and March 31, 2021, were eligible for a three-year tax holiday (Tax exemption under Section 80 IAC of the Income Tax Act, 1961). Budget 2021 extended this eligibility until March 31, 2022 (now it has been extended to March 31, 2023, to March 31, 2024). Qualifying startups can enjoy a 100% tax rebate on profits for three years within a block of seven years (now ten), provided their annual turnover does not exceed Rs. 25 crores in any financial year. This tax benefit helps startups meet their working capital requirements during their initial years of operation.
- Under Section 54 EE of the Income Tax Act, 1961 (ITA) eligible startups can be exempt from tax on long-term capital gains. If a startup or a portion of it is invested in a notified fund within six months from the date of asset transfer, the tax on long-term capital gains can be waived. The maximum investment amount in the specified asset is Rs. 50 lakh, and the investment must remain in the fund for three years. Premature withdrawal within this period will result in the revocation of the exemption.
- Investments made above the fair market value in eligible startups are exempt from tax. This exemption applies to investments by resident angel investors, family members, and non-registered venture capital funds. It also includes investments made by incubators above the fair market value.
- Section 54GB of ITA 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 invested in eligible startups. To qualify, the investment must be used to subscribe to 50% or more equity shares of the startup. However, these shares should not be sold or transferred within five years from the acquisition date. The startup should also utilize the investment to purchase assets that remain untransferred for a period of five years.
- Eligible startups can carry forward losses if all shareholders holding voting power on the last day of the loss-incurred year continue to hold shares on the last day of the subsequent year. Additionally, the requirement of holding at least 51% voting rights, as stated in Section 79 of the ITA, has been relaxed for eligible startups changing shareholding pattern. This allows startups to set off carry forward losses and capital gains even if there is a change in majority shareholding.
- Others:
- The Government of India has introduced a welcome relief for startups by implementing a tax exemption on angel investments (see here). This means that startups can now secure the necessary funds from angel investors without the burden of additional taxation. This move not only encourages angel investors to support startups but also allows entrepreneurs to utilize the investment to further develop their companies, without worrying about tax implications. By eliminating the angel tax, the government aims to facilitate the growth and financial stability of startups.
- Startups with an annual turnover below INR 2 crore can benefit from the Presumptive Tax Scheme. This scheme provides a significant advantage as it relieves startups from the requirement of maintaining detailed books of accounts, which can be time-consuming and burdensome. Startups can focus more on their core operations and allocate their resources towards innovation and business growth. The Presumptive Tax Scheme not only eases the tax planning process for startups but also ensures that they have more funds at their disposal to explore new ideas and drive their businesses forward. This tax benefit is aimed at supporting startups in becoming self-sustaining entities, fostering their success and contributing to the overall growth of the entrepreneurial ecosystem.
TAX BENEFITS FOR MSMEs
The following are the tax benefits for MSMEs:
- The Income Tax Act, 1961 provides certain domestic manufacturing companies with the opportunity to benefit from concessional tax rates. These companies, falling under section 115BA of the ITA, are eligible for a reduced tax rate of 25% as opposed to the standard rate of 30%. This concession specifically applies to the MSME sector and includes companies with a turnover of up to INR 400 crore. However, companies availing this benefit are not allowed to claim specified deductions, set-offs, or carry-forwards. It is important to note that such companies must be established and registered on or after March 1, 2016.
- MSMEs can also avail of a reduced tax rate of 22% under Section 115BAA, subject to certain conditions. Any domestic company, including MSMEs, can opt for this lower tax rate by computing their total income without considering various deductions, depreciation, and set-offs. Furthermore, companies availing of this benefit are exempt from paying the maximum alternate tax as per Section 115B.
- Under section 115BAB, newly established domestic manufacturing companies can choose a tax rate of 15%. The conditions for this section include complying with all the requirements specified under section 115BAA. Additionally, the company must fulfil the following criteria:
- The company must be established and registered on or after October 1, 2019.
- It is not eligible to claim deductions under section 80-ID.
- The company should not be engaged in any other business activities.
- MSMEs have the option to choose from various presumptive tax schemes that can help reduce their tax liability. These schemes have specific conditions that need to be fulfilled. For example Section 44AD of ITA which is available to eligible businesses with a total turnover or gross receipts of up to Rs. 2 crore, Section 44ADA where professionals operating in certain fields can avail of the presumptive taxation scheme under this section, and Section 44AE where businesses engaged in the carriage of goods have the option to opt for this section.
CONCLUSION
The tax benefits for startups, including income tax exemptions, capital gains exemptions, and deductions for R&D expenses, provide much-needed financial relief and enable startups to allocate resources towards innovation and expansion. On the other hand, the tax benefits for MSMEs, such as lower income tax rates, presumptive tax schemes, and GST benefits, reduce the tax burden on these enterprises, facilitating their growth and competitiveness.
The government aims to stimulate job creation, attract investments, and foster a culture of entrepreneurship and innovation in India by supporting startups and MSMEs through tax incentives. These tax benefits not only enhance the financial viability of startups and MSMEs but also contribute to the overall development of the economy.
Startups and MSMEs shall leverage these tax benefits effectively by understanding the eligibility criteria, compliance requirements, and relevant provisions, and by making informed decisions and taking advantage of the available tax incentives, startups and MSMEs can drive their success, contribute to economic growth, and create a positive impact in India’s entrepreneurial landscape.
This article has been written by Team YLCC. For any other queries, reach out to us at: queries.ylcc@gmail.com
