Published Editorial

Budget 2017 - A kick-start to start-ups?

February 2017

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KT Chandy
Tax Partner, EY India

When the FM presented the tax proposal in Budget 2017, the thrust of his proposals was inter-alia to promote the digital economy in India, which is the bedrock of the Indian start up ecosystem. The FM seems to have ridden on the ‘Start-up India Action Plan’ launched in January 2016, and one sees in the fine print, some tinkering in response to the asks of the Industry. 

The income-tax exemption granted to eligible start-ups for any 3 consecutive years in the first five years of its operations has been extended to first 7 years of its operation.   Also, section 79 of the Income-tax Act, 1961 which limits carry-forward of losses when there is a greater than 49% change in the shareholding of a Company, has been overhauled.  In case of eligible start-ups, business losses can be carried forward for a period of 7 years so long as all the shareholders of the Company in the year loss was generated, continue to be shareholders in the future year where the losses are to be set off.  Both these amendments seem to be a response to business realities for start-ups, which more often than not suffer losses in initial years, and where there is continues dilution in shareholding due to the constant need to raise funds.  So long as there is no complete exit of a Promoter / investor from the Company, the net operating loss of a start-up should be available to be carried forward. 

At a wider level, the decision to reduce corporate tax rate to 25% in case of Companies having turnover of less than INR 50 Crores will be beneficial to start ups.  Also, the amendment in the indirect-transfer rule, which exempts indirect transfers in specified FIIs and the exemption of the conversion of preference shares into equity from being regarded as a taxable event in some way clears ambiguities for investors and funds investing in Indian Companies.  The announcement to phase out the foreign investment promotion board, signals the continuing outlook of the government towards lesser regulation and ease of business. 

Having said this, has the FM does enough to kick-start the growth of start-ups in India?

All the existing and proposed incentives to start-ups are linked to the definition of ‘eligible start up’ in section 80-IAC of the Act.  To qualify, a start-up must be an innovative business, meeting prescribed conditions including obtaining a certificate from the Inter-Ministerial Board of Certification (IMBC) of the Government.  This scheme has had few takers, with only 8 registrants till date – an abysmally low response from the third largest ecosystem in the world.  The need for IMBC approvals and the processes deployed need a relook, to make this scheme friendlier and more effective. 

The introduction of section 50CA which deems the fair market value (FMV) of unlisted shares as consideration while computing capital gains, if such FMV exceeds the price of transferred shares is likely to spook investors, and make deal closures challenging. Complexities increase since the gift tax provisions continue to exist in the tax law in a wider form, where a recipient of shares is taxed to the extent the consideration paid is lower than the net asset value of such shares.