Start-up India Action Plan – Devil is the detailing (Part 4)

Finance Act, 2016 and amendments incorporated into the Income Tax Act, 1961

Finance Minister Mr. Arun Jaitley during the Union Budget 2016-17 on 29 February 2016 announced certain tax incentives for “eligible start-ups”[1] in the Finance Bill, 2016. On 14 May 2016, the Finance Bill, 2016, after various amendments, has received the assent of the President and the Finance Act, 2016 has been published in the official gazette (“Finance Act”). The same shall be incorporated into the Income Tax Act, 1961 (“ITA”) and shall be applicable for the AY 2017-18. Some of the major tax incentives accorded to an “eligible start-up” are as follows:

New Section 80-IAC under the ITA

Under Section 80-IAC of the ITA, an ‘eligible start-up’ shall be entitled to a deduction of 100% of the profits earned from an ‘eligible business’[2] for any three consecutive financial years out of 5 financial years from the date of its incorporation.

This benefit shall only be available to start-ups which fulfil the following conditions:

• it has not been formed by splitting-up or reconstruction of an existing business.
• it has not been formed by the transfer to a new business of machinery or plant previously used for any purpose.

The Finance Act has introduced Section 80-IAC which includes Limited Liability Partnership (“LLP”) under the definition of “eligible start-up” and is a very welcome step as LLPs have been gaining traction as the preferred legal structure for doing business. Exclusion of LLPs would have curtailed the benefit being available to start-ups.

Devil is in the detail: Notwithstanding this benefit, such profits earned by the start-ups shall still be taxable under the Minimum Alternate Tax (MAT) which is calculated on the basis of book profit and not on net profit.

Section 54EE under the ITA

Assessee who transfers a long-term capital asset (“Original Asset”) and invests the whole or part of capital gains in long-term specified asset, within 6 months from the date of transfer of the Original Asset shall be exempt from paying capital gains tax on whatever sum is invested in the long-term specified asset.  Provided however that the amount of investment in the long-term specified asset shall not exceed INR 50 lacs in any financial year and the benefit shall also be available in the subsequent financial year if the period of 6 months from the date of transfer spills over to the subsequent financial year.

Assessee must hold the long-term specified asset for at least 3 years to avail this benefit and a transfer of the long-term specified asset before that would lead to the exemption being revoked. This also includes situations where the assessee raises a loan or advance against the security of such long-term specified asset within 3 years which is deemed to be the income chargeable under the head “Capital gains” relating to long-term capital asset of the previous year in which the long-term specified asset is transferred.

Tax Exemption on Capital Gains through amendments to Section 54GB under the ITA

The existing exemption from tax on long term capital gains from sale of residential property when such gains were invested in small or medium enterprise as defined under the Micro, Small and Medium Enterprises Act, 2006 has been expanded to include gains included in eligible start-ups.

After the amendment, when an individual or a HUF sells residential property and invests the gains to subscribe to more than 50% of the shares of a company as mentioned above and such company uses the amount invested to purchase assets (which has now been expanded to include computers or computer software), then such gains are exempt. This benefit is lost if the company transfers the asset within 5 years of its purchase.

Tax Exemption to start-ups for 3 years 

To facilitate growth of business and meet the working capital requirements of the start-ups during the initial years of their operations, Section 80-IAC under the ITA provides that start-ups shall be exempt from income-tax for a period of 3 consecutive assessment years. The said exemption, may be claimed by the start-up for any 3 consecutive years out of the 5 years since its incorporation.

Tax exemption on investments above Fair Market Value

Vide notification dated 14 June 2016, the Central Board of Direct Taxes has exempted tax being levied on investments above fair market value (FMV) in start-ups by resident angel investors, family offices or funds which are not registered as venture capital funds. Investments made by incubators above FMV shall also be exempted.

[This is the fourth of a series of 6 posts that seeks to consolidate all the benefits and policy directives directed towards promoting Start-ups in India.]

[1] “eligible start – up” has been defined as a company engaged in eligible business which satisfies all the following conditions:

• It is incorporated on or after April 1, 2016 but before April 1, 2019;
• The total turnover of its business does not exceed 25 Crore rupees in any financial year between April 1, 2016 and March 31, 2021; and
• It holds a certificate of eligible business from the Inter-Ministerial Board of Certification (“IMBC”) as notified by the Central Government.

[2] “eligible business” has been defined as a business which involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property.