– By Trisha Shreyanshi
Abstract:
The year 2020 had been a rough year for almost all business entities. Startups are one such category that have lesser funding, man power and recognition, thus, they are always in dire need of support. The much awaited budget of 2021-22 was anticipated to safeguard the Startups and online industries to a large extent. In order to incentivize and encourage the startups, the government has provided certain relaxations in terms of conversion, tax holidays, capital gains, turnover limits among a few. The article aims at discussing the major developments for Startups pursuant to the Annual Union Budget of 2021-22. This article paper exclusively addresses the following 5 questions:
- How is the big Digital push in budget 2021 going to ease the doing of business in India?
- How does a start-up differ from small companies?
- How would the tax exemptions for startups help the Indian economy?
- In what circumstances, the new one person company amendment might not prove helpful to the startup founders?
- What benefit would Indian economy ripe from allowing NRI entrepreneurs to start one person company in India?
Overview:
Now, to begin with ‘Startups’ as defined under clause 1(a) of the G.S.R. notification 127(E) issued by the Ministry of Corporate Affairs should fulfill the following conditions:
- The Startup should be incorporated as a ‘private limited company’ or registered as a ‘partnership firm’ or a ‘limited liability partnership’.
- Turnover should be less than INR 100 Crores in any of the previous financial years since inception.
- An entity shall be considered as a startup up to 10 years from the date of its incorporation.
- The prospective Startup should be working towards innovation/ improvement of existing products, services and processes or have the ability to create employment and generate wealth.
However, if an entity is formed by splitting up or reconstruction of an existing business, it shall not be considered as a “Startup”.
Definition of Small Companies
Post the Budget 2021, the definition of the Small Companies under Section 2(85) read with the Companies (Specification and Definitions Details) Rules, 2014, has been widened to incorporate paid up capital of less than 2 Crores or turnover not exceeding 20 Crores. Following this, a lot of startups shall be recognized as small companies to avail greater benefits in their operations.
Budget Announcements for One Person Company (OPC)
As per Companies Act, 2013, One Person Company (OPC) is a company with only one member as described under Section 2(62) of the Act. OPC is a subclass of private limited company and hence, could also include a lot of Startups within its ambit.
- NRIs allowed to incorporate OPC in India – Earlier NRIs could not incorporate OPC in India. However, the Union Budget of 2021-22 proposes that Non-Resident Indians be allowed to incorporate One Person Companies in India. In pursuance of the same, amendments shall be made to the Companies (Incorporation) Rules, 2014 by virtue of Companies (Incorporation) Second Amendment Rules, 2021.
Doing so would entitle more people to establish One-Person Companies and in turn boost Indian economy by increased funding and increased payment of taxes.
- Residency requirement for the promoter (Indian citizen) of OPC to be 120 days – It has been proposed that residency limit for an Indian resident of otherwise is reduced from 182 days to 120 days. A person should reside for at least 120 days in a year in India in order to establish their own One Person Company.
By reducing the minimum requirement of residence in the preceding year, the number of people eligible to incorporate a One Person Company has increased. Moreover, this would also act as an incentive and show how the Indian Economy favours startups and One Person Companies for future entrepreneurs.
- No restriction on paid up capital and annual turnover – According to the earlier position of law, only if a company has fulfilled the criteria of (i) Paid up Capital of 50 Lakhs; and (ii) Turnover capital of 2 Crores, it could be qualified to convert into a public or a private Company. According to the proposed amendment by the Budget 2021-22, even if the threshold of paid up share capital and annual turnover is not complied with; the company can convert into a private or a public company after fulfilling the other abovementioned conditions.
This amendment reduces the monetary impediments for the startups if they wish to grow into a private or a public company in the near future.
- Process for converting into a Public or Private Company – Before the Budget of 2021, for an OPC to be converted into a public or private company, it needed to (i) pass a resolution as per Section 122 of the Act, (ii) increase the minimum number of members and directors, and (iii) File E-Form No 5 and 6 along with copies of altered Memorandum and Articles of Association. As per the proposed amendment, the requirement to file E-form No.INC-5 has been removed. Further, the format of INC- E-Form No.6 has been edited such that a company’s compliance costs are reduced. Moreover, it has become less technical for a layman to develop his own company, thereby encouraging more people to become first hand entrepreneurs.
Merger and Amalgamation of Start Ups:
Companies may choose to merge due to various reasons like:
- Increased market share
- Satisfy growth objectives
- Gain competitive edge
- Save costs in areas of weaknesses
However, startups were not entitled to such benefits since the current Section 233 of the Companies Act allowed only small companies or holding-subsidiary to undergo amalgamation. Post the Budget announcement by the Indian Finance Minister, Nirmala Sitharaman, the proposed amendment to the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, allows (i) 2 or more startups; or (ii) Startups and small companies to undertake a merger. Such an amendment proves to allow startups to gain advantages equivalent to the small companies despite the differences.
Tax Exemptions for Startups:
There are two types of tax exemptions under the Income Tax Act of 1961 which startups can claim, namely (i) Tax Holidays, and (ii) Capital Gains. The Union Budget on the 1st February 2021, proposed amendments to the corresponding Act in the following manner.
- Extension of tax holidays
In the financial world, Tax holiday means tax reduction or elimination to certain businesses as notified by the government. As per the Companies Act read with the Income Tax Act, startups could claim 100% Tax Holiday for 3 consecutive assessment years out of 7 since incorporation, if their turnover is less than 25 Crore. However, the Budget of 2020-21 proposed amendment allowed Startup to (i) claim 100% reduction, (ii) for 3 consecutive assessments years out of the 10 years of incorporation, (iii) if their turnover is less than 100 Crores in the previous year, (iv) if they are incorporated after 1st April 2016 but before 1st April 2021.
The Budget of 2021-22 allows the startups, 1-year extension for claiming the tax holiday by amending the Clause 36 of the Finance Bill of 2020, pertaining to Section 80- IAC of the Income Tax Act. Now, the startups incorporated between 1st April, 2016 and 31st March, 2022 can claim tax reductions, thereby increasing the duration for the availing the advantage.
- Extension of Capital Gain Exemption
If an amount accruing from the capital gains from a long-term asset (residential asset- land, house, plot) is invested in equity shares of an eligible company (which includes startups) before the filing of income tax, and the same is invested by the eligible company in a new asset, it is exempted from the Income Tax provisions by virtue of Section 54GB.
After the completion of the abovementioned steps, the entity shall be eligible to claim an exemption from being taxable as an income of the previous year. Prior to the budget, this benefit was available only if the residential property was transferred on or before 31st March 2021. However, as proposed in Budget 2021-22, the deadline for claiming capital gains exemption for such investments has been increased by 1 year to 31st March 2022.
This helps startups to raise funds for assets through subscription of shares. Through this way government is also able to keep a check on investments made by eligible entities so that it does not become a mechanism of tax evasion.
The Government extended the tax holidays by one more year (31st March 2022) to help promote growth, development, and diversify domestic industries. Government has created tax holidays as incentives for business investment. It is believed that Tax holidays would increase the long-term tax revenue because they help businesses maintain or grow operations, which creates more taxable revenue for the tax authority. Startups do not start generating profits soon after they are incorporated. By extending tax holiday by one more year, it would give stimulus to the startups which will be incorporated after March 31, 2021. So, it is providing a boost to the companies which will be registered in the future (before 31st March 2022) and giving them the benefits of tax exemption. All the benefits proposed in the Budget 2021-22 are available only to the startups which have DPIIT recognition. So, just registering the startup in the Startup India portal is not enough to get the benefit of tax exemptions and capital gains, the startup ought to have a DPIIT recognition.
Exemption from auditing
The Income Tax Act, 1961 requires businesses to undergo auditing of their accounts. Under Section 44AB of Income Tax Act, businesses which carry out 95% of their transactions including receipts and expenditure digitally, with an aggregate of sales, receipts and turnover of less than Rs.1 crore, are exempted from getting their business accounts audited. In the Union Budget 2020-21, the threshold was increased from Rs.1 crore to Rs.5 crore whereas, in Budget 2021-22, it is proposed to further increase it to Rs.10 crore. This is a stark representation of how the Finance Ministry of India in collaboration with the Government strive to reducing the compliance for small startups. With growing economy and expenses, the budget also recognizes the time value of money as shown in the gradual increase in the threshold.
No depreciation on goodwill
Just like Intellectual Property, Goodwill is also an intangible asset for a company. Like all other assets, goodwill also undergoes depreciation over the years and the same has been upheld in the Supreme Court case of Smifs Securities Ltd under the ambit of Section 32. In the Budget, 2021, it has been proposed that goodwill of businesses or professions should not be considered as a depreciable asset under the “block of asset”, in any situation be it acquired or self-gained by amending Section 2(11) of the Income Tax Act. Even though the startups are comparatively newer and established on a smaller scale, a lot of them have a good repute among the common man, for instance: Paytm, Zomato, Byju’s etc. Where goodwill is purchased, the purchase price of the goodwill will continue to be considered as cost of acquisition for the purpose of computation of capital gains under section 48 of the Income Tax Act, 1961 subject to the condition that in case depreciation was obtained by the assessee in relation to such goodwill prior to the assessment year 2021-22, then depreciation so obtained shall be reduced from the amount of purchase price of the goodwill.
However, the proposed amendment is retrospective to the extent that tax depreciation claimed in the past years cannot be regained. Eg: HUL acquisition of Horlicks accounted for depreciation of goodwill, due to which it was valued higher. According to the existing provisions there is no depreciation on goodwill, the transaction would have happened taking into consideration the tax deductibility and valuations would have been determined on that basis. When the proposed amendments will become enforceable goodwill will not be taxable, the businesses will not be able to claim depreciation and the tax cost will significantly increase. Moreover, restructuring will also become more costly, leading to a significant rise in litigations.
1500 Cr. Fund allocation:
The Union Budget 2021-22 announced the appropriation of 1500 Crores to the digital payment sector in order to enhance the digital India Movement and ensure financial and technical ease. Startups like Paytm have really appreciated this act of the government since it not only helps the business survive today, but prepare the citizens for a relaxed lifestyle in the future.
Apart from the appreciation of the Budget by various startup founders such as Ola, IAN Fund and Indifi Technologies, there are certain areas that are left unattended by the Union budget 2021-22. National Associated of Software and Service Companies (abr: NASSCOM) suggests a few of those, as listed below:
- Taxation Law (Amendment) Ordinances, 2019 announced the low tax rate of 15% for new manufacturing units incorporated in Special Economic Zones (SEZs) commencing operations within a prescribed period and creating jobs beyond a certain threshold. However, the Budget of 2021-22 did not address the same;
- Budget of 2020-21 announced a Deferment of tax liability on Employees Stock Option Plans (ESOP) granted by all start-ups to a time exiting from the company. This year’s Budget remains silent on it and the benefit is still not available to all startups, but just to eligible startups;
- The Budget also does not cater to the harmonization of tax rate for the resident investors who are related to the unlisted shares issued by recognized start-ups and exemption from Minimum Alternate Tax (MAT) to all recognized startups.
Concluding remarks:
To conclude, the Annual Union Budget of 2021-22 has in all aspects supported the Startups and One-person companies from the formation, conversion, paid up capital restrictions and incorporation by NRI. The Budget has also catered to the need of the hour by supporting digital platforms and health industries with funds. It provides for reduced compliances and relaxations in claiming tax holidays and gains. It deals with much more detailed concepts of auditing and depreciation as well. Even though the removal of depreciation from the ‘block of assets’ may lead to increased costs of M&A, the budget in its totality has been in favour of a hassle-free formation and operation of startups in India to support the Aatmanirbhar Bharat mission.
References
- https://www.startupindia.gov.in/content/dam/invest-india/Templates/public/198117.pdf
- Section 2 (68), Companies Act, 2013
- Section 59, Partnership Act, 1932.
- Section 2 (n), Limited Liability Partnership Act, 2008.
- Clause 1(a) (ii), G.S.R. notification 127(E), Ministry of Commerce and Industry, 2019.
- Clause 1(a) (i), G.S.R. notification 127(E), Ministry of Commerce and Industry, 2019.
- Clause 1(a) (iii), G.S.R. notification 127(E), Ministry of Commerce and Industry, 2019.
- (Startup Recognition & Tax Exemption, n.d.)
- Companies (Specification and Definitions Details) Amendment Rules, 2021.
- Section 62, Companies Act, 2013
- Section 233, Companies Act, 2013.
- Section 80-IAC, Income Tax Act, 19
- CIT v. Smifs Securities Ltd., (2012) 348 ITR 302 (SC).
- Section 32, Income Tax Act, 1961.
- Section 2 (11), Income Tax Act, 1961.
- Available at: https://nasscom.in/sites/default/files/NASSCOM_Union_Budget_2021-22_Key_Highlights.pdf
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