The Department of Industrial Policy and Promotion (DIPP) vide its notification dated 11 April 2018 has amended its previous notification dated 23 May 2017 on the eligibility guidelines for ‘start-ups’. This notification is in supersession of the earlier notification dated 23 May 2017.
Definition of Start-Up:
An entity shall be considered as a start-up:
- up to a period of 7 years from the date of incorporation/registration, if it is incorporated as a private limited company or registered as a registered partnership firm or a limited liability partnership in India. In the case of start-ups in the biotechnology sector, the period shall be up to 10 years from the date of its incorporation/ registration.
- The turnover of the entity shall not exceed Rs.25 Crore.
- The entity should be working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation. However, an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘start-up’.
Income Tax benefits:
Relaxation under section 80-IAC
Prior to this notification, in case of claiming tax benefits under section 80-IAC of Income Tax Act, 1961, the start-ups had to be incorporated on or after 1 April 2016, but before 1 April 2019 but as per the new notification, the period has been extended to 1 April 2021 and can claim 100% tax exemption on profits for 3 out of 7 years. With this new change, the start-ups shall enjoy income tax benefit for 3 out of 7 consecutive assessment years. Further, the Certification from the Inter-Ministerial Board is necessary to avail such exemption.
Tax benefit under section 56 (2) (viib) of Income Tax Act 1961
As per section 56(2) (viib) of Income Tax Act 1961, in case of Company receiving consideration issuance of shares above Fair Market Value (FMV), then the excess of consideration above the FMV would be taxed in the hands of Company as other Income. Prior to this notification, the start-ups were exempted from the aforementioned provisions. The valuation of the Company in such case should be as per 11UA of the Income Tax Act 1961, which states that it should be as per Discounted Free Cash Flow method determined by either Merchant Banker or by Chartered Accountant.
Pursuant to this notification, the start-ups could avail such tax benefits on issue of shares for a consideration above the fair market value, only upon fulfilment of following conditions:
- The aggregate amount of paid-up share capital and share premium of the start-up after the proposed issue of shares should not exceed Rs.10 Crore.
- The investor/ proposed investor, who proposed to subscribe to the issue of shares, should either have (i) an average returned income of Rs.25 Lakh or more for the preceding three financial years or (ii) Net worth of Rs. 2 Crore or more as on the last date of the preceding financial year.
- The start-up has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11 UA of the Income Tax Rules 1962.
Further, start-ups shall have to make an application to Inter-Ministerial Board and obtain the approval for such exemption.
Pursuant to this notification, it shall be expensive for start-ups to obtain merchant banker certificate for such issuance. This may require clarity as rule 11UA allows both Merchant Banker or by a Chartered Accountant to issue valuation certificate. However, this notification mandates such valuation could be done by only merchant banker.