BCL Startup Learning Series | #1 – Tax Benefits to Startups

BCL India endeavours to empower startups with knowledge. In a series of articles to be published here we shall share important information that concerns you. To start off, we shall discuss about Notification G.S.R. 364(E) released in April 2018 this year. This Notification prescribes the eligibility, forms and process for startups to avail tax benefits

  • Before we understand the benefits, we need to understand who is eligible to avail the benefit. There are, amongst others, two important benefits that startups can avail under Income Tax Act
    • Income tax exemption on profits earned for 3 consecutive years out of 7,
    • Exemption from tax on ‘super-premium’ on capital raised, and

Here’s what the notification has to say

Exemption from taxes on profits

Governed by Sec. 80-IAC, eligible startups benefit from 0% taxes for a period of 3 consecutive years out of 7 years starting from the date of incorporation of the startup.

Who is eligible to claim benefit?

  • Eligible startups are defined to mean businesses
    • established as a Private Limited Company (PLC) or as a Limited Liability Partnership (LLP) [as is evident, simple partnership firms will not benefit from this section]
    • incorporated on or after the 1-April-2016 but before 1-April-2021
    • whose total turnover does not exceed Rs. 25 crore in the year for which benefit is being claimed
    • it holds a certificate of eligible business from the Inter-Ministerial Board of Certification
  • The startup should be engaged in ‘eligible business’, i.e. should be
    • engaged in innovation, development or improvement of products or processes or services or,
    • a scalable business model with a high potential of employment generation or wealth creation

What is the process of claiming the benefit?

  • An application in Form I has to be made to obtain the Inter-Ministerial Board certificate.
    • The certificate comprises of information about the business, its PAN and details about the activity carried on by it.
    • Where applicable, it shall also submit income tax returns and annual accounts for the last 3 financial year.
    • A write up of how the business is innovative or scalable should accompany the application.
  • The Inter-Ministerial board comprises of representatives from Department of Industrial Policy and Promotion, Ministry of Corporate Affairs, Reserve Bank of India, Central Board of Direct Taxes etc.
  • The Board may call for further documents or make further inquiries before issuing (or rejecting) the registration certificate u/s 80-IAC.

Exemption from tax on super-premium

Governed by Sec. 56 any private limited company that receives investment from a resident & issues shares at a value which is higher than its fair market price, shall be subject to tax on that excess. For example,

  • Company ABC Private Limited received an investment of Rs. 10,00,000 and has issued 10,000 shares of price Rs. 100 each. The nominal value of the shares is Rs. 10 and RS. 90 is the premium on issue of shares.
  • It is identified that the fair market value of the shares is only Rs. 80 per share. The issue price can be now be analysed as
    • Rs. 10, nominal value, and not subjected to tax
    • Rs. 70 (i.e. FMV Rs. 80 – Rs. 10), acceptable premium, and not subjected to tax
    • Rs. 20 (i.e. issue price Rs. 100 – FMV Rs. 80), ‘super-premium’ and subject to tax u/s 56

Who will determine the fair market value of the shares? Wouldn’t the startup know best?

The Income Tax Act thinks otherwise! In order to curb the influence that ‘black-money’ has on the economy, a law was introduced under Sec. 56 that required ‘super-premiums’ to be subject to tax. There is thus an onerous responsibility cast upon private companies to ensure shares are issued at fair price. From our experience with the tax department at the time of income tax assessments, we further understand that there is also a responsibility to ensure that the investment has come from tax paid income.

What is the benefit offered to Startups?

Eligible Startups are exempt from taxes on super-premium.

Who is eligible to claim benefit?

Any startup which has been in existence for not more than 7 years, with a turnover of less than Rs. 25 crores in each of these years working towards innovation shall be entitled to claim benefit. Additionally the following conditions should be satisfied,

  • the aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed Rs. 10 crores.
  • the investor who proposed to subscribe to the issue of shares of the startup has
    • Average minimum returned income of Rs. 25 lakhs for the preceding 3 financial years, or
    • Minimum Net Worth of Rs. 2 Crores as on the last day of the preceding financial year.
  • the startup has obtained a report from a merchant banker specifying the fair market value of shares

What is the process of claiming the benefit?

  • An application in Form 2 to the Board shall be made.
  • Form 2 is more detailed than Form 1 and requires, amongst other matters, information about
    • the types of shares issued by the company,
    • existing paid up capital and premium,
    • details of the proposed issue of shares towards investment
    • details of the investor including PAN,
  • Additional documents to be submitted along with Form 2 shall be
    • the annual accounts of the startup from the date of its incorporation;
    • name, PAN and address of the existing shareholders along with their shareholding and the amount at which shares are issued to them
    • copy of income-tax returns of the investor for the last three financial years;
    • copy of balance sheet of the investor as on the last day of the preceding financial year; and
    • merchant banker’s report.

In case of any questions, please do not hesitate to reach out to us on pavan@bclindia.in or vighnesh@bclindia.in or write to us on bclindia.in/contact/. We would be glad to be of your assistance.


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