Ms. Urvi Asher (Consultant - Manohar Chowdhry & Associates) discusses proposals specifically impacting startups. She is of the view that extension of the time limit for set-off of losses from 7 years to 10 years may not be a material factor in commercial transactions, viz. where a startup founder decides to sell his venture completely or partially or a FDI investor exits the company after a few years. The author opines that by removing the exception of non-residents under Section 56(2)(viib), there may be heavy foreign exchange inflow from NRIs , HNIs  and overseas family offices of Indians who invest in closely held Indian companies to enjoy the tax benefits, during the months of Feb and Mar 2023. She also foresees litigation due to amendment in Section 45(5A) as the Revenue may try to apply it in earlier years too citing that it is a clarificatory amendment.

Budget 2023: Proposals for Startups

The much-awaited Finance Bill 2023 (the Bill) was released on 1^st February 2023. Being an “Election Budget”, an attempt has been made to appease all sections of the society. 

In this article, we have enumerated some of the proposals specifically impacting startups (as defined in section 80-IAC of the Income tax Act, 1961 (the Act)) and other provisions which are likely to impact all startups in general.

1. Relief for startups defined under section 80-IAC

1.1 Currently, section 80-IAC of the Act provides for a deduction of 100% of the profits of an eligible start-up for 3 consecutive assessment years out of 10 years, beginning from the year of incorporation, provided:

• total turnover of its business does not exceed Rs. 100 crores;

• it holds a certificate of eligible business from the Inter-Ministerial Board of Certification, and

• it is incorporated on or after 1st day of April, 2016 but before 1st day of April 2023.

The Bill proposes to amend the provisions of section 80-IAC so as to extend the period of incorporation of eligible start-ups to 1^st April 2024.

1.2 Presently, section 79 of the Act allows “eligible start-ups” defined under section 80-IAC to carry forward and set-off losses incurred within 7 years from date of incorporation, provided all the shareholders of the company in the year in which the loss was incurred, continue to be shareholders in the year in which setoff is claimed, notwithstanding that their aggregate shareholding is less than 51%. The Bill proposes to increase the period from 7 years to 10 years from the date of incorporation to align with the provisions of section 80-IAC which provides a window of 10 years. This amendment is effective from AY^[1] 2023-24 (FY^[2] 2022-23).

1.3 Extension of the time limit for set-off of losses from 7 years to 10 years may not be a material factor in commercial transactions, viz. where a startup founder decides to sell his venture completely or partially or a FDI^[3] investor exits the company after a few years.

2. Investors in a startup

2.1 Currently, section 56(2)(viib) of the Act provides that when a closely held company receives any consideration for issue of shares at premium exceeding FMV^[4] of the shares from any resident taxpayer, such excess is chargeable to tax under the head ‘Income from other sources’. This is popularly known as “angel tax”. Any payment for share subscription from a non-resident taxpayer is out of the purview of angel tax.

2.2 The Bill proposes to remove this exception for non-residents effective from AY 2024-25 (FY 2023-24). This provision is likely to impact NRIs^[5], HNIs^[6] and overseas family offices of Indians who invest in closely held Indian companies to enjoy the tax benefits accorded to non-residents under the Act and the treaties. The months of February and March 2023 may witness heavy foreign exchange inflow from such investors.

2.3 Non-resident investors investing in India must comply with FEMA^[7] Guidelines on valuation aspects. Pursuant to the amendment, such non-residents would also be required to adhere to valuation under the Act.

3. Startups engaged in the online gaming industry

3.1 The Bill proposes to insert a new section 194BA in the Act with effect from 1^st July 2023, to provide for deduction TDS^[8] at 30% on net winnings in the user account at the time of withdrawal or at the end of the financial year, whichever is earlier. There is no threshold limit provided for deduction of tax on online games, unlike other sections.

3.2 This amendment impacts startups in the gaming sector – online or offline. It separates TDS provisions for online gaming (section 194BB – TDS on net winnings, no threshold limit) and offline gaming (section 194B – TDS on gross payment exceeding Rs. 10,000). This certainly increases compliance for startups in the gaming sector.

4. Capital gains tax provisions clarified

4.1 Various judicial precedents have held that capital gains on sale of self-generated intangible assets cannot be computed if the cost of the asset is not ascertainable. The Bill proposes to amend section 55 of the Act to provide that the cost of acquisition and improvement of such intangible assets (other than those specified) shall be considered NIL. This amendment is effective from AY 2024-25.

4.2 Section 45(5A) provides that for the purpose of computing capital gains of an individual or HUF from the transfer of land or building or both, under a Joint Development agreement (JDA), the full value of consideration shall be taken as the stamp duty value of his share, as increased by the consideration received in ‘cash’. The Bill proposes to amend the provision to the effect that consideration shall include any amount received in cheque, draft or any other mode.

This amendment is particularly relevant for startups in the real estate sector who must deduct TDS under section 194-IC before making payment to the land owner. Though the amendment is effective from AY 2024-25 (FY 2023-24), the tax authorities may try to apply it in earlier years too citing that it is a clarificatory amendment.

5. Presumptive income thresholds for budding entrepreneurs and professionals raised

5.1 Section 44AD provides for a presumptive income scheme for budding entrepreneurs who are (a) resident in India, (b) assessed as individual, HUF or a partnership firm other than LLP^[9], (c) carrying on eligible business and (d) having a turnover or gross receipt up to Rs. two crores. Income of such entrepreneurs is deemed to be equal to 8% or 6% (for digital proceeds) of the turnover or gross receipts.

The Bill proposes to raise the turnover limit to Rs. 3 crores in case where the aggregate turnover / receipts in cash is less than 5% of total turnover / receipts.  

5.2 Likewise, section 44ADA provides for a presumptive income scheme for budding professionals who are (a) resident in India, (b) assessed as individual or a partnership firm other than LLP, (c) carrying on eligible profession and (d) having gross receipts up to Rs. 50 lakhs. Income of such professionals is deemed to be equal to 50% of the gross receipts.

The Bill proposes to raise the turnover limit to Rs. 75 lakhs in case where the aggregate receipts in cash is less than 5% of total receipts. 

5.3 These amendments are effective from AY 2024-25 (FY 2023-24).

5.4 This proposal may not be relevant for startups registered as companies or LLPs. However, if you are a budding entrepreneur, it would be worthwhile to analyze the pros and cons of operating as a company / LLP or as an individual / firm.

6. Compliance provisions

6.1 The Bill proposes to use Permanent Account Number (PAN) as the common identifier for all business establishments using digital systems of various government agencies.

6.2 Payments in kind in the course of business attract TDS. The Bill proposes to introduce penalty and prosecution provisions for failure to comply with TDS provisions citing that the payment was made in kind.

Conclusion

Startups in India have played a crucial role in elevating India’s position in the global economy. The stakeholders in the startup ecosystem expected some radical announcements like rationalization of the capital gains tax rate structure, deferment of taxation on exercise of stock options, tax concessions for reverse flipping (internalization of holding structure) etc. However, there were no major announcements on this front.

Meanwhile, extension of angel tax to non-resident investors is likely to pose some riders on the applicability of angel tax to issue of convertible instruments to non-residents, conversion of debt instruments into equity post 1^st April 2023 etc. It would be worthwhile for startups and their investors to revisit their agreements to examine the applicability of angel tax under the proposed provisions.

[1] Assessment Year

[2] Financial Year

[3] Foreign Direct Investment

[4] Fair Market Value

[5] Non Resident Indians

[6] High Net Worth Individuals

[7] Foreign Exchange Management Act

[8] Tax deducted at source

[9] Limited Liability Partnership