Union Budget 2019: Startup Ecosystem Welcomes Tax-Related Announcements

For the first time in the history of Indian Budget speeches, the word ‘startup’ was mentioned 18 times in the 127-minute-long budget speech by the finance minister Nirmala Sitharaman. Barring the creation of Seed fund and Innovation Zones as demanded by startups and promised by Modi government 2.0, for the first time, startup issues were addressed at such a length in the Union Budget, and it was done with a multi-dimensional approach.

Presenting the Union Budget 2019, Sitharaman said, “Startups in India are taking firm roots and their continued growth needs to be encouraged. To resolve the so-called ‘angel tax’ issue, startups and their investors who file requisite declarations and provide information in their returns will not be subjected to any kind of scrutiny in respect of valuations of share premiums.”

The issue of establishing the identity of the investor and source of his funds will be resolved by putting in place a mechanism of e-verification. With this, funds raised by startups will not require any kind of scrutiny from the Income Tax Department. – Nirmala Sitharaman

This has been widely appreciated by startups and investors. Saurabh Srivastava, chairman & cofounder, Indian Angel Network stated that with this, FM Nirmala Sitharam has addressed the regulatory elements that currently harass both start-ups and angel investors. A robust implementation of the proposed measures should eliminate virtually all the issues plaguing the angel investment landscape. The alleviation of regulatory friction has opened the way for the smooth progress of the country’s startup ecosystem. This will allow us to not only meet but exceed the target of 50,000 stated by the President but also create millions of jobs, contribute to economic growth and find innovative solutions to the country’s many challenges in affordable healthcare, education, agricultural productivity, clean energy, water and sanitation.

The use of technology for verifying angel investors has been welcomed by many startups. Vivekanada H.R., CEO and cofounder of bicycle rental platform Bounce said, “The proposed e-verification mechanism to make the angel funding process hassle-free is a welcomed initiative. Additionally, the funding towards R&D will help propel the country’s technology ecosystem and pave the way for innovation-led growth.”

Angel Tax Exemption

Since the introduction of Section 56(2)(viib) of I-T Act — income from other sources — and the infamous angel tax os 2012 is applicable if the value of shares exceeds the fair market value, but for startups, angel investments became hard to come by as a result of the tax. According to Inc42’s The State Of Indian Ecosystem report, angel investments in 2018 were down by around 53% compared to the investments made in 2017.

Startups, since then, have fought a long battle pertaining to assessing fair market values. In the past, income tax assessing officers have repeatedly refused to accept the discounted cash flow (DCF method) of determination. Instead, they assessed the value based on NAV (Net Asset Value) method. This had resulted in startups getting tax notifications as part of Section 56(2)(viib).

Finally, in February this year, Suresh Prabhu, the then commerce minister after having a series of meetings with Indian startup ecosystem stakeholders as well as with the finance ministry officials announced the exemption of angel tax through a notification.

According to the new notification released by the Central Board of Direct Taxes (CBDT):

1. The startups will continue to be considered as startups till a period of 10 years since their incorporation. Turnover of the entity for any of the financial years since incorporation/registration has not exceeded INR 100 Cr.
2. All the startups are liable to receive angel tax exemption regardless of their share premium values given that the aggregate amount of paid-up share capital and share premium of the startup after issue or proposed issue of shares, if any, does not exceed, INR 25 Cr.

There are issues that the notification had failed to address, including:

• Startups who received assessment orders will still have to fight the battle
• Section 68 of I-T Act is yet to be addressed
• The certification process for the tax exemption under Section 80-IAC has been left unaddressed

However, since the matter resolved on February 19, In a tweet, Ramesh Abhishek, secretary, DPIIT recently said that 541 startups have been granted angel tax exemption by CBDT so far. However, 36 applications were incomplete and are being worked upon by Startup India team to address deficiencies.

Power To Bureaucrats Again?

Acknowledging the current exemption resolution, Sitharaman further said, “Special administrative arrangements shall be made by the Central Board of Direct Taxes (CBDT) for pending assessments of startups and redressal of their grievances. It will be ensured that no inquiry or verification in such cases can be carried out by the Assessing Officer without obtaining approval of his supervisory officer.”

Sitharaman also proposed to extend the Category I Alternative Investment Funds benefits to Category-II Alternative Investment Funds also. And, therefore, the valuation of shares issued to these funds shall be beyond the scope of income tax scrutiny.

While many of the stakeholders have welcomed the step, some of the entrepreneurs such as Sreejith Moolayil, cofounder of True Elements told Inc42 that the budget has brought back more powers to bureaucrats “No structural change / no mention on retrospective effect. Status quo continues,” Moolayil said.

Anuj Golecha, cofounder of Venture Catalysts, however, welcomed the e-verification idea. He said, “This will act as a catalyst in driving investment towards our startup segment and promote cutting-edge technological solutions. It has also proposed measures to carry forward and set off losses for startups while increasing the period of exemption for capital gains through the sale of residential house for startup-centric investment up to March 2021.”

Sitharaman has also proposed plans to relax some of the conditions for carry forward and set off of losses in the case of startups. The FM also proposed to extend the period of exemption of capital gains arising from the sale of residential house for investment in startups up to March 31, 2021, and relax certain conditions of this exemption.

Archit Gupta, founder & CEO of ClearTax said that the Union Budget looks very promising for startups and gave it a good rating. He said the following promises must be put into practice soon and aggressive scrutiny of startups receiving funding must be put to an end.

• A capital gains tax exemption is allowed under section 54gb of the Act to an investor who sells a residential house or plot and invests the net consideration in equity shares of a startup company, which company, in turn, has to use the amount to purchase a new asset. This exemption is available for investments made until March 31, 2019. This is now extended to March 31, 2021.
• Pending assessment of startups – no inquiry/verification to be carried out by Assessing Officer without obtaining approval of the supervisory officer
• Relaxed norms for set off and carry forward of losses for startups have been proposed
• No scrutiny to check the valuation for ‘Angel Tax’ if startups and investors file declaration via e-verification

With this Budget, Sitharaman seems to have maintained the status quo regarding the current angel tax exemption procedure through co-operative federalism. The e-verification process is expected to address the current investors’ tax-related issues to a certain extent. However, it would have been better had the government announced the e-verification process after putting the same in place. Because without its implementation, nothing changes for startups.