[Key Takeaways] Decoding The Budget For Startups: Mixed Bag For Taxes; Big Boost For Manufacturing

Finance minister Nirmala Sitharaman only mentioned the word ‘startup’ twice in her entire Union Budget 2024-25 address, but the budget itself had plenty in it for the evolving startup ecosystem, including companies in the manufacturing and MSME spaces.

Indeed, this year’s budget address signalled that the government is looking at startups as part of the corporate world at large, given many of the broader measures and the budgetary allocation for large sectors and industries.

The biggest announcement for startups was related to the abolishment of the contentious Angel Tax for investors in all classes, which would be a big relief for startups, but pending Angel Tax investigations are still a sore point for many startups.

In terms of sector-specific allocation, India’s spacetech startups are under the spotlight once again in the Union Budget 2024, but besides this, the biggest push has come for the manufacturing industry.

Additionally, the Union Budget 2024-25 showed that the government is looking at uplifting the MSME sector and startups in a big way by expanding the various credit access platforms available to this class of businesses.

For individuals, though, not much relief was found from the current tax regime in the Union Budget 2024. While some adjustments were made to the income tax structure, the bigger focus has been on increasing the tax collection by targetting the growth seen in securities and derivatives trading.

Sitharaman also spoke about the government’s focus on digital public infrastructure (DPI) for modernising agriculture, healthcare, finance, ecommerce, education, law and justice, logistics and other key areas. These are undoubtedly areas that Indian startups can target.

For instance, land records in urban areas are set to be digitised with geo information systems (GIS) mapping, while sector-specific databases will be created under the Digital India mission to improve data governance, collection and processing.

Here are the five key areas that were under the spotlight during Sitharaman’s 90-minute Union Budget 2024-25 address:

Huge Focus On Skilling, Employment 

• One-month wage to all persons newly entering the workforce in all formal sectors
• Incentive boosts for employers and new employees in the manufacturing and other sectors
• 1,000 Industrial Training Institutes will be upgraded around skill-focussed outcomes
• Loans for upskilling and higher education in domestic institutions

As expected in the run-up to the Union Budget 2024, Sitharaman focussed heavily on encouraging new employment and job creation in key sectors.

Job-creation measures included the new internship scheme, EPFO-based benefits for employees and employers as well as a focus on skill development through the Industrial Training Institutes.

In addition to the PLI schemes that have catapulted India in the global supply chain market, the government is looking to encourage investments in large-scale manufacturing and formal sectors by rewarding employers for hiring new workers.

Those in the manufacturing sector, in particular, stand to benefit as the pace of new job creation is higher in this sector as compared to the services industry. We can see these incentives driving investments in new manufacturing units for semiconductors, automotive and EV industry, while the already booming electronics manufacturing industry is likely to expand its base in India — especially when you read these changes along with the lower customs duty on many critical raw materials and inputs (more on this later).

Interestingly, the budget speech did not announce any particular government investments in the semiconductor manufacturing space, preferring to focus on incentives that cover the entire gamut of manufacturing. In the past year, the government set aside INR 1K Cr to fund semiconductor design startups, along with a $10 Bn allocation for semiconductor manufacturing research and design.

Budget 2024 Brings Mixed Bag For Taxes

• Contentious Angel Tax For Startups Abolished From April 1, 2024
• 2% Equalisation Levy AKA Digital Tax On Foreign Cos Abolished From August 2024
• Short-Term Capital Gains Tax Hiked To 12.5% From 10%
• Long-Term Capital Gains Tax Hiked To 20% From 15%

When it comes to tax-related changes, Sitharaman’s budget dished out the good news with an equal measure of the bad.

Firstly, most startups will welcome the abolishment of Angel Tax, which has been a thorn in the side of early-stage startups for the past six years when the IT department began looking at potential violations and sending notices to companies and their investors.

Ever since it was introduced in 2012, the Angel Tax clause was used to harass startups whichraised capital from investors, often at a premium based on valuation reports. The tax was levied on the difference between issue price of unlisted shares and their fair market value.

The government has now abolished the contentious Section 56(2)(viib) from April 1, 2024, but several cases are still pending with authorities as we reported a few days ago. These are unlikely to be cast away without a resolution, so startups could still see some residual pain from angel tax for the time being.

In conversations with Inc42, many investors have suggested that the government needs to wipe the slate clean when it comes to these pending probes.

Equalisation Levy Removed, TDS On Ecommerce Slashed

Next, Sitharaman threw a surprise when she abolished the 2% equalisation levy often called the digital tax on foreign tech and ecommerce companies operating from India. This tax was meant to offset the loss of revenue for India from foreign companies selling services or products in India.

The change in the equalisation levy is expected to provide a lot of cheer for US-based companies, which have long asked for this tax to be removed. The change will reduce the cost of some online and digital services, such as global companies advertising in India through digital ad networks, which have to pay a 2% premium to the service provider in many cases.

For ecommerce operators in India, the government has proposed a lower tax deducted at source (TDS) rate, slashing it significantly from 1% to 0.1%. This is likely to spur on digital commerce adoption as it reduces the cost of online selling in a big way. The TDS was introduced as a way to monitor ecommerce transactions for round-tripping of funds and to prevent money laundering. Lowering this will allow the government to continue monitoring transactions for those red flags, while operators will have to incur lower upfront costs to facilitate transactions.

Concerns Over Capital Gains Tax Hikes

Finally, in what is expected to raise a lot of concerns among individual and institutional investors, the finance minister hiked the tax rate on short term and long term capital gains, as well as the securities transaction tax (STT) applied for derivatives (futures and options). From October 1, 2024 — subject to the passing of the Finance Bill — the STT on options up from 0.062% to 0.1%. STT on futures goes up from 0.0125% to 0.02%.

According to Zerodha CEO and cofounder Nithin Kamath, this would result in 66% higher STT collection from users based on 2023 volumes. The volumes themselves have grown significantly —  monthly futures and options turnover reached a record $1.1 Tn in March 2024 from approximately $27 Bn in March 2019.

These higher taxes, coupled with higher STCG and LTCG taxes, are likely to cool down some of the F&O frenzy in the derivatives market, particularly for traders with low volumes.  If the idea was to cool down the activity in the markets, this might just do the trick,” Zerodha’s Kamath said in a post on X.

Budget 2024 Boost For Spacetech Startups

• INR 1,000 Cr government-backed venture fund for space economy

Following the privatisation of the space sector in 2020, and after introducing 100% foreign direct investments (FDI) for spacetech in February this year, Sitharaman brought in more good news for the space economy.

While the contours of the dedicated space economy fund will become clearer in the next few months, we know that the focus has been on indigenous manufacturing and creating application testbeds for spacetech startups.

While the FDI route is essential for scaled-up startups and for growth funding, the government-backed fund is likely to be a big boost for startups in seed and pre-seed stage.

Besides this, exempting and lowering customs duty on minerals such as lithium, copper, cobalt and rare earth elements is seen as a critical boost for sectors such as nuclear and renewable energy as well as space, defence and telecommunications, which have overlaps in terms of the component value chain.

Fuelling Manufacturing Growth

• Customs duty on mobile phones, mobile printed circuit board assembly (PCBA) and chargers reduced to 15%
• Ecommerce exports hub to be set up for MSMEs in manufacturing space
• Customs duties on 25 critical minerals, oxygen-free copper and parts for manufacturing of connectors
• 50% increase in customs duty on importing PCBs for telecom equipment

As expected, Sitharaman’s Union Budget 2024-25 ushered in the next phase of the central government’s major focus on manufacturing.

A host of raw materials and inputs have seen a reduction in basic customs duty (BCD), which is expected to drive domestic manufacturing and is seen as a hope of reducing the cost of finished goods. These savings are likely to be passed on to consumers in key areas such as smartphones and mobile devices, EV and smartphone batteries, and finished goods that are dependent on refining minerals and chemicals.

“A comprehensive review of the customs duty rate structure will also be carried out over the next six months to rationalise and simplify it for ease of trade, removal of duty inversion and reduction of disputes,” Sitharaman said in her budget speech.

While manufacturing costs are expected to go down, the changes are also likely to reduce disputes with the customs and imports authorities over raw materials. The customs duty exemptions are for 25 critical minerals, including cobalt, lithium, copper, germanium, and silicon, many of which are vital for electronics and battery manufacturing.

In addition, the relief through reduced customs duties on gold and silver (6% vs 15% previously) and platinum (6.4% from 15.5 %) will give a fillip to gems and jewellery industry as well as other sectors that leverage precious metals for manufacturing components, such as semiconductors and electronics manufacturing.

Credit Push For MSMEs

• Credit guarantee scheme for purchase of machinery and equipment without collateral
• Public sector banks will build their in-house capability to assess MSMEs for credit
• The limit of Mudra loans doubled to INR 20 Lakh for entrepreneurs
• Expanding TReDS trade invoicing platform to boost MSME working capital
• New SIDBI branches to serve major MSME clusters

The lower BCD on input and raw material will be critical to fuel large-scale manufacturing in electronics, space, clean energy, and other emerging industries. What did the Budget 2024-25 have in store for smaller businesses that are also looking to build India’s manufacturing capacity.

Firstly, the government plans to establish ecommerce export hubs in a public-private partnership (PPP) model to empower MSMEs and traditional artisans to sell their products in international markets.

These hubs will operate under a seamless regulatory and logistic framework, offering a comprehensive range of trade and export-related services under one roof, significantly enhancing the ease of doing business for small and medium enterprises (SMEs).

The ecommerce export hubs will be backed by over 100 food quality and safety testing labs certified by the National Accreditation Board for Testing and Calibration Laboratories (NABL), which are likely a measure to boost MSME food exports.

Further, the limit of loans provided under the Pradhan Mantri MUDRA Yojana (PMMY) will be increased to INR 20 Lakh from the existing INR 10 Lakh. The loan limit will be increased for entrepreneurs who had applied, availed and repaid MUDRA loans under the TARUN category previously.

Expanding MSME Credit Guarantees

Sitharaman also announced a credit guarantee scheme for MSMEs in the manufacturing sector. The government has provided MSMEs in the manufacturing sector with a guarantee cover of up to INR 100 Cr. “The scheme will operate on pooling of credit risks of such MSMEs, a separately constituted self-financing guarantee fund will provide to each applicant guarantee cover up to INR 100 Cr, while the loan amount may be larger,” the finance minister said.

The FM added that national banks will be tasked with creating credit assessment models for MSMEs based on a digital footprint score, instead of relying on external assessment, which rely on asset and turnover criteria.

The credit guarantee programmes should ideally allow MSMEs to secure loans from registered entities without providing collateral or a third-party guarantee. Additionally, term loans will be made available to facilitate the purchase of machinery, further supporting the growth and operational efficiency of micro, small and medium enterprises.