How to Account for Startup Expenses before Incorporation?

Are you incurring expenditure for advertising, promotions, and printing etc. before forming a company?

These are termed as Preliminary expenses or Startup expenses. Currently the small scale businesses and startup companies are unaware of the benefits that can be claimed regarding these expenses. Costs incurred in the formation of a firm, and in advertising, promotional activities, employee training, etc., before the firm can open its doors for business, can be claimed as deduction against the income chargeable to tax.

Another substantial expenditure incurred during the incorporation of a company, and which will form integral part of this article, is the Registration fees for the Authorized Share Capital of the company and the Stamp Duty associated to the same. Considering form a small scale business man’s point of view, we generally register our company with the authorized share capital of Rs. 1 lac. However as the business grows the capital base of Rs. 1 lac seem rather minute, and we go for the increase in authorized share capital of the company which costs us another set of stamp duty fees etc.

These expenses fall within the composition of pre-incorporation expenses. Hence, we can amortize the same over 5 years. However when similar expenses are incurred during the course of the business for increase in authorized share capital of the company, then the benefit of amortization is not available.

The reason quoted by the government behind this through a court ruling (Punjab State Industrial Development Corporation Ltd vs Supreme Court) is that-

The fees paid for the increase in authorized share capital of the company is directly related to the capital expenditure of the company. It would certainly help in the business of the company, but still it retains the nature of capital expenditure since the expenditure was directly related to expansion of the capital base of the company.

Following is an example explaining the above case-

Case A

ABC Ltd incorporated with an authorized share capital of Rs. 1 lac, increasing the same to 25 lac later

In this case the expenditure incurred for the authorized share capital of the company comes to Rs. 7000. We can claim deduction for the same to the tune of 1/5 of the expenditure each year over five years.

However at the end of 3 years, a need of more capital came up for Rs. 50 laces, now first we need to increase the authorized share capital of the company which costs another 100,000. Further according to the above ruling we cannot amortize the same.
This increases the tax burden of the company.

Case B

EFG Ltd incorporated with an authorized share capital of Rs.50 lac

The expenditure incurred for the authorized share capital of the company comes to Rs. 100,000. We can amortize the same to the tune of 1/5 of the expenditure over five years. Hence a figure of 20,000 hits the statement of profit and loss every year bringing down the profit for taxation purposes. This helps reduce the tax burden of the company.

Hence if we are clear about the growth motive of the company from the beginning, we should begin with the tentative authorized capital of the company, and keep the subscribed and paid up capital to the extent required initially at the inception. Rather than increasing the authorized share capital as and when required, it is always feasible to start with the required capital base, and remain entitled to the tax benefits, which really brings business value in the initial years

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