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Union Budget 2020 – iSPIRT Recommendations

India is among the top startup ecosystems in the world with home to 50,000+ startups and 3,500+ funded startups growing at a rapid pace at 30 per cent. While the future outlook of the Indian startup ecosystem is definitely promising, further accelerated growth can happen only if the government introduces more startup-friendly policies, other than the existing support under ‘Startup India’.

With Budget 2020 less than two months away, the startup ecosystem is hoping to get a major boost with respect to the following measures:

  • Improve ease of doing business for startups.
  • Attract domestic and foreign investors.
  • Increase working capital flow for startups.

iSPIRT has made a 13-point recommendation list for Budget 2020 with respect to the above-mentioned measures:

1. Remove the TDS payment for DPIT registered Startups

Currently, payments to DPIT registered startups are subject to Tax Deduction at Source (TDS) of 10% under section 194J. It takes at least 1-2 years for startups to get refunds after filing of their returns, which blocks their working capital for that time period. 

2. Harmonise the Tax Rate and Holding Period between Listed and Unlisted Securities of Startups 

The higher holding period and higher tax rate disincentivise investments into startups from Indian sources. Globally, no such differentiation exists.

This recommendation seeks:

  • Reduction of the holding period for unlisted securities to 12 months from the current 24 months.
  • Levy of a lower tax rate of 10% on the sale of unlisted securities.
  • Removal of the “superrich” surcharge of 25%/37% on the sale of unlisted securities.

3. Change in the taxation of ESOPs for Startups:

The existing definition of Rule 3(8)(iii) of the Income Tax Rules, 1962 does not take into consideration the discrepancies in the determination of ‘Fair Market Value’.

The new recommendation seeks amendment to this rule as as per Rule 11UA(1)(c)(b), provided such fair market value shall not be less than the exercise price.”

4. Clarification on the February 19th, 2019 DPIIT circular on “Angel Tax” with regard to Form 2

This circular states that the exemption lapses in the case the startup has or will invest or conduct any of the activities below for a period of 7 years after investment, inter alia:

  • Make capital contributions to other entities, 
  • Make investments in shares and securities, 
  • Give loans and advances (except in the case of lending startups

The recommendation seeks an amendment to this notification

  • Extend the “business model” test applicable to all the other investments mentioned in Form 2 to all points mentioned therein
  • Allow Startups to make Loans and Advances in the ordinary course of business provided that the PAN of the recipient is reported
  • Allow startups to invest into shares and securities and make capital contributions provided that such downstream investments do not make further investments into any of the other points listed in Form 2

5. Allow for AIF expenses to be capitalised/passed-through

Expenses of an AIF can add up to up to 25%-30% of its corpus during the lifetime of a scheme, making a large chunk of the fund is a “dead-loss”.

The new recommendation seeks AIF expenses to be capitalised as the Cost of Acquisition or allowed to be set off against the income.

6. Classification of securities held by AIFs as Capital Assets by amending section 2(14) of the Income Tax Act, 1961.

There is still friction between the startups, investors and income tax department with respect to taxation of short-term gain from the sale of securities under AIF.

The new recommendation seeks an amendment to Section 2(14) as “any securities held by a Foreign Institutional Investor or AIF which has invested in such securities in accordance with the regulations made under the SEBI. 

7. Pass-Through Status for CAT III AIFs

Unlike CAT I and CAT II AIFs, CAT III AIFs do not have pass-through tax status, rendering their income to be taxed at the maximum marginal rate for their income earned, regardless of the tax status of the underlying investor.

The new recommendation seeks an amendment to Section 115UB and Section 10(23FBA) by including CAT III AIFs.

8. Allow Universities and Public Trusts to invest in AIFs

Currently, investments are allowed in SEBI registered Mutual Funds or notified Mutual Funds set up by a public sector bank or a public sector financial institution.

The new recommendation seeks an amendment to this section to include ‘Units of an Alternative Investment Fund registered with the Securities and Exchange Board of India”

9. Notify all SEBI registered AIFs as “long-term specified assets” under section 54EE

Section 54EE was introduced on April 1, 2016, to give capital gains exemption of Rs 50 lakhs for any gains invested into “long-term specified assets”, defined as “a unit or units, issued before the 1st day of April 2019, of such fund as may be notified by the Central Government in this behalf”

So far, the Central Government hasn’t notified any such funds, so no tax-payer has been able to avail of this benefit.

The new recommendation seeks issuance of a Central Government notification to notify all SEBI registered AIFs as “long-term specified assets” under section 54EE and announce measures to extend this to April 1, 2025.

10. Time-bound response from the Inter-Ministerial Board (IMB) and allowing all startups to reapply

The IMB has not been effective yet in timely responses to startups.

The new recommendation proposes DPIIT to issue a notification stating that:

  • IMB will respond in 60 days from the date of submission by the Startup.
  • Startups who were denied IMB recognition prior to February 19th, 2019 can re-apply for IMB recognition once again under the new criteria.

11. Exempt Software product Companies from Softex

Software product exporters are required to file SOftex form to report the inward remittance on export invoices in convertible foreign currency. However, Software products have a publicly listed MRP/List price and hence do not require any valuation.

The new recommendation seeks RBI to exempt software product companies from filing Softex and create a separate category of Purpose code for disposal of inward remittances by authorised dealers.

12. Creation of aHSN code for Software Product Startups

Under the GST regime, all IT Software has been treated as “Service”.  Yet, there exists HSN codes and SAC codes both. 

It is recommended that an HS code classification for specific categories can be issued using the last 2 digits (first 6 Digits being defined under international system). 

13. R&D Credits for Software Product Companies 

As startups and young software product companies don’t have taxable profits, they are unable to take advantage of current R&D tax benefits that involve setting off R&D expenses against taxable profits. To overcome this limitation, they should be allowed a deferred tax credit for up to 7 years after the R&D investment.

You can read about Budget Representation 2020 in detail here.

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iSPIRT Foundation’s Official Response to Union Budget 2019

The budget has some relief for startups, but not an outsized role in the $5 Trillion plan
 
In her first budget presented today by the newly-appointed Finance Minister Nirmala Sitharaman started her speech with strong words stating that “We do not look down on legitimate profit-making. Gone are the days of policy paralysis and license-quota-control regime”. Given the resounding mandate of the people, this government has the political capital to execute a bold budget and this is what the country was expecting. While the vision is bold, the recommendations made by the government were a mixed bag – some solid announcements, but also notable for its omissions.

Startups may, at last, see the end of the dreaded “Angel Tax” that has plagued them since 2012. The creation of an e-verification process and “special administrators” whose permission would be required before an Assessing Officer can begin inquiries against start-ups who have already received orders should extend relief to those who were excluded from the February 2019 circular by DPIIT. This can also solve for section 68 – wrt unexplained cash credits – which was the more onerous section by ensuring verification of investors. Extending the exemption of section 56(2)(viib) to Cat II AIFs also brings parity and greater participation between AIFs. The tax deduction for investments into startups saw relaxations in the holding period (5 to 3 years), reduction in the minimum threshold (50% to 25%) and extending the time period.

In this budget, the government recommitted to its ideal of a less-cash economy. By allowing digital payments to the government, they are essentially legitimizing the use of digital payment methods. Further, by disincentivizing cash withdrawals by applying TDS and mandating digital payment acceptance without charges for firms over turnover Rs 50 Crores, they will further “nudge” users into preferring paying digitally. The approach just provides for a reduction in cost and discourage cash expense. This is hardly a definite fiscal measure for incentivizing digital payment. Most importantly, the government is eating its own dogfood, and starting to make digital payments through a dedicated payments platform to its own MSME suppliers and contractors, not only boosting digital payments but providing a critical lifeline to MSMEs by reducing their working capital requirements. In fact, the government has announced a significant boost to improve the availability of credit to the economy.  This includes providing Rs 70,000 Crore to the banking system, as well as a partial credit guarantee for the purchase of Rs 1 Lakh crore of pooled assets from the NBFC system. These measures should improve the availability of credit to the private sector, and boost growth!  The govt has also announced an amendment to enable all NBFCs to lend against invoices through TReDs. These are steps in the right direction and will free up much-needed working capital for the industrial sector.

It is encouraging to see the government adopt technology to improve convenience and simplification for tax-payers. Currently, there are nearly 40 crore citizens in India with a PAN in contrast to 120 crore Indians with Aadhaar. “Interchangeability of PAN and Aadhaar” was announced by Nirmala Sitaraman which has the potential to increase the tax filing base to all Aadhar holders. The details about implementation are specified as follows. Income Tax Department shall allot PAN to every person who will be filing tax with Aadhaar and currently do not have a PAN. The demographic verification will be carried out using data from the Unique Identification Authority of India (UIDAI). Additionally, citizens who have both PAN and Aadhaar can choose to use either of the options to file their returns. While the move of interoperability clearly seems to increase ease of filing taxes, whether it would also increase the number of tax-payers in informal sectors is still a question that needs examination. Further, understanding the implications of increased data linkage includes the discussion of data security.

What was missing was an indication of “Startup India 2.0” – the new phase of Startup India. The Rs 20,000 Cr Startup Seed Fund wasn’t announced, nor were fresh incentives for investments into VC Funds or startups, rationalisation of ESOP taxation, amongst others. Lowering the LTCG ( Long term capital gain) rate on startups shares, which was alluded to in the Economic Survey, also doesn’t find mention in the Budget. Additionally, there have been no measures to help our startups list in Indian exchanges. Overall, this budget has also not delivered on promoting Rupee Capital Formation which would help local startups wean off volatile foreign capital.

Despite the Economic Survey’s focus on Data as a public good, no significant announcement was made to leverage the Data assets of the country. In the speech about soft power, while Yoga and Artisans rightfully got their place, new-age digital platforms like Aadhaar, BHIM-UPI and India Stack, which are truly world-class, did not see a mention. Recognizing these Digital Public Goods as elements of soft power that can be exported to other countries would also give a massive boost to India’s start-ups in markets abroad.

Reach out to Sanjay Jain ([email protected] ) in case you would like to know more details.

Special thanks to our volunteers Saranya Gopinath, Rakshitha Ram, Siddarth Pai, Tanuj Bhojwani, Sudhir Singh, Sanjay Jain, Nakul Saxena, Sharad Sharma, Karthik KS.
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Disciplining The Not So Angelic, Angel Tax

If you are an entrepreneur, investor, or simply interested in the start-up sector, then you already know that Angel Tax is the buzzword right now.

Based on a law that was introduced in the 2012 budget by Mr Pranab Mukherjee, the rule aimed to target money laundering through high share premium. But unfortunately, the same provision is today attacking startups for their “high” share premiums and treating the difference between book value and DCF (Discounted Cash Flow) projections as income taxable at 30%. (For those interested in a more in-depth study of the provision and associated rulings can check out this article.

Thus, a law to penalize shell corporations and sham transactions are now being used against startups employing tens of people and generating value for the community.  Valuations are usually based on a startup’s future potential for growth and revenue and using book value, a method that’s better suited to asset-heavy manufacturing industries, is like measuring time in light years – it sounds right but is blatantly inappropriate

Hence the problem. This section hasn’t kept pace with the other anti-laundering and anti-abuse measures instituted by law and has become a blanket provision with little opportunity for a Startup to distinguish itself from a fake business. It also specifically discriminates against domestic investments thereby discouraging both investors and startups from accepting investments from Indian residents.

Latest changes, notified just yesterday, provide some way out for certain startups. However, this is a partial solution to a much larger problem, the CBDT needs to solve for the basic reason behind the cause of Angel Tax to be able to give a complete long-term solution to Indian Startups.

While the share capital and share premium limit after the proposed issue of share is till 10 crores and helps startups for their initial fundraising, which is usually in the range of Rs 5-10 Cr. Around 80-85% of the money raised on LetsVenture, AngelList and other platforms by startups is within this range, but the government needs to solve for the remaining 15-20% as startups who are raising further rounds of capital, which is the sign of a growing business, are still exposed to this “angel tax”. Instead, the circular should be amended to state that section 56(2)(viib) will not apply to capital raises up to Rs 10 Cr every financial year provided that the startups submit the PAN of the investors.

The notification also introduces the concept of an “accredited investor” into the startup ecosystem, which is an acknowledgement of the role that domestic investors play. Globally, an accredited investor tag is given to sophisticated investors investing in risky asset classes to denote that they acknowledge the risks associated with such investments and that they have the financial ability to do so. But instead of fulfilling both criteria of income and net worth, they should follow the global model of fulfilling either criteria and lowering the threshold to 25 lakhs of income or a net worth of Rs 1 crore. Their investment into startups should be excluded from the scope of section 56(2)(viiib). As a process mechanism if the CBDT could put in place a simple once a year mechanism for the Investor to submit his returns and giving him a reference number valid for the financial year, this will enable him to invest in more startups in the year without the need to get permissions every time the investor invests his funds.

Most importantly, any startup who has received an assessment order under this section should also be able to for the prescribed remedies and submit this during their appeal. They should not be excluded from this circular since its stated scope is both past and future investments. The CBDT should also state that the tax officers should accept these submissions during the appeals process and take it into consideration during their deliberation.

So, to summarise:

  • The angel tax should not apply to any investment below Rs 10 crore received by a startup per year, from Indian investors provided that the startup has the PAN of the investors
  • The angel tax should not apply to investors who have registered themselves with DIPP as accredited investors, regardless of the quantum of investment
  • The threshold stated should be either a minimum income of Rs 25 lakhs or a net worth of at least Rs 1 crore
  • Any startup who has received an assessment order should be able to seek recourse under this circular during their appeal

Through this circular, DIPP has reaffirmed its commitment to promoting entrepreneurship and startups in India. With these suggestions, the spectre of the “angel tax” will end up as a footnote in the history of the Indian startup ecosystem. We look forward to these pending matters

Start up India, Stand up India.

The post is authored by our policy experts, Nakul Saxena and Siddarth Pai.