New Economy: So far, so good

Vivek Ananth | Updated on February 01, 2020

The Change

The Union Budget has raised the eligible turnover limit for start-ups to claim income-tax deduction of profits to ₹100 crore from ₹25 crore, and the total eligible period for deduction of profits to 10 years from seven years. The tax on employee stock options imposed on the employees of eligible start-ups has been deferred by at least five years, meeting a long-pending demand of start-up founders and employees.

The Background

As part of the government’s Start Up India push, many entrepreneurs have raised funds over the past decade to set up new businesses. To fund their enterprises, they tap investors who are looking to play the India growth story. These businesses, many in the e-commerce space, have in the past few years faced some trouble with the income-tax and GST authorities. Tech start-ups raised nearly $14 billion in early-stage funding in the five years till 2019.

However, India’s start-up ecosystem is maturing, and this can be seen in the number of late-stage deals overtaking early-stage fund-raises in value. One factor that pushed early fund-raising for start-ups backward was the dreaded ‘angel tax’. This especially impacted early-stage investors, who were sent notices to explain the valuation of shares of the companies that they had invested in. Even entrepreneurs got such notices.

This led to a slowing of early-stage funding rounds in new tech start-ups to 1,222 deals in 2018, compared to 1,502 in 2017. In 2019, the number fell further to 915. The government moved to change its adversarial stance and laid down some conditions. But complying with these conditions is still cumbersome for many, according to a survey conducted by LocalCircles.

Many start-ups also use ESOPs to lure and reward their employees. But sometimes this becomes a burden for employees who exercise their right to receive these stock options. They are charged tax as salary in the year when these options are vested (when they exercise the right to receive their compensation in ESOPs). However, till they actually sell these shares, they don’t earn the income. This lacuna in taxation of ESOPs does hurt start-ups.

Some of these firms are forced to set up establishments in the States to which they move their goods before selling them. These companies have to now have multiple GST registrations, which leads to unnecessary compliance costs.

The Verdict

Raising the eligibility of turnover to claim deduction of profits for start-ups will broadbase the benefit to more start-ups. Increasing the eligible period for which the deduction is available to 10 years from seven years will allow more companies to use this benefit. Rationalisation of tax on ESOPs to eligible start-ups and employees will help companies and employees avoid a tax shock due to the need to pay taxes the moment the ESOPs are vested.

Setting up a fund for early-stage start-ups will help entrepreneurs raise funds in an environment where funding for start-ups has gone slow.

Published on February 01, 2020

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