The New Indian Initiative for Start-ups

The Indian Prime Minister Mr. Narendra Modi announced some big-ticket plans for Start-up India on January 16, 2016. The Start-up Policy makes some bold announcements and will cover different sectors across the economy. 

This article discusses the following:

•  Salient features of the start-up policy
• Definition of “start-up” to the eligible for various benefits and incentives under the Policy
• Taxation incentives as per the Policy
• Exchange control & FDI regulations
• Companies Act, 2013- Recommendations of the Companies Law Committee
• Summary.

Salient features of the start-up policy:

• USD 1450 Million funds for start-ups over a 4-year period – this will help start-ups in addressing funding needs and enhancing value – please note the term “start-up” has been defined in the Start-up Policy Action Plan for the purposes of eligibility of Govt schemes in this regard (discussed below).
• Single point registration for starting a company in India or setting up a startup via Mobile App which is scheduled to be launched on 1st April,2016
• 3-year (out of 5-year period) Tax holiday for start-ups and also exemption from capital gains invested in these start-ups – Fiscal Budget 2016 will likely clarify these in more detail.
• Fast track mechanism for patent application filings and support for facilitation for processing – 80% rebate for facilitation fees to encourage creation and protection of patents and Intellectual Property Rights(IPR)
• Credit guarantee fund through National Credit Guarantee Trust Company or SIDBI with an annual corpus of USD 72 Million

Start-up Hub for collaborative efforts which will help:

•  Work in a hub and spoke model and collaborate with Central & State governments, Indian and foreign Venture Capitalists, angel networks, banks, incubators, legal partners, consultants, universities, and R&D; institutions.
• Assist Startups through their lifecycle with a specific focus on important aspects like obtaining financing, feasibility testing, business structuring advisory, enhancement of marketing skills, technology commercialization, and management evaluation.
• Organize mentorship programs in collaboration with government organizations, incubation centers, educational institutions, and private organizations that aspire to foster innovation for starting a new business in India.

Relaxed norms of public procurement :

• Whenever a tender is floated by a Government entity or by a Public Sector Undertaking, very often the eligibility condition specifies either “prior experience” or “prior turnover”. Such a stipulation prohibits/ impedes Startups from participating in such tenders.
• In order to promote Startups, Government shall exempt Startups (in the manufacturing sector) from the criteria of “prior experience/ turnover” without any relaxation in quality standards or technical parameters.
• The Startups will also have to demonstrate the requisite capability to execute the project as per the requirements and should have their own manufacturing facility in India.

Easier and faster exit mechanism as required:

• The Insolvency and Bankruptcy Bill 2015 (“IBB”), tabled in the Lok Sabha in December 2015 has provisions for the fast track and/or voluntary closure of businesses.
• In terms of the IBB, Startups with simple debt structures or those meeting such criteria as may be specified may be wound up within a period of 90 days from making an application for winding up on a fast-track basis.

Atal Innovation mission to encourage entrepreneurship and innovation:

The Atal Innovation Mission (AIM) shall have two core functions:

• Entrepreneurship promotion through Self-Employment and Talent Utilization (SETU), wherein innovators would be supported and mentored to become successful entrepreneurs by new company formation India
• Innovation promotion: to provide a platform where innovative ideas are generated

Launching of Innovation-Focused Programs for Students:
In order to promote research and innovation among young students, the Government shall implement the following measures: 

• Innovation Core: The innovation Core program shall be initiated to target school kids with an outreach to 10 lakh innovations from 5 lakh schools. One lakh innovations would be targeted and the top 10,000 innovations would be provided prototyping support. Of these 10,000 innovations, the best 100 would be shortlisted and showcased at the Annual Festival of Innovations in the Rashtrapati Bhavan.
  
• NIDHI: A Grand Challenge program (“National Initiative for Developing and Harnessing Innovations) shall be instituted through Innovation and Entrepreneurship Development Centres (IEDCs) to support and award USD 0.01 Million to 20 student innovations from IEDCs.
  
• Uchhattar Avishkar Yojana: A joint scheme that has earmarked USD 36 Million per annum towards fostering “very high quality” research amongst IIT students. The funding towards this research will be 50% contribution from MHRD, 25% from DST, and 25% from industry. This format has been devised to ensure that the research and funding gets utilized bearing in mind its relevance to the industry. Each project may amount to USD 0.7 Million only. This scheme will initially apply to IITs only.
  
• An entity incorporated or registered in India – in existence for not prior than 5 years
  
• With annual turnover not exceeding USD 3.6 Million in any preceding financial year
  
• Working towards innovation, development, deployment, or commercialization of new products, processes or services driven by technology or intellectual property.
  
• As per Action Plan 9, an exemption to persons who have capital gains during the year if they have invested such capital gains in the Funds recognized by the Govt. This will augment the funds available to various Venture Capitalists for investment in start-ups.
  
• As per Action Plan 10, eligible start-ups will be entitled to 3 year tax holiday for profits earned by them provided there is non-distribution of dividends. This is an income-tax holiday that can be availed for 3 out of 5 years of operations. Start-up shall be eligible for income tax holiday for 3 out of 5 years after it obtains certification from the Inter-Ministerial Board setup for such purpose.
  
• In order to provide a complete tax holiday, it may be clarified that profits of each year will be independently eligible to tax holiday without setting off past year’s losses and/or unabsorbed depreciation, if any.
  
• As per Action Plan 11, Tax Exemption on Investments above Fair Market Value:
  
  • Under The Income Tax Act, of 1961, where a Startup (company) receives any consideration for the issue of shares which exceeds the Fair Market Value (FMV) of such shares, such excess consideration is taxable in the hands of the recipient as Income from Other Sources.
    
  • In the context of Startups, where the idea is at a conceptualization or development stage, it is often difficult to determine the FMV of such shares. In the majority of the cases, FMV is also significantly lower than the value at which the capital investment is made. This results in the tax being levied under section 56(2) (vii b).
    
  • Currently, investment by venture capital funds in Startups is exempted from operations of this provision. The same shall be extended to investments made by incubators in the Startups.
    
• In order to grow the business, the start-up enterprise may incur substantial brand-building &Advertisement; Marketing and Promotion [AMP] expenses. If these expenses are written off, it may erode the net worth of the company whereas the benefit of such expenses may be realized over time. For this purpose, start-up enterprises may be given the option to defer brand building & AMP expenses and capitalize the same.
  
• The Action Plan is silent on the Applicability of Minimum Alternate Tax (MAT). It is important that these start-ups are exempt from MAT to actually avail of tax benefits. Also, it is not clear what happens when an investor sells shares of a start-up and earns capital gains.
  
• The Action Plan is silent on the applicability of indirect taxes including service tax. This needs better clarity.
  
• The Action Plan further provides that existing capital gain tax exemption for investment in newly formed manufacturing MSMEs by individuals shall be extended to all start-ups. Currently, such an entity needs to purchase ‘new assets’ with capital gains received to avail of such an exemption. It is also specified that investment in ‘computer or computer software’ (as used in core business activity) shall be considered as the purchase of ‘new assets’ to promote technology-driven start-ups.
  
• It would also further help if capital gains from the divestment of shares of start-ups are exempt from capital gains tax provided these are invested in another start-up. This can further help the funding of start-ups.
  
• It should be noted that the term ‘start-up’ is defined in the above part of the Plan with an annual turnover not exceeding USD 3.6 Million in any financial year. This limit is low and may be revised upwards as appropriate.
  
• One of the important conditions for being eligible as a start-up is that the entity is not formed by splitting up or reconstruction of a business already in existence. It is not clear if all the machinery should be new or say 20% of machinery can be old like in the case of a new industrial undertaking definition.
  
• In order to bring certainty and reduce unnecessary tax litigation, some or all of the aspects discussed above may be clarified in Union Budget 2016-17.
  
• Enabling start-ups (irrespective of the sector) to receive foreign venture capital investment (FCVI) and explicitly enable the transfer of shares from FVCI to other residents or non-residents.
  
• Permitting receipt of consideration amount in case of transfer of ownership on a deferred basis and also enabling escrow arrangement or indemnity arrangement up to 18 months Enabling online submission of A2 forms for remittances on the basis of form alone.
  
• Simplifying the process for dealing with the delayed reporting of FDI-related transactions by building a penal structure into the regulations.
  
•  Permitting start-up enterprises to access rupee loans under the ECB framework with relaxations in respect of eligible lenders, etc
  
• Issuance of innovative FDI instruments like convertible notes by start-up enterprises
  
• Streamlining of overseas operations of start-up enterprises.
  
• Issue of shares without cash payment through sweat equity or against legitimate payment owed by the company remittance of which does not require any FEMA permission
  
• Collection of payments by start-up enterprises on behalf of their subsidiaries abroad.
  
• The sweat equity limit for start-ups should be increased from 25% to 50% of paid-up equity share capital.
  
• Also, ESOP should be given to promoters who are working as employees or employee directors, or Whole time directors in case of start-ups. This will help the promoters to gain from an increase in further valuation of the company without in any way impacting the finances of the company during its initial years.
  
• Also, at present, private companies are permitted to accept deposits from their members’ deposits up to 100% of their paid-up capital and free reserves with relaxed compliance requirements. The Committee felt that with a view to ease in raising funds without additional compliance cost, for start-ups (which are private companies), the limits with regard to raising deposits from members may be removed for the first 5 years from their incorporation by using section 462 of the Act.
  
• The entity is not to be formed by splitting up or reconstructing a business already in existence.
  
•  In order to reduce the regulatory burden, Startups shall be allowed to self-certify compliance (through the Start-up mobile app) with 9 labor and 3 environmental laws.
  
• The Building and Other Constructions Workers’ (Regulation of Employment & Conditions of Service) Act, 1996
  
• The Inter-State Migrant Workmen (Regulation of Employment & Conditions of Service) Act, 1979
  
• The Payment of Gratuity Act, 1972
  
• The Contract Labor (Regulation and Abolition) Act, 1970
  
• The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952
  
• The Employees’ State Insurance Act, 1948
  
• In case of the labor laws, no inspections will be conducted for a period of 3 years
  
• The Water (Prevention & Control of Pollution) Act, 1974
  
• The Water (Prevention & Control of Pollution) Cess (Amendment) Act, 2003
  
• The Air (Prevention & Control of Pollution) Act, 1981