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DPIIT notifies new definition for startups and conditions for claiming exemption for the purpose of Section 56(2)(viib) of the Income Tax Act, 1961

NASSCOM Policy Brief

19.02.19

DIPP notification dated February 19, 2019

Exemption for the purpose of Section 56(2)(viib) of the Income Tax Act, 1961

In order to catalyze entrepreneurship by enabling angel investments into startups, a Gazette notification in partial modification of Gazette Notification G.S.R 364(E) dated April 11, 2018 was issued on February 16, 2019. However, concerns were expressed regarding taxation of angel investments and there were issues that needed to be addressed to ensure availability of capital to Startups.

With a view to address these concerns of stakeholders, the Department for Promotion of Industry and Internal Trade (DPIIT) in consultation with Ministry of Finance (MoF) has released Gazette Notification No. G.S.R 127(E) [“new notification”] in supersession of Gazette Notification No. G.S.R. 364(E) dated April 11, 2018 as modified vide Gazette Notification No. G.S.R. 34 (E) dated January 16, 2019.

Key amendments:

  1. Widening the definition of startups – The period for which an entity shall be considered as startup has been increased from 7 years to 10 years and turnover limit has also been increased to INR 100 crores. This would allow the benefits to be available to a large pool of startups.
  2. Composition of Inter- Ministerial Board of certification (“Board”) – The Board will now be a 3-member committee instead of earlier 8 member committee. The new Board shall comprise of members from DPIIT, Department of Bio-technology and Department of Science & technology.
  3. Certification for the purpose of section 80-IAC of the Act – Section 80-IAC provides for 100% deduction from profits and gains for a period of three consecutive assessment years out of seven years. As per the new notification, a Startup being a private limited company or limited liability partnership fulfilling conditions specified in sub-clause (i) and sub-clause (ii) of Explanation to section 80-IAC of the Act may apply for certification. However, as per sub-clause (ii) of Explanation to section 80-IAC, an entity should have a turnover less than INR 25 crores. This may require amendment in Income Tax Act to synchronize with the conditions specified in the new notification. Further, certification for the purpose of section 80-IAC shall be done by the Inter- Ministerial Board of certification.
  4. Conditions to be fulfilled by startups for claiming exemption for the purpose of section 56(2)(viib) of the Act – A Startup shall be eligible for notification under clause (ii) of the proviso to section 56(2)(viib) of the Act and consequent exemption from the provisions of that clause if:
  • The entity has been recognised by DPIIT
  • Aggregate amount of paid up share capital and share premium of the startup after issue or proposed issue of share, if any, does not exceed, INR 25 crores
  • It has not invested money in certain assets specified (such as residential building and land appurtenant, capital contribution to other entity, shares, motor vehicle or any mode of transport cost of which exceeds INR 10 lakhs, jewellery, etc.)
  1. Exemptions for calculating aggregate amount of paid up share capital and share premium of the startup: The amount of paid up capital and share premium received from the following persons shall not be included in calculating the limit of INR 25 crores:
  • a non-resident
  • a venture capital company or a venture capital fund as defined in explanation to section 56(2)(viib;
  • specified company – A company whose shares are frequently traded within the meaning of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and whose net worth on the last date of financial year preceding the year in which shares are issued exceeds INR 100 crore or turnover for the financial year preceding the year in which shares are issued exceeds INR 250 crores.
  1. Declaration to be filed by startups – A startup fulfilling conditions as specified in the new notification shall file duly signed declaration in Form 2 to DPIIT, which shall then forward the same to Central Board of Direct Taxes.
  1. Scope of exemption from section 56(2)(viib) of Income Tax Act – The exemption shall apply irrespective of the dates on which shares are issued by the Start up from the date of its incorporation, except for the shares issued in respect of which an addition under section 56(2)(viib) of the Act has been made in an assessment order made under the Act before the date of issue of the notification. Further, notification referred to in para 4 shall apply only in respect of startups and shall not grant any exemption in respect of applicability of other provisions of the Act. Hence, no recourse has been provided for startups where tax demand has already been raised by the income tax department.
  1. The requirement for the Start-up to obtain a merchant banker report has been removed – As per the last notification, startups were required to provide justification for valuation of shares along with supporting documents. The new notification has done away with this requirement, making it easier for startups to claim exemption. However, there is no clarity on whether the Income Tax department will accept or question the valuation of shares submitted by startup.
  1. Financial limit for investors has been removed – DPIIT has also done away with the financial limits specified for an investor to invest in startup. This addresses a concern faced by small investors desirous of making investments in startups.
  1. No clarity on the time limit and form for seeking approval from CBDT for exemption under section 56(2)(viib) – Earlier, a time bound approval process was laid down requiring CBDT to either grant/ decline approval within 45 days. The new notification does not specify the time period within which CBDT may be required to process the application granting/ rejecting approval. Further, no format for applying for the exemption has been notified in the new notification.

The new notification will be effective from the date of its publication in Official gazette (i.e., February 19, 2019).

Next steps:

Startups fulfilling the above conditions shall be notified as “Class of Persons” under clause (ii) of the proviso to clause (viib) of sub-section (2) of section 56 of the Act. For the new notification to take full effect, it will be important to wait for corresponding notification under Income Tax Act.

NASSCOM’s earlier policy brief on DIPP notification dated January 16, 2019 is accessible here https://community.nasscom.in/communities/policy-advocacy/government-eases-conditions-to-avail-safe-harbour-from-angel-tax.html`

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