Tax planning for start-ups

Union Budget Overview

The much-awaited Union Budget 2017-18 seems to have maintained a right balance between populism and fiscal prudence. However, a few sectors like insurance and e-commerce felt disappointed as they hardly found a place in it. With an agenda to Transform, Energize and Clean India, the budget of this year focused primarily on the long-term benefits of the country.

The formal inauguration of the “Startup India” campaign last year and the demonetization drive followed by an aggressive push towards digital economy made the start-ups and SMEs to expect highly from the upcoming budget. Though most of their expectations remained unfulfilled, a few measures have been taken, which can be quite beneficial for the startups.

Let’s see what the Union Budget 2017 has offered to incentivize and encourage start-ups in India.In the last few years, government is encouraging the start-up businesses by announcing various incentives and tax exemptions. The taxation policies of the government have also witnessed lot of changes. The Govt launched the Start-up India Action plan to boost the start-up culture and encourage entrepreneurship. Apart from measures like simplification of registration process, low-cost patent registration, setting up of Rs. 10,000 crores start-up fund, setting up of research parks, faster exit norms, government action plan also included tax exemptions to start-ups in the form of exemption from income-tax and capital gain taxation.

But in order to tap the benefits of such policies and incentives announced by the government, it is very important to thoroughly understand and analyse them.

Following are the key highlights of various tax incentives announcedby the government that can help start-ups in doing effective tax planning for 2017-18:

1. Tax Holiday enhanced to 7 Years in Budget 2017

A start-up company or Limited Liability Partnership (“LLP”) incorporated after April 1, 2016 has the option to claim tax deduction of 100% of the profit earned in three consecutive years out of seven years beginning from the year of incorporation. Since most start-ups take time to make profits, it is certainly a positive move. The exemption can be claimed only if following conditions are satisfied:

• Engaged in a business involving innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property (‘Eligible Business’).
• Company should hold a certificate of eligible business from the Inter-Ministerial Board of Certification as notified by Central Government.
• Incorporated between 1st April 2016 and 31st March 2018.
• Turnover of which does not exceed Rs. 25 Crores in any of the years from Financial Year 2016-17 to Financial year 2022-23.
• It is not formed by splitting up, or the reconstruction, of a business already in existence.
• At least 80 percent of the plant and machinery of the start-up should be new.

2. Capital Gain Exemption in respect of LTCG proceeds invested in specified start-up fund

The government has established a specified fund called fund of fundswhich intends to raise Rs 2500 crores annually for four years to finance the start-ups.

The long term capital gain of start-ups would be exempted if the long term capital gain proceeds are invested in such specified fund subject to a condition that amount remains invested for a period of 3 years failing which exemption shall be withdrawn. The investment in the units of this specified fund shall be allowed up to Rs. 50 lakh.

Also, long term capital gain arising to individual and HUF will be exempt if the long term capital gain proceeds are invested in subscription of the shares of an eligible start-up company. This will promote investment in start-up companies.

3. The condition for Carry Forward of Losses relaxed in Budget 2017

A company is allowed to carry forward losses for up to 7 years and then set off against profit after 7 years. But the carry forward of losses was allowed only if there was 51% shareholding intact in the period of loss. This condition has been relaxed in the budget 2017. From now onwards, in order to carry forward losses, only the founders need to hold shares. This measure taken by the government would be very beneficial for start- ups due to frequent changes in their investments and buy- outs.

4. Reduction in corporate Tax rate to 25% in case of companies having turnover less than Rs 50 crores

In order to make medium and small companies more viable and competitive, the income tax rate oncompanies with annual turnover up to Rs 50 Crores has been reduced to 25% instead of existing rate of 30%.A large number of medium and small enterprises will benefit from this change.This is a very welcome step for all start-ups and small and medium enterprises functioning under the company format.

5. Extended Period for carry forward of Minimum Alternate Tax(MAT)

Start-ups are exempt from income tax under Section 80-IAC but are liable to pay MAT (Minimum Alternative Tax). Currently, the government announced that it cannot abolish MAT. It will, however, extend the time period for availing MAT credit to 15 years from the current limit of 10 years. This will benefit start-ups claiming tax exemptions and those that having a huge MAT credit lying unused.

What Else We Expected but Didn’t Come True

Most startups provide ESOPs or Employee Stock Ownership Plan to their employees additionally with their salary. ESOPs are beneficial as the startups do not earn much profit in the initial years. Hence, ESOPs are provided to compensate for the low amount of salary the employees receive. But as the company grows and the employees want to liquidate the ESOP, a significant amount goes out as tax at the time of selling out the shares. Therefore, we expected that ESOPs will be made tax-free in the hand of employees. Unfortunately, no such measure is taken by the government to incentivize on the practice of giving ESOPs for the financial benefit of the startup employees.

Moreover, currently, any capital gain arising out of shares held more than a year is tax free, if STT is paid even at the time of selling shares. But in the budget, it was announced that Long Term Capital Gain benefit can only be claimed if STT is paid at the time of acquisition of shares. This will have a negative impact on the start-ups which are going to be listed in the coming years.


The finance minister also made an announcement in the budget to abolish FIPB. Instead, the government should have taken serious measures to strengthen FIPB in the direction of providing better funding to startups or new age companies.

Startups are the backbones of economic growth leading to more job creation in the country. Hence, more tax reforms and benefits were expected for the growth of startups in India.

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