Let's start 'em up in Budget 2017: How entrepreneurship fared in 2016

We all start small – that’s the way of life – and like the legend of David taking over the mighty Goliath, startups are doing the same in the modern business arena. To start with, startups may be small companies, but play a significant role in economic growth. They create jobs, which leads to more employment, which in turn means an improved economy. Startups also contribute to economic dynamism by spurring innovation and injecting competition. Beyond the boundaries of the corporate world, they have a far-reaching ripple effect on the socio-economic fabric of the demography in which they operate. Realising the importance and the transformational power of startups, the Government has been laying down policies to create a business environment conducive for startups to flourish. In his budget speech of 2016-17, the Finance Minister gave a fillip to startups by proposing a 100 percent deduction of profits for three out of five years for startups set up between April 2016 to March 2019. He also proposed that the capital gains tax would not be taxed if invested by individuals in regulated fund of notified start-ups, in which they hold majority shares, wherein the maximum investment allowed is upto 50 lakhs. Further, it was also announced that the registration of the companies will be done in one day and that Companies Act, 2013 will be amended to improve the enabling environment for start-ups. [caption id=“attachment_3239176” align=“alignleft” width=“380”]  Representational image[/caption] The Budget allocated Rs.1100 crores toward ‘Start-up India, Stand-up India’ initiative (“Initiative”) launched by the Government to give a push to the start-up ecosystem. This Initiative incorporates a 19-point action plan which provides incentives such as self-certifying certain compliances for labour and environmental laws, a 3-year tax holiday and concessional rates of duties for startups operating in the manufacturing and biotechnology sectors. Implementation and challenges During the year 2016-17, the Government took a number of steps towards facilitating ease of doing business for startups. The Norms under foreign exchange laws have been relaxed to allow startups to raise external commercial borrowings. Foreign Venture Capital Investors (FVCIs) who, hitherto, could invest in only certain specified sectors have now been permitted to invest in all startups, irrespective of the sector. Startups are permitted to issue sweat equity shares up to 50 percent of their paid up capital as against other companies which are restricted from issuing sweat equity shares in excess of 25 percent of their paid-up capital. Startups have been permitted to issue ESOPs to their promoters and directors who hold more than 10 percent unlike other companies who are restricted from doing so. The Companies Act was amended to enable startups to borrow up to Rs 25 lakhs by way of a convertible note in a single tranche without the same being treated as a deposit. The Government has undertaken to bear the employer contribution to EPF up to 8.33 percent for all new employees for three years. Startups having subsidiaries outside India have been permitted to open foreign currency bank accounts overseas for crediting their foreign exchange earnings arising out of exports/sales made by the overseas subsidiary. Despite the impetus given to startups by the Government, several proposals still remain in consideration like streamlining of overseas investment operations for startups, setting up alternative institutional trading platforms under Sebi to enable assistance to startups in the listing process and in raising funds in the domestic market, fast tracking the examination and disposal of patent applications, development of mobile applications to establish single window clearance for easing compliance burden. Similarly, on the fiscal front, though the startups can claim 100 percent deduction of profit for the first three years, however, they are subjected to Minimum Alternative Tax (“MAT”) at the rate of 18.5 percent, which effectively nullifies the tax benefit provided to them. MAT should, therefore, be exempted for startups. Also the treatment of investments made by Private Equity and Venture Capital in unlisted shares should be clarified as to whether sale of such investments resulting in change of control or management would constitute capital gains or business income. Though the CBDT has recently clarified that change of control or management should not be applied in case of investments by AIF who invest in unlisted shares of startups with some form of control and management of the business. Having said this a specific legislative clarification would be desirable in order avoid any interpretational ambiguity especially since the impacted parties are predominantly startups. The DIPP has proposed that the employee stock option plans (ESOPs) for start-ups should be taxed at the time of sale of these stocks. Larger start-ups can now rejoice since this would provide them with transparency from a valuation perspective as well as further boost their liquidity from a tax outflow perspective. In addition to witnessing actual implementation of the proposals, at the dawn of the upcoming budget, startups are hoping to benefit from the Government through increased reforms across all sectors. Some possible ways to support such growth could perhaps include expansion of digital finance, exploring avenues of enabling startups to meet global customers and investors alike, and building smart cities which could lead to increased opportunities for entrepreneurs. (The authors are partners at HSA Advocates) For full coverage of Union Budget 2017 click here.