Startup India is a flagship initiative of the Government of India to promote and support the growth of startups in India. By providing various tax benefits, it aims to create an environment that is conducive to the growth of startups in the country. One of these tax benefits is Section 56 of the Income Tax Act (ITA), which provides certain exemptions or deductions to startups for their income. In this article, we will discuss the various tax benefits available under Section 56 of the Income Tax Act for startups in India.
What Section 56(2)(viib) of the Income Tax Act & DIPP Notifications says
Section 56(2)(viib) of the Income Tax Act states that any consideration received by a person from any investor in respect of issue of shares which exceed the fair market value of the shares shall be chargeable to income-tax as income from other sources.
The Department of Industrial Policy and Promotion (DIPP) issued a notification on May 19, 2016, to provide exemption to startups under Section 56(2)(viib) of the Income Tax Act, 1961. This notification is intended to exempt startups from the provisions of section 56(2)(viib) of the Income Tax Act, 1961, which states that any consideration received by a startup for the issue of shares in excess of the fair market value shall be taxable as income from other sources. The notification states that any consideration received by a startup for the issue of shares, which is in excess of the fair market value, shall be exempt from tax.
A Startup shall be eligible for exemption to clause (viib) of subsection (2) of section 56 of the Act if it fulfils the following three conditions which was issued by notification dated 19th feb 2019: (i) it has been recognised as startup by DPIIT
(ii) 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, twenty-five crore rupees:
Provided that in computing the aggregate amount of paid up share capital, the amount of paid up share capital and share premium of twenty five crore rupees in respect of shares issued to any of the following persons shall not be included─
(a) a non-resident; or
(b) a venture capital company or a venture capital fund;
Provided further that considerations received by such startup for shares issued or proposed to be issued to a specified company shall also be exempt and shall not be included in computing the aggregate amount of paid up share capital and share premium of twenty five crore rupees.
iii) It has not invested in any of the following assets, ─
(a) building or land appurtenant thereto, being a residential house, other than that used by the Startup for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
(b) land or building, or both, not being a residential house, other than that occupied by the Startup for its business or used by it for purposes of renting or held by it as stock-in trade, in the ordinary course of business;
(c) loans and advances, other than loans or advances extended in the ordinary course of business by the Startup where the lending of money is substantial part of its business;
(d) capital contribution made to any other entity;
(e) shares and securities;
(f) a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the Startup for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
(g) jewellary other than that held by the Startup as stock-in-trade in the ordinary course of business;
(h) any other asset, whether in the nature of capital asset or otherwise, of the nature specified in sub-clauses (iv) to (ix) of clause (d) of Explanation to clause (vii) of sub-section (2) of section 56 of the Act.
Provided the Startup shall not invest in any of the assets specified in sub-clauses (a) to (h) for the period of seven years from the end of the latest financial year in which shares are issued at premium.
Form-2 Declaration to DIPP As per the DPIIT Notifications, Startups that fulfil the conditions stipulated above must submit to the Department of Industrial Policy and Promotion (DIPP) a duly signed Form-2 declaration certifying that they indeed comply with said clause's requirements.
Revocation of Exemption Under Section 56(2)(Viib) of Income Tax Act
In case the Startup, that has submitted a declaration in Form-2 for exemption under Section 56(2)(viib) of the Act fails to fulfil above mentioned three conditions before the end of seven years from the end of the latest financial year in which the shares were issued at a premium, the exemption provided under Section 56(2)(viib) of the Act shall be revoked with retrospective effect.
The Tax Benefits of Startup India provided under Section 56 of the Income Tax Act are an invaluable source of relief and support for entrepreneurs across the country. The exemption from capital gains tax on investments made by angel investors and venture capitalists makes it more appealing for investors to back new startups, while the easy refund of taxes on profits reinvested in the business encourages entrepreneurs to reinvest in their own companies. Ultimately, the Tax Benefits of Startup India provided under Section 56 of the Income Tax Act provide a much-needed boost to the startup ecosystem and are essential for continued growth and development of the sector in India.
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