By Anusmita Mazumder, Department of Law, University of Calcutta.

What is a startup and how do they work?

A startup company or a startup is an entrepreneurial venture or a new business in the form of a company, partnership or a temporary organisation which is designed to target those sectors which are believed to be in demand and might prove to be innovative in the process of development.

Beginning any business requires a considerable amount of investment and the smooth running of it needs a steady cash flow. So, money is the most important factor for every business, even for startups. Most startups begin operating on seed-funding. Seed-funding or seed capital, as the name suggests, means the money used at the earliest stage of business for the initial market research and product development. It is a form of securities offering in which an investor invests capital in exchange for an equity stake in the company. Seed money comes usually from the family funding or friends, angel investors, venture capitalists, crowdfunding or government programmes.Venture Capital investment mostly takes place after the seed or angel funding. It is considered growth funding because it generates a return, when the start-up goes for an IPO, trade sale, strategic investment, etc.

The current scenario in India

Some of India’s most successful startups include Flipkart, Ola, PayTM, Quickr, Zomato, etc. India is ranked third in the global startup ecosystem.  However, experts estimate that nearly 90% of start-ups fold up in the first two years of their inception due to lack of funding support. According to the present provisions, capital raised by an unlisted company from any individual against an issue of shares in excess of the fair market value is taxable as “income from other sources” under Sec 56(2) of the Income Tax Act. The Finance Act, 2013 imposes tax on seed capital provided to startups by domestic angel investors. Thus, a start-up raising money from angel investors is deprived of 33 per cent of its initial investment as tax. “Raising initial rounds of funding is hard for any company. The tax creates an unnecessary burden on startups,” said a co-founder of the Gurgaon-based Rocket Internet. As a result, a sizeable number of start-ups move to Singapore and the UK where such taxes are milder.

The tax provision in question treats infusion of funds by domestic angel investors as income in the hands of the start-up, making India the only country in the world to penalise local angel investors in such a manner. Senior government officials working on the Start Up India action plan said, “Tax is one of the key reasons that 90 per cent of Indian start-ups are financed by foreign venture capital and angel funds. We have decided to iron out many of the regulatory issues that are deterring access to finance for start-ups and forcing them to look overseas for funding. We are definitely keen to do away with the tax provisions that characterise angel investments into a new venture as the investee company’s income, thus taking away roughly 30 per cent of the investment from the start-up’s cash flow as it is taxed.”

The innovative Startup Action Plan

Prime Minister Narendra Modi launched the Startup India Plan on January 16, 2016 to facilitate startups in India, announcing a string of concessions and programs to encourage fledgling enterprises.

Salient features of the start-up plan as announced by Prime Minister Narendra Modi:-

  • Self certification based compliance system in respect of 9 labour and environment laws introduced for start-up business;
  • No inspection for 3 years of start-up businesses in respect of labour, environment law compliance post self-certification;
  • 80% reduction in patent filing fee and fast-track mechanism for start-up patent applications. Also, a panel of legal facilitators for startups to file IP (patents, designs, trademarks) with costs borne by government;
  • Rs. 500 Crore per year credit guarantee;
  • A dedicated fund of Rs.10,000 Crore corpus to backup the startups;
  • Start-ups to get 3 year Income Tax holiday;
  • Capital gains tax to be exempted for venture capital investments;
  • Faster Exit for Startups within 90 days;
  • Relaxed norms of public-procurement for startups. No requirement of turnover or experience, but no relaxation in quality;
  • Rolling out of a Mobile App & Portal – Starting a Startup in 1 day on a Mobile App;
  • 5 lakh schools and 10 lakh students to be involved in core innovation programmes. National and international startup festivals to provide visibility;
  • Atal Innovation Mission (AIM) for promotion of research and development including 500 tinkering labs, 35 public-private sector incubators, 31 innovation centres at national institutes, 7 new research parks, 5 new bio-clusters;
  • A Startup India Hub – a single point of contact for interactions with the government.

Tax exemption on investments above fair market value- In line with the exemption available to venture capital funds to invest in startups above fair market value (FMV), investments made by incubators above FMV shall also be exempted. Tax exemption on capital gains – Exemptions shall be given in case capital gains are invested in the Fund of Funds recognized by the government. Funding support through the Fund of Funds with a corpus of INR 10000 cr – to provide funding support for development and growth of innovation driven enterprises, Government will set up a fund with an initial corpus of INR 2500 cr and a total corpus of INR 10000 cr over a period of 4 years.

Intending to provide a major boost to India’s start-up world, the Finance Minister of India, Arun Jaitley said the country will finally come out of the conventional license raj system and act as a key facilitator for the entrepreneurial spirit in the country. For the startups looking to raise funds at the initial stage, the government will, in the next Budget, scrap the tax on seed funding by angel investors, which has been identified as a major impediment for entrepreneurs to get domestic funds.

The Plan has been acclaimed widely by a host of the nation’s top entrepreneurs. Nidhi Agarwal, CEO & Founder, KAARYAH.com said, “Startup India has been a very motivating event that has brought to the fore the power of India’s startup ecosystem.”  Rohan Bhargava, Co-founder, CashKaro.com said, “ Increased access to funding was a key expectation from this Plan and the Rs 10,000 Fund of Funds corpus is likely to be a huge support for startups.” Shamit Khemka,  the regional director of Entrepreneurs’ Organization, South Asia, CEO & founder of an IT company – SynapseIndia, and Co-founder of a food portal – Foodcloud, stated, “What Mr Modi rightly pointed was that entrepreneurs are scared of government interference, which will change as there will be less interference and more support. The self-certification is a great example of less interference and the capital gains and income tax exemptions along with the startups fund of funds a great example of support.” Radhika Aggarwal, Co-founder & CBO, Shopclues stated her approval by saying, “The policies around cleaning the license raj will be a huge booster for Startup community while both setting up and dissolving a company. Other initiatives such as tax benefits, easy IPR regulations, and government academia will go a long way in making India’s startup ecosystem super successful.”

Conclusion

The Start-up India Plan is a grand initiative on the part of the government to build a strong ecosystem for nurturing innovation with a view to driving sustainable economic growth and generating large-scale employment opportunity. India with a rapidly growing number of Internet users is seen as the world’s largest growing startup hotspot. Though most of the points mentioned in the Plan require actual approval of the Legislature to be implemented, yet it at least showed that the Government understands the needs of the entrepreneurs.