While there have been sops and benefits provided to start-ups by the Government since the formal launch of the Startup India initiative in 2016, there have been a bevy of demands and requests from the industry to increase and better streamline the benefits and assistance. It is during the recent Budget announced in February 2017 (“Budget”) by the Finance Minister, which seems to be in-line with the Government’s vision and policies regarding the investment ecosystem so far, that a few important and forward looking changes have been announced, which should definitely give boost and impetus to the start-up ecosystem in India. Following are the key changes proposed in the Budget in this regard.

Tax Break Timeline

One of the important changes made by the Budget provides that start-ups recognised under the Startup India policy (essentially, recognised by the DIPP or the Department of Industrial Policy & Promotion) should now be able to claim tax benefits in 3 out of the first 7 years from the date of their incorporation (instead of the earlier period of 3 out of the first 5 years) under Section 80-IAC of the Income-tax Act, 1961. It is pertinent to note that the Government had in fact received several representations from the industry on the same and heeding to the logic that start-ups rarely make profits during the initial years of their operations made this concession. This is definitely a welcome move and may encourage more start-ups to register under the Government’s Startup India initiative.

Carry Forward of Loss

Another change has been made with respect to carry forward of losses. Under Section 79 of the Income Tax Act, 1961, a company is allowed to carry forward losses for a period of 7 years and set-off against profits of future years. However, there existed a restriction which did not allow the carry forward and set-off in case 51% shareholding of the said company did not remain intact in the year of loss and in the year of the set-off. Since start-ups operate in a rapidly changing environment requiring multiple rounds of funding resulting in constant changes to their shareholding patterns, this resulted in start-ups not being able to meet the criteria set in Section 79. Now the Budget has permitted recognised start-ups to carry forward and set-off of losses even if the majority shareholding has changed hands, provided the shareholding of the promoter(s) of the start-up continues to remain unchanged. Permitting carry forward despite the changes to the shareholding is a welcome move since we have seen an increase in investments and buy-outs in the start-up ecosystem during recent times which result in substantial changes to the shareholding pattern of such start-ups.

Minimum Alternative Tax

The industry was expecting the removal of the Minimum Alternative Tax (“MAT”), however the Budget has merely allowed companies to carry forward their MAT to 15 years from the

present period of 10 years. MAT is the minimum amount of tax (based on the registered book profit) that a company has to pay irrespective of its size and turnover and is around 20%. It is important to note that book profit may be very different from the net profit of the company as it does not take into consideration certain deductions or exemptions, hence, it is entirely possible that even if a start-up is making book profit, it may actually be incurring net losses too. Having said that, though this is not what the start-up industry expected (the expectation was for an exemption from MAT) it does give start-ups an additional time of 5 years to claim the MAT credit.

Capital Gains on Conversion of Preference Shares

The Budget has also made a significant positive change by abolishing capital gains on the conversion of preference shares into equity shares, which should give a shot in the arm to investments in start-up (and in other companies as well). The Budget has exempted conversion of shares from preference to equity from being considered as a ‘transfer’ and hence liable to capital gains. This should come as a big relief to start-up investors who prefer making their investments using convertible preference share due to a variety of reasons and should increase investments in start-ups.

Reduced Corporate Tax

The Budget has made a big change by reducing the corporate income tax for Micro Small and Medium Enterprises) (which apparently covers over 96% of such companies in India) from FY 2017-18 onward to 25% from the current rate of 30% for all companies that had a turnover or gross receipts up to INR 500 million in FY 2015-16. This would directly result in reduced tax outgo for such companies, resulting in better margins and their becoming more attractive to investors.

To sum up, though the Budget did not exactly meet all the expectations of the start-up industry, it would not be entirely wrong to say that the Budget did bring some much needed relief to the start-up ecosystem like a cool shower during an Indian summer.