Tax Exemptions for Startups in India | Complete Guide (2024)

Tax Exemptions for Startups in India

India has seen a rise in entrepreneurial spirit lately, thanks in part to the government’s proactive steps in encouraging innovation and business growth. The government’s Startup India Tax Exemption initiative provides tax benefits which is a crucial aspect of this initiative customized to aid startup growth.

Eligible startups can enjoy a full exemption from taxes on their profits during this time, allowing them to reinvest in their businesses, fueling expansion and growth. This program encourages entrepreneurship and innovation, creating more job opportunities for the youth and opening new avenues for development in the country.

In their beginning years, startups struggle with money while they work on making their ideas into successful businesses. They spend money on things like rent, equipment, salaries, and taxes, usually using the savings of the entrepreneur. To help startups succeed and encourage more people to become entrepreneurs, it is important for the government to lessen the financial load on them.

This program offers various perks like tax benefits to eligible startups. This blog breaks down who can benefit and how, making it easier for budding entrepreneurs to understand the tax benefits available to Indian Startups.

To know more on how to set up your startup effectively to take advantage of these tax exemptions, read our guide on how to start a startup in India and the ultimate legal checklist for startups in India.

Eligibility Criteria for Startups to qualify for Tax Exemptions

To qualify for taxation and access other government perks, a startup needs to meet the following criteria:

• The company’s age must be under 10 years. In simpler terms, it should have been incorporated/registered for less than 10 years.
• The company must be registered as either a private limited company, limited liability partnership, or partnership firm to avail startup-related benefits.
• Its annual turnover for any year following incorporation should not exceed ₹100 crores.
• The startup must be actively engaged in developing and innovating products and services.
• The company should not have been formed through the reconstruction or splitting up of an existing company.

Department for Promotion of Industry and Internal Trade (DPIIT) Startup Recognition

To benefit from the Startup India Scheme, startups need to register with the Department for Promotion of Industry and Internal Trade (DPIIT), a process facilitated through the Startup India website.

After registration, startups can apply for a range of benefits, including tax exemptions, patent filing, and funding support, using the Startup India portal. Applications undergo evaluation by a panel of experts. Upon approval, the startup receives a certificate recognizing it as a “startup” and gains access to the scheme’s benefits.

For tax exemptions, startups can enjoy a tax holiday for three consecutive years within their initial seven years of operation. This tax relief is applicable solely to startups incorporated as private limited companies or limited liability partnerships (LLPs) with a turnover of less than Rs—100 crore in any of the seven years since incorporation.

Furthermore, startups are exempted from paying income tax on investments received from venture capital funds or angel investors. However, this exemption is solely available for investments made in eligible startups recognized under the Startup India scheme.

To access these benefits, startups must adhere to various regulations, including maintaining accurate accounting records and timely filing of income tax returns.

Budget 2024-25

The government, through Finance Minister Nirmala Sitharaman, has proposed tax benefits for startups and pension funds in the Interim Budget 2024-25. In her Budget Speech, Sitharaman noted that certain tax benefits for startups and investments made by pension funds, along with tax exemptions for specific income of IFSC (International Financial Services Centre) units, are set to expire on March 31, 2024. To ensure continuity, she suggested extending the deadline to March 31, 2025.

Presently, approximately 1.17 lakh startups have received recognition from the government. This extension is like a helping hand for all these Indian startups, keeping them going for another year despite the slowdown in global funding. It is important for keeping things stable and allowing our startups to keep growing.

Tax Incentives and Exemptions for Startups

We have introduced to various tax benefits and exemptions for startups in the country. Below are the different available:

1. Three-Year Tax Holiday: Startups established or registered between April 1, 2016, and March 31, 2025, are eligible for a complete tax exemption on their profits for a three-year tax holiday at any point within a ten-year period post-incorporation. However, their annual turnover should not exceed 100 crores. This tax holiday aids startups in launching their ventures without financial constraints, managing their expenses and reach profitability sooner, leading to increased profits later. Startups set up before March 31, 2023, could enjoy a three-year tax break under Section 80-IAC. Now, with the deadline extended by one year, startups established by March 31, 2025, can benefit from this. This extra time gives new startups a chance to access tax relief, possibly boosting entrepreneurship and business growth. To qualify, startups must register with the Department of Industrial Policy and Promotion (DIPP), having an annual turnover below Rs. 100 crores in the previous year and obtaining a certificate of eligible business from the Inter-Ministerial Board of Certification.
2. Exemption on Long-term Capital Gains: Capital gains tax is a fee charged on profits earned from selling assets like stocks, bonds, and real estate. In India, the tax rate varies depending on the type of asset and how long it has been held.

According to the Income Tax Act, eligible startups can claim exemption from long-term capital gains tax by reinvesting gains in specified funds within six months of the transfer date.

The maximum investment allowed is 50 lakhs, which must remain invested for three years to retain the exemption.

To be eligible for this exemption, startups must meet specific requirements:

• Recognition by DPIIT: The startup must be acknowledged by DPIIT under the Startup India initiative.
• Date of Incorporation: The startup should be established between April 1, 2016, and April 1, 2021.
• Nature of Business: The startup must engage in an “eligible business” focused on innovation, development, or scalable business models with substantial potential for employment or wealth creation.
• Shareholding: Non-residents of India should not hold more than 25% of the startup’s total capital.
• Turnover: The startup’s turnover should not exceed Rs. 100 crores in any previous year.

Once a startup meets these criteria, it can enjoy a tax exemption on long-term capital gains from selling shares or units for up to 10 years from its incorporation date.

1. Angel Tax Exemption: Investments exceeding the fair market value by angel investors, incubators, and non-registered venture capital (VC) funds are tax-exempt. This exemption provides startups with additional operational funds. Certain exemptions to the fair market value rule encourage tax-free investments in startups, promoting their growth. One key exemption, Section 56(2)(viib) of the Income Tax Act, allows private companies to issue shares to resident individuals or domestic companies at prices exceeding fair market value without incurring tax liabilities. To qualify, startups must meet specific criteria, including turnover not exceeding Rs. 25 crores, engagement in eligible businesses, and approval from the Department for Promotion of Industry and Internal Trade (DPIIT).

1. Relaxation in taxation of Employee Stock Options for the startups’ employees: If an eligible startup issues ESOP to its employees on or after April 1, 2020, a tax deduction is applicable. However, according to the Finance Act, this has been deferred pending fulfilment of certain conditions.

These tax advantages, coupled with other incentives, have fostered the growth potential of startups. Some notable provisions include:

• Simplified startup registration procedures,
• Streamlined patent application processes and improved tracking mechanisms to support innovation,
• Relaxed regulations for External Commercial Borrowing, and
• Enhanced access to funds through Alternate Investment Funds.

Startups can encourage employees to invest in life insurance policies with term insurance benefits to safeguard their family’s financial well-being and avail tax benefits on their income.

1. Tax exemptions for Individuals/Hindu Undivided Family (HUF): Individuals or HUFs selling residential property can invest proceeds in eligible startups or SMEs to be exempt from long-term capital gains tax under [Section 54GB](https://www.bajajfinserv.in/section-54gb-of-income-tax#:~:text=This provision aims to promote,ups within the specified timeframe.).

As per tax regulations, any long-term capital gains arising from the sale of a residential property, when invested in a startup, are eligible for income tax exemption under the following conditions:

• The capital gains must be utilized to subscribe to 50 percent or more equity shares in the startup.
• The acquired shares cannot be transferred or sold within five years from the date of acquisition.
• If the startup uses the invested funds to acquire assets, those assets must not be transferred for five years from the date of purchase.

This serves to contribute to the expansion and development of the business.

1. Set-off of Carry Forward Losses Allowed: Startups can carry forward losses under Section 79 of the Income Tax Act if shareholders holding voting power on March 31 of the relevant year retain their shares. Losses can be carried forward for up to seven years from the company’s incorporation date. However, Section 80-IAC (2) currently specifies a timeline of 10 years from the company’s incorporation for this purpose.

The proposed extension from seven to ten years aligns with the mentioned provisions of the IT Act. This change benefits startups in several ways:

• Offers much-needed relief for startups facing financial challenges in their early years.
• Provides startups with a longer time frame to recover and utilize their losses effectively.
• Enables startups to lower taxable income and reduce tax obligations, allowing for more capital reinvestment and improved financial planning.
• Enhances cash flow management and financial planning for startups.
• Promotes greater financial stability, enhancing creditworthiness and increasing opportunities to secure loans and investments by reducing tax liability.

Key Takeaways

The Indian government knows that helping entrepreneurs with taxes is key to driving innovation. These rules make it easier for entrepreneurs to get tax breaks and funding, helping them build successful companies.

Startup India has made it easier for startups to thrive in India. One big perk is tax exemptions, which lighten the financial load for startups. Understanding the rules, taxes, and benefits is important for startups to grow smoothly. Taking advantage of tax breaks shows that the government supports growth.

By understanding and using these rules, startups can save money on taxes in India, setting themselves up for success with a clear focus on innovation and doing good.

With these tax breaks under Startup India, the government aims to create a better environment for new businesses. The three-year tax relief has boosted the spirits of Indian entrepreneurs, making them feel more confident in taking risks in the market. With the government’s support for startups meeting the criteria, aspiring entrepreneurs have plenty of opportunities for growth and success.