Wednesday, March 16, 2016

One Tax Issue Severly Affecting Startup Still Not Solved by Government !

While the scheme of creating,funding and running a new startup in India is becoming easier better and tax incentives for startups have added bonus  , thanks to the vision of Sri Narendra Modi , one tax issue that will hover over the head of the startups in India remain to be solved. Noteworthy is the fact that the government recognized this problem on its own and the vision document mention this problem. However the , problem is left untouched as the Finance Bill 2016 does not mention any thing.

What is  the tax issue affecting startups?

Startups need funding. The investors buys the shares in expectation of return in future years . So , initially when the startups are not earning or generating profits , the Fair Market Value of share of startup is low. Now , if investors pays premium for acquiring shares in hope of a decent return in future , which is a case in most of startups , will create problem for startups on account of a provision under Income Tax Act. In other words  Section 56(2)(viib) of Income Tax Act is an issue because it provides that  if an unlisted company issues shares at a premium, the difference between Fair Market Value and the issue price is added income of the unlisted company. Relevant Section 56(2)(viib) of I.T.Act is given as under :

 (viib)   where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:

  Provided that this clause shall not apply where the consideration for issue of shares is received—
(i)   by a venture capital undertaking from a venture capital company or a venture capital fund; or
(ii)   by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

This is a big bottleneck for growth of the start-up companies . So, government actually recognized this in Point 11 of the Action Plan published by DIPP  which is given below :


To encourage seed-capital investment in Startups Details Under 

The Income Tax Act, 1961, where a Startup (company) receives any consideration for issue of shares which exceeds the Fair Market Value (FMV) of such shares, such excess consideration is taxable in the hands of recipient as Income from Other Sources. In the context of Startups, where the idea is at a conceptualization or development stage, it is often difficult to determine the FMV of such shares. In majority of the cases, FMV is also significantly lower than the value at which the capital investment is made. This results into the tax being levied under section 56(2) (viib). Currently, investment by venture capital funds in Startups is exempted from operations of this provision. The same shall be extended to investment made by incubators in the Startups.

So, the government is expected , when the problem is visualized , to resolve the tax issue for the stratups

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