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Budget 2012: Startups Gain A Little But Lose A Lot

19 March, 2012

Finance minister Pranab Mukherjee has driven a nail through the heart of the startup business community in India while trying to apply the plain old pain balm at the same time. But this is unlikely to be much of a palliative unless the nail is taken off.

In particular, startups are affected by four specific measures stated in the Budget which would have direct (or close indirect) impact on them. These include taxation of funds raised for investment (Yes! You have read it right); relaxation of auditing rules for smaller-sized entities (if you are really a tiny firm, you can skip auditing and thereby, the cost); tax benefit for an investor who needs to park the money after selling his real estate property in order to invest in a startup (but there are riders, more on that later) and finally, a proposal that would boost venture capital and private equity investments in general, through extension of pass-through tax benefit across sectors. Now, let us take a close look at them.

Devil In The Budget: Pay Tax On Funds Raised For Investment!

First things first. The government has done what is probably unheard of in the annals of taxation. Private companies who raise funds from individuals against shares (mind you, not equity convertible instruments) over and above the face value (or fair market value) of those securities, will have to pay tax on the money raised starting from April 1, 2013 (no, it’s not a joke in advance).

The gem of an idea to tax growth capital must have been driven by the need ‘to prevent generation and circulation of unaccounted money.’ But instead of simply assessing individual investors who back such startups, the government has chosen to impose the tax on the investees (for more on this, read).

But there are ways for startups to get around the problem if they are not bootstrapped for a marathon. Startups can seek individual investors (after all, angel investors also need to invest, hoping to find the next big thing) who form entities through which they can invest; they can raise money from individual investors via the equity convertible route (such as convertible debt); they can look for angel investors outside India (hello Dave McLure, Ashton Kutcher); or they can chase seed funds for early-stage capital (after all, not every startup gets an angel investor) besides trying to crack a tough cookie.

If you are pretty well bootstrapped by now, here’s some good news.

Raising Turnover Limit For Audit Compliance & Presumptive Taxation

Under the existing provisions of section 44AB, every person carrying on business is required to get his/her accounts audited if the total sales, turnover or gross receipts in the previous year exceed Rs 60 lakh ($120,000). Similarly, a person carrying on a profession is required to get his accounts audited if the total sales, turnover or gross receipts in the previous year exceed Rs 15 lakh ($30,000).

In order to reduce the compliance burden of small businesses and professionals, the government has proposed to increase the threshold limit of total sales, turnover or gross receipts for getting accounts audited, from Rs 60 lakh to Rs 1 crore in the case of persons carrying on business, and from Rs 15 lakh to Rs 25 lakh in the case of persons carrying on profession.

It is also proposed that for the purposes of presumptive taxation (under section 44AD), the threshold limit of total turnover or gross receipts would be increased from Rs 60 lakh to Rs 1 crore. These amendments will take effect from April 1, 2013, and will, accordingly, apply to the assessment year 2013-14 and thereafter.

Tax Incentive For Individual Investors In Product Startups

This one is for the product startups and by product, we mean hardware firms who are into manufacturing. To boost the SMEs in the manufacturing sector, the government has proposed to provide rollover relief from long-term capital gains tax to an individual or an HUF on sale of a residential property (house or plot of land) if that money is re-invested in the equity of a new SME in the manufacturing sector. As of now, such relief to investors is valid only for re-investment in other properties.

But there are a bunch of riders, which would dilute the usefulness of this measure.

For one, the money is to be utilised for the purchase of new plant and machinery within a period of one year from the date of subscription in the equity shares. So if you already have a small set-up and want some money to hire people, forget this.

More importantly, the amount is to be used for subscription in equity shares in the SME company in which the investor holds more than 50 per cent share capital or more than 50 per cent voting rights.

Safeguards to restrict the transfer of the company’s shares, plant and machinery, for a period of five years, have been proposed to prevent the diversion of these funds.

The relief would be available in case of any transfer of residential property made on or before March 31, 2017.

Tax Pass-through For VC/PE Firm Extended Across Sectors

This long-pending demand of the investment community has been met in the Budget and will have a positive indirect impact on the early-stage investment space, as well as more mature investments. More on this, here.

So what do you think of the small incentives and big disincentive for startup investments?


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Budget 2012: Startups Gain A Little But Lose A Lot

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