Government and RBI draw startup revolution roadmap

The government’s 2016-17 budget, released on 29 February, included a number of initiatives promised for startups, such as one-day company registration, 100% deduction of taxes (except minimum alternate tax) on profits for three consecutive years out of five for startups set up from April 2016 to March 2019, long-term capital gains tax exemption on investments up to ₹5 million (US$75,000) in notified units, and long-term capital gains exemption to an individual or Hindu undivided family on sale of residential property if proceeds are used to subscribe to more than 50% of the shares of an eligible startup and to acquire new assets before the filing of returns. The budget also proposed a concessionary tax model for patent exploitation and introduction of hybrid foreign direct investment (FDI) instruments to facilitate business.

Earlier, on 16 January, the government unveiled its Start-up India action plan, which envisages changes to the regulatory environment aimed at one primary objective: ease of doing business for startups. While these steps and more reflect a positive change towards doing business as a startup, it is important to understand the types of entities that would be eligible for the declared benefits. To qualify as a startup, an entity must have an annual turnover of less than ₹250 million; be within the first five years since its inception; be working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property; and not have been formed by splitting up or restructuring an existing business. To obtain tax benefits, a certificate of eligible business from an Inter-Ministerial Board of Certification will be required.

The Reserve Bank of India (RBI), in its sixth bi-monthly monetary policy statement for 2015-16, pledged its support to the startup action plan. Much to the cheer of the startup community, the RBI promised to take steps to ease doing business and contribute to an ecosystem that is conducive for the growth of startups. Even before the release of the action plan, the RBI had launched a dedicated email helpline to assist startups in their foreign exchange transactions by helping startups to understand and prepare for some of the basic groundwork through a single platform.

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As promised in the policy statement, the RBI came out with a press release announcing regulatory relaxations for startups, which include regulatory changes the RBI intends to make under the Foreign Exchange Management Act regime, proposals for regulatory changes that are presently under consideration, and two clarifications to be made concerning issues permissible under the existing regulatory framework.

Under the regulatory changes, the RBI plans to allow startups to receive funds from foreign venture capital investors irrespective of the sector a startup operates in, while enabling such investors to transfer their shares to resident Indians and non-resident Indians. The RBI also intends to allow deferred consideration for transfer of ownership of startup enterprises, and escrow/indemnity arrangements for up to 18 months. Simplification of delayed reporting of FDI transactions with penalty has also been announced.

It is notable that while the RBI had invited public comments on a proposed penalty of 1% of the total investment amount (with lower and upper caps) for delay in reporting beyond the prescribed period, whether such a penalty structure will apply to startups has not yet been clarified. Details on how the above proposals will be implemented are still awaited. Once active, startups will enjoy important advantages over non-startups, which will be a further boost for the existing angel investment stream into the country.

The RBI is also considering proposals to permit startups to access rupee loans under the external commercial borrowing framework with relaxations regarding eligible lenders, enabling startups to issue FDI instruments such as convertible notes, and streamlining overseas investment operations for startups. Further, the RBI clarified the pooling arrangements between a startup and its foreign subsidiary to allow flexibility in doing business subject to repatriation being done within nine months and executing tripartite agreements with customers. The RBI also clarified that startups can issue shares without any cash payment in cases of sweat equity or against legitimate payment owed.

The government may need to consider whether the theoretical reform in tax deduction on profits for the initial years for startups has any practical relevance as most startups may not be profitable in their initial years. Startups may also have to choose between registering as a startup first to receive the declared benefits or registering their intellectual property. The government’s flexibility in listening to startups and being open to change will also play a crucial part.

The number of recent reforms aimed at ease of doing business for startups provides high hopes that budding entrepreneurs will lead a startup revolution in India. The litmus test will be successful implementation and results after laying down the reforms’ foundation.

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Luthra & Luthra Law Offices is a full-service law firm with offices in Delhi, Mumbai, Bangalore and Hyderabad. Dipti Lavya Swain is a partner and Harshit Anand is an associate at the firm. The views of the authors are personal. This article is intended for general information purposes only and is not a substitute for legal advice.