[Opinion] Union Budget 2023 | 5 Key Expectations for Start-ups

Authored by Kashif Ali  – Chartered Accountant

Table of Contents

Background

1. Deferment of ESOP taxation should be available to every DPIIT recognized start-up

2. Reduction in rate of Minimum Alternate Tax (MAT) for start-ups

3. Extend the sun set clause for incorporation of start-ups

4. Increase the emolument threshold of section 80JJAA to INR 50000

5. Rationalise the provisions of section 68

Background

The budget 2023 is around the corner. The Finance Minister and her team is all set to announce the Union Budget 2023 on 1 February 2023. Given the facts that last few years have been extremely challenging due to Covid scenario, global war related crisis and soaring inflation, it has been tough times to sustain the crisis for every emerging industry specially for the start-ups. Further, there is fear of a global recession already looming large. Hence, start-ups being one of the emerging contributors to the Indian economy in terms of employment generation, would have certain expectations from the Union Budget 2023.

In this backdrop, this article attempts to highlight five key Budget expectations from the Union Budget.

1. Deferment of ESOP taxation should be available to every DPIIT recognized start-up

Employee Stock Option Plans (ESOP) have been a significant component of the compensation for the employees of start-ups, as it allows the founders and start-ups to employ highly talented employees at a relatively low salary amount with balance being made up via ESOPs.

Under the ESOP, employees are issued shares at significantly less than the fair market value (FMV) subject to fulfilment of conditions prescribed.

Under section 17(2) of the Income-tax Act, 1961 (The Act), such ESOP is taxed as perquisite at FMV less exercise price. Accordingly, the employer is required to withhold tax on such perquisite which leads to cash flow problem as this benefit of ESOP is in kind.

In order to address the issue of cash flow, the legislature vide Finance Act, 2020 deferred the payment of tax on such ESOP (both self assessment and withholding) for “eligible start-ups” and their employees to a deferment period which is within 14 days of the earliest of the following:

(i) After expiry of 48 months from the end of the relevant Assessment Year; or

(ii) Date of sale of such security; or

(iii) From the date, the employee ceases to be employee of the employer.

The definition of “eligible start-up” under the explanation (ii)(c) to section 80-IAC of the Act inter alia requires it to hold a certificate of eligible business from the Inter-Ministerial Board (IMB).

As per the latest figure available on Department for Promotion of Industry and Internal Trade (‘DPIIT’) website (Homepage (startupindia.gov.in), there are more than 88000 DPIIT recognized start-ups, of which, not even 1% are holding IMB certificate, leading to deprival of benefit of the aforesaid ESOP deferred taxation to majority of DPIIT recognized start-ups. Meaning thereby, there will be cash flow problem to such start-ups and their employees.

Therefore, it is suggested that the condition of holding IMB certificate is relaxed and the relaxation of deferment of ESOP taxation should be available to every DPIIT recognized start-up.

Further, If the provision is retained in current form, consequential amendments may be made to section 234A, 234B and 220(1) of the Act to clarify that employee’s liability to pay interest gets triggered only in case the employer fails to deduct tax within the prescribed deferment period.

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2. Reduction in rate of Minimum Alternate Tax (MAT) for start-ups

Section 115JB of the Act requires every company to pay 15% of MAT where the normal tax liability of such company is less than 15% of the book profit.

A company opting for special rate taxation under section 115BAA and 115BAB of the Act are exempt from paying MAT. Further, a company, being a unit of an International Financial Services Centre (IFSC) and deriving its income solely in convertible foreign exchange, will be required to pay MAT at 9% (plus cess and surcharge as applicable).

In this regard, it is suggested that the rate of MAT be reduced to 9% for start-ups as well. This will help the start-ups under loss, in meeting the liquidity crunch due to additional MAT liability.

3. Extend the sun set clause for incorporation of start-ups

Section 80-IAC of the Act provides a deduction to eligible start-ups of an amount equal to 100% of the profits and gains derived from eligible business for three consecutive assessment years. The conditions for start-ups to qualify as “eligible start-ups” amongst other include date of incorporation to be between 1 April, 2016 and 31 March 2023.

It is suggested that the last date of incorporation be further extended by a period of five years to 31 March 2028.

Similarly, the sun-set clause for “eligible start-ups” for the purpose of section 54GB (which provides exemption from capital gains to eligible investor being individual and HUF) is suggested to be extended to by a period of five years to 31 March 2028.

4. Increase the emolument threshold of section 80JJAA to INR 50000

Section 80JJAA of the Act provides deduction of 30% of additional employee cost incurred on additional employees employed during the previous year. The definition of “additional employee” amongst other include condition that the monthly emolument of such employee shall not exceed INR 25000. The threshold was prescribed vide the Finance Act, 2016.

The deduction is quite helpful for start-ups as it helps them in mitigating their tax liability. However, in view of the increase in inflation, the threshold is quite low and requires reconsideration. Therefore, it is suggested that the said threshold be increased to INR 50,000.

5. Rationalise the provisions of section 68

Section 68 of the Income-tax Act, 1961 (The Act) provides that where any sum is found to be credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer (AO), satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

Vide Finance Act, 2012, it was provided that the nature and source of any sum, in the nature of share application money, share capital, share premium or any such amount by whatever name called, credited in the books of a closely held company shall be treated as explained only if the source of funds is also explained in the hands of the shareholder.

The scope of this section was inter alia extended by Finance Act, 2022 whereby closely held company, have been required to explain the nature and source of any sum, whether in form of loan or borrowing, or any other liability credited in the books of an assessee.

The amendment has impacted the start-ups from taking loan/credit from friends or family. It was introduced to curb pernicious practice of conversion of unaccounted money by crediting it to the books of assesses through a masquerade of loan or borrowing. However, it disincentivises friends/family to lend money to the start-ups causing more difficulty for emerging start-ups to sustain the crisis.

Therefore, it is expected from the Budget 2023 to withdraw the aforesaid amendment. Alternatively, it is suggested to rationalise it by prescribing a threshold to keep small loan or borrowing, or any other liability out of the ambit of section 68.

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