Budget 2020: Cheer For Startups As Government Announces Tax Relief
Finance Minister Nirmala Sitharaman presents the Union Budget 2020-21 in the Lok Sabha, in New Delhi. (Source: PTI)

Budget 2020: Cheer For Startups As Government Announces Tax Relief

The central government announced tax relief for startups as part of its efforts to boost the ecosystem in the country.

Accordingly, the turnover limit and eligibility period for startups to claim tax relief have been increased.

Startups with turnover of up to Rs 100 crore can now claim 100 percent deduction on their profit for computing tax liability for three consecutive years out of 10 years since its incorporation, Finance Minister Nirmala Sitharaman said in her Union Budget speech in Parliament. That’s subject to the condition that the startup’s turnover doesn’t exceed Rs 100 crore.

Previously the eligibility limit, under the provisions of the Income Tax Act, was Rs 25 crore and the period to claim the tax benefit was seven years.

That, according to Swati Bhargava, co-founder of CashKaro, “is a liberating move on the part of the government”. Offering a three-year extension to increase the eligibility of startups to claim this deduction is a boon for young companies who are slowly moving towards profitability, Bhargava said.

Sitharaman also deferred the tax incidence on notional benefits on the conversion of employee stock options—also known as ESOPs—into shares.

ESOPs are frequently used by startups to compensate their employees, offering them the option to purchase shares at a future period for a rate derived by a methodology. Each ESOP has a:

  • Vesting period, when the employee earns the right to purchase shares.
  • Exercise period—or when employees can exercise the rights to purchase them.

Under the current regime, employees are subjected to tax in the year when they exercise their option to purchase the shares, leading to tax incidence despite not incurring any cash gain. The tax is paid on the difference between the market value and exercise price of shares.

Union Budget 2020 resolves this cash flow issue.

According to the new provisions, ESOPs of startup employees will be liable for tax in one of the three cases:

  • Five years after exercising the option.
  • The year in which they sell shares.
  • The year when the employee leaves the company, whichever is earlier.

“This is great news as the current system collects taxes too early,” Harish Jain, co-founder of Groww, told BloombergQuint. “This will encourage more startups to get incorporated and create jobs. It will make it easier for startups to incentivise good talent and attract more skilled talent.”

Nakul Saxena, director (policy) at iSPIRT, a think tank for India’s software products companies, agreed. The proposed five-year deferment of tax payments on ESOPs by startup employees is a great move to attract high-quality talent to the startup ecosystem in the country. But, according to Saxena, there are also certain limitations to it which are restricting the benefits. “The ESOP taxation changes in its current form apply only to around 200 startups recognised by the IMB (Inter-Ministerial Board), thereby, severely restricting its scope.”

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