The Start-up India Scheme delivers numerous benefits to the start-ups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) based on certain specified criteria, one of which prescribes the limit on annual turnover not exceeding ₹1 billion since incorporation.

A similar annual turnover threshold of ₹1 billion is also prescribed under the Income Tax law in the financial year for which tax holiday is to be claimed. Recognition and benefits are subject to the entity not being formed by splitting up or reconstruction and such benefits shall be discontinued from the year in which the turnover threshold is exceeded.

Additional tax benefits

Typically, perquisite taxation on ESOPs is at the time of exercise of options, i.e., on allotment of shares, but the monetary benefit of such perquisite is only availed on exit or transfer of shares.

Addressing this hardship, the tax provisions were relaxed for employees of start-ups recognised by DPIIT and certified by the Inter-Ministerial Board and such employees are liable to tax on ESOPs on the earliest event of transfer of shares or termination of employment or expiry of 5 years from shares allotment.

ESOPs to promoters

Normally, ESOPs are prohibited to the promoter group and director (including relatives of such director) holding more than ten percent equity shares of the Company under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.

However, for promoting the growth of the start-up ecosystem, an exception was made vide an amendment in the said rules permitting DPIIT-recognised start-ups to issue ESOPs to promoters and directors within ten years from the date of its incorporation.

Valuation certificate

Valuation certificate from a registered valuer is mandatory under Section 42 and Section 62 of the Companies Act, 2013 while issuing shares to the investors. Also, issuance of shares at a price lower than Fair Market Value (FMV) could have income tax exposure in the hands of investors as gift tax or issue at a price higher than FMV could attract tax on excess premium for start-ups under Section 56(2) of the Income Tax Act.

Nonetheless, DPIIT-recognised start-ups qualifying certain investment criteria are exempted from tax on issue of shares at a premium. Besides, start-ups issuing shares to person resident outside India is also required to adhere to pricing guidelines prescribed by regulations under the Foreign Exchange Management Act. The method for determining the Fair Market Value of shares in such cases is prescribed under laws.

Variable voting rights

As per the Company Law, shares up to 26 per cent of post issue paid up equity share capital could have differential voting rights with additional conditions. The Ministry of Corporate Affairs has recently increased such limit on shares with differential voting rights to 74 per cent. This will allow companies to raise additional funds by issuing shares with variable rights to external investors without diluting their control over the Company.

(The author is a partner at Nangia Andersen LLP)

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