No coercive action till expert panel resolves issue of taxing startups: CBDT

The government on Thursday gave relief to startups that have come under the scrutiny of tax officials for having raised capital above the fair value of their shares, a common practice among new-age enterprises.

The Central Board of Direct Taxes (CBDT) said in a statement that no coercive action related to tax demands would be made till the time an expert panel resolved the issue of taxing startups. “CBDT recognizes that startups are going to bring a lot of innovation to the country and, therefore, have to be supported in every possible manner,” the statement from the apex direct tax policymaking body said.

The announcement seeks to ease concerns raised by startups about tax officials questioning the share premium received at the time of raising capital through the issue of fresh shares. Startups’ problems stem from an anti-abuse provision introduced in the Income Tax Act in 2012 to curb the practice of politicians accepting bribes in the guise of share premium in unlisted companies set up by them. Section 56(2)(viib) of the Income Tax Act provides for taxation of the share premium that is above the fair valuation of shares as “other income”. Since startups are valued based on the business potential of their ideas, which could change with time, they are finding it hard to justify the share premium received. While tax officials prefer to value these enterprises based on their net asset value, companies tend to be valued based on estimates of their future earnings.

CBDT clarified that it is committed to promoting startups in the country. The Narendra Modi government has been promoting innovation and entrepreneurship under the Startup India mission as these new-age companies have the potential to create jobs.

The decision was made at a meeting of revenue secretary Ajay Bhushan Pandey, department of industrial policy and promotion secretary Ramesh Abhishek and CBDT chairman Sushil Chandra. The expert committee on startup taxation to be set up with members from institutions such as IITs and IIMs will make recommendations on issues relating to recognition of startups for exemption from share premium tax and “other connected matters”.

Analysts say there has been a surge of tax notices to startups in recent weeks, which have rattled these enterprises. “It is a big issue among new-economy companies. Many startups have received tax notices. They are struggling with it as they have little cash flow,” said Girish Vanvari, founder of advisory firm Transaction Square.

The government had earlier eased the tax provision by building safeguards, although it could not ease the pain entirely. The relaxations include exemption from share premium tax to startups notified by the government as well as to investments received from venture capital funds. In May, the tax department extended this relief to cover angel investors, or high net worth individuals, too. This relief is subject to certain riders and is limited to small start-ups with paid-up capital and share premium up to ?10 crore after the share issue. The angel investor should have had ?25 lakh average income in the preceding three years or ?2 crore net worth at the end of the previous fiscal. Experts say these riders are restrictive and cover only a small part of the new-age economy.

Tax officials said that all that startups had to do was to show their worth as per valuation methods specified in the rules.

The provision covers only unlisted companies where public interest is not substantial and excludes bona fide investors.