Page 96 - DTPA Journal December 21

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Nov. - Dec., 2021

reduce cash flows in early stage Startups and also Startups, allowing them to carry forward losses as
for retaining the top quality employees. They’re long as all the shareholders continue to hold at
offered to the employees at a discount to the fair least 1 share in the startup.
value of the shares.
c. The catch: By now you know too well.
b. The problem: When employees purchase Eligible Startups refer to IMB certified startups
these shares, they’re supposed to pay tax on the only. Which means that most of the startups
differential amount between fair value and the continue to surrender their losses every time there
discounted price they actually pay. Which means is a major stake sale. Sigh!
they’re dishing out cash to buy shares and then also
5. Angel Tax exemption: Only good for early
paying tax on it. Their fleeting moment only comes stages:
when they finally get to sell these shares which
a. You should know: If a company issues
often takes 1-3 years at the least.
shares at a price more than its fair value, it attracts
c. The solution : In 2020, the GoI finally took
taxes under section 56(2)(viib) of the Income tax
cognizance of this problem and decided that Act, which is dubbed as ‘Angel tax’.
employees of Eligible Startups can defer the
b. What’s fair value?: For Income tax
payment of tax on ESOPs until they sell their
purposes, fair value is determined from a
shares or on expiry of 5 years or when they leave
Merchant Banker report which conducts a
the startup, whichever is the earliest. Wow!, right?
Discounted Cash Flow (DCF) valuation of the
d. The catch : Employees of Startups having company. This valuation drill comes at a
turnover exceeding INR 25 Crore cannot avail this considerable price which is the problem for early
benefit. That’s a tiny threshold! stage Startups who have little cash to spare.

e. The bigger catch : Eligible Startups refer to c. The solution: DPIIT recognised startups
IMB certified startups only. Which is a coveted can fill up a simple declaration form at the Startup
group of only 399 Startups as of today. India portal to exempt themselves from Angel tax.

4. Carve out for carry forward of losses: But you This basically means that these Startups can raise
again can’t take benefit: funds by issuing shares in excess of their fair value
or basically without bothering a merchant banker
a. You should know: If there is a significant
for a report.
change in ownership of a company (more than 49%
shareholding change) then the losses cannot be d. The catch: While this scheme has clear
carried forward. cash flow benefits for early stage startups, those
that are raising funds in excess of INR 25 Crore
Here’s a fact: Most startups incur losses to blitz-
(i.e. appx. $3.5Mil) cannot take advantage of this.
scale and most startups issue shares and sell stakes
to raise funds. Without the brought forward losses, So now you’ll agree: While the GoI has done
these startups will have to pay taxes as soon as they commendable work in identifying areas where it
make profit. could extend monetary benefits to startups, most
of these benefits still remain parked in theory
b. The solution: The GoI introduced a carve
books without having any meaningful impact on
out in Section 79 of the Income tax Act for Eligible
the startup ecosystem.

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