Three Years’ Tax Holiday for Start-Ups – Reality or Illusion?

The Government of India has always come up with different schemes and benefits to promote start-ups in India with a vision of transforming the country from job seekers to job creators. One such scheme to encourage innovation and build a robust start-up ecosystem was launched on 16^thJanuary, 2016 in the form of the ‘Start-up India Initiative’. Under this scheme, the Government has taken a number of steps to assist emerging start-ups in the country, such as providing a rebate on patent and IPR applications, allowing start-ups to self-certify compliance with six labour laws and three environmental laws, offering various Income-tax incentives, etc.

One such tax benefit given by Government to the eligible start-ups was the exemption from paying taxes for three consecutive years out of the ten years from the year of their incorporation. But, since start-up companies also have to comply with provisions of Minimum Alternate Tax (MAT) of the Act, they still have to pay taxes at the rate of 15% with the applicable surcharge and health and education cess, which ultimately leads to the outflow of funds. In this article, we will analyse this issue and try to find some remedies that the Government should provide to mitigate the same.

Also Read: Start-ups in India

Analysis

With the introduction of the Start up India initiative, the Government offered eligible start-ups the exemption from paying taxes for a period of three consecutive years out of the ten years from the year of their incorporation under section 80IAC of the Income Tax Act. According to the memorandum to Finance Bill, 2016 (the Finance Bill in which this exemption to start-ups was introduced), this benefit was offered to provide an impetus to start-ups and facilitate their growth in the initial phase of their business. It aimed to address their working capital requirements, thereby promoting the country’s start-up community.

However, due to the applicability of MAT provisions specified under section 115JB of the Income Tax Act, which override all other provisions of the Act, the eligible start-up is required to pay taxes at the rate of 15% along with the applicable surcharge and health and education cess on its profits.

Let us look at the below example to understand the issue:
 

Particulars	Calculation of Tax Liability of a Non-Start-up Company (In Rs.)	Calculation of Tax Liability of a Start-up Company Availing Benefit of Section 80IAC (In Rs.)
	CASE I	CASE II
Profit/Book Profit in FY 2022-2023 (assuming both to be the same)	4,00,00,000	4,00,00,000
Calculation of Tax Liability as per Normal Tax Provisions
Applicable tax rate	25%	25%
Tax amount (A)	1,00,00,000	1,00,00,000
Add: Surcharge @7% (B)	7,00,000	7,00,000
Tax amount + surcharge (A+B)	1,07,00,000	1,07,00,000
Add: Health & Education Cess @4% (C)	4,28,000	4,28,000
Total tax amount (A+B+C)	1,11,28,000	1,11,28,000
Less: Deduction available as per section 80-IAC	N/A	(1,11,28,000)
Total tax as per normal tax provisions (1)	1,11,28,000	Nil
Calculation of Tax Liability as per MAT Provisions u/s 115JB
Applicable tax rate	15%	15%
Tax amount (E)	60,00,000	60,00,000
Add: Surcharge @7% (F)	4,20,000	4,20,000
Tax amount + surcharge (E+F)	64,20,000	64,20,000
Add: Health & Education Cess @4% (G)	2,56,800	2,56,800
Total tax as per MAT provisions (E+F+G) (2)	66,76,800	66,76,800
Final tax liability to be paid (Higher of 1 and 2)	1,11,28,000	66,76,800

Interpretation

Case I

As per the normal Income Tax provisions, the company having profits/book profits of Rs. 4 crores has a tax liability of Rs. 1,11,28,000, and as per the MAT provisions, the tax amount comes out to be Rs. 66,76,800. Hence, the company has to pay Rs. 1,11,28,000 being the higher of the two amounts, as tax to the Income Tax department.

Case II

In case II, illustrated in the table above, it can be observed that an eligible start-up earning profits/book profits of Rs. 4 crores has a NIL tax liability as per the normal tax provisions because it has availed the benefit of section 80IAC. But due to the applicability of MAT provisions, it has to pay Rs. 66,76,800 as Income Tax to the Government despite availing the exemption benefits as shown above.

Hence, it can be concluded from the above illustration that due to the applicability of MAT provisions of Section 115JB of the Act, the start-up companies end up paying a considerable amount of taxes to the Government even in the years in which they claim the exemption provided under Section 80IAC.

MAT Credit

The requirement to comply with section 115JB leads to the blockage of the entire amount of taxes paid as per MAT provisions in the years of claiming exemption u/s 80IAC in the form of MAT credit. In the above illustration, the MAT Credit for FY 2022-23 would be Rs. 66,76,800. Such MAT credit can be used to offset the difference between the tax on total income computed as per normal provisions and the tax payable under section 115JB in the following years. Consequentially, such MAT credit can only be redeemed in the year in which the tax calculated as per normal provisions is higher than the tax amount calculated as per MAT provisions.

Also, such credit can be carried forward for 15 years only. It means that in case the eligible start-up does not have tax payable according to the normal provisions higher than the tax calculated as per MAT provisions in any of the following 15 years, then such MAT credit would be of no use for the start-up. Ultimately, the tax holiday would become illusory for start-ups in such cases.

Therefore, the MAT provisions defeat the ultimate goal of the initiative of offering the exemption for three years and instead of addressing the working capital requirements, it blocks the funds as MAT credit which could have been invested in the business and used for its multi-fold growth in the initial years of its operations.

Also Read: All you need to know about Setting up Business in India

Possible Remedies

Considering the above difficulties, we expect the Income-tax department to provide any of the following remedies to the eligible start-ups,thereby enabling them to freely avail the benefit of the exemption offered to them:

1: The eligible start-ups are exempted from MAT provisions, and a complete exemption is provided to them, as levying MAT on the eligible start-ups is against the very concept of giving tax concession to them and facilitating their growth, or

2: any further policy is made wherein it is specified where to invest such amount of MAT credit that is available with the start-ups for set off in further years on account of tax paid in the years of claiming the exemption instead of paying it to the Government in such a way so that it can minimize its impact on the working capital of the start-ups, or

3: the profits of the eligible start-ups are charged to tax at a lower rate and are exempted from MAT provisions as in the case of manufacturing companies claiming the benefit provided under section 115BAB wherein they are liable to pay tax @15% in respect of their total income and are exempted from the provisions of MAT, or

4: a lower rate of tax is prescribed to be levied under MAT provisions on the book profits of the eligible start-ups as in the case of a company which is a unit located in an International Financial Services Centre and derives its income only in convertible foreign exchange, wherein the rate of tax applicable to such units is 9% of the book profits instead of 15% under section 115JB.

Also Read: Common Myths about Company Incorporation

Summing Up

The three-year tax exemption offered under the start-up initiative aimed at reducing the cash outflow amounting to savings, further accelerating reinvestment into start-ups. However, due to the applicability of MAT provisions, the exemption does not seem to make much of a difference for start-up companies.

Moreover, the actual purpose of introducing MAT provisions was to address the practice of certain huge profit-making companies of managing their affairs in such a way as to avoid payment of Income Tax by taking advantage of various deductions allowed under the Income-tax Act.But now, it is causing hardships in availing the present-day exemptions offered by the Government to the eligible start-ups and is acting as a barrier in achieving the objectives of the Start-up India Scheme.

Join the movement for fair taxation for start-ups in India. For More Info, Contact us today at info@manishanilgupta.com

Disclaimer: The information provided in this blog is for general purposes only and should not be considered as professional advice