[Budget 2020] Start-Ups Still Seeking Respite

The 2020 budget was the most highly anticipated budget for startups since the 2016 Budget, when "Startup India" was announced and startups entered the common lexicon. Prior to the budget, the expectation from the government and the Finance Minister centred around the following:

1. Tax startups shares the way they tax their listed counterparts
2. Create a more beneficial ESOP taxation regime
3. Ease working capital for startups by reducing the amount of TDS applicable

The fulfilment of all three of these would have ushered in Startup India 2.0 – the next iteration of the Startup India initiative and it will bridge the fundamental gaps between Indian startups and their global counterparts when it comes to such matters. Of these, ESOPs were taken up by the honourable Finance Minister, Shri Nirmala Sitharaman.

She acknowledged the cashflow issue faced by employees of startups due to the ESOP taxation regime in India and proposed that the tax payable upon the exercise of ESOPs will be determined at the point of exercise, but payable at the earlier of:

1. Five years from exercise
2. The employee departing the company
3. Sale of the shares

India's ESOP taxation issue has been the payment of tax on notional gains at the point of exercise. India's taxation regime on ESOPs is as follows:

1. The difference between the Fair Market Value and the Exercise Price of the options is taxed as Income from Salaries
2. The difference between the Sale Price and the Fair Marker Value at the point of sale is taxed as Income from Capital Gains

Due to Indian tax laws, the Fair Market value is usually the price of the latest round of funding since that needs to happen at the FMV, lest it be treated as income. But the tax at the point of exercise is on notional gains, leading to ESOPs losing lustre amongst startup employees.

But the changes rolled out by the Finance Bill 2020 extend only to those startups incorporated after April 1, 2016 and who hold a certificate of recognition from the Inter-Ministerial Board, who decides which startups are "innovative" enough to merit recognition. From the universe of over 50,000 startups in India, only 27,000+ are DPIIT registered; a smaller universe of them are IMB recognised. This severely limits the scope of this change and penalises those who started their entrepreneurial journey early.

Startups are hopeful that the government drops the requirement for IMB certification for this and creates a level playing field for startups in India as compared to their global counterparts. India can ill afford to lose her entrepreneurs to other geographies due to her tax policies.