Startups In India - Government Action Plan

Introduction

At a day-long global workshop on startup entrepreneurship conducted by the Government of India in New Delhi on 16 January 2016, the much awaited 'Startup India' initiative has been announced by the Government to boost the startup ecosystem in India. The key policy changes introduced by the Government are discussed in this Ergo newsflash.

Background

In recent times, Indian startups are increasingly looking to move outside India owing to various difficulties faced by them in conducting business in India such as bureaucratic processes, lengthy incorporations and liquidations, restrictions on structuring transactions, problems in early-stage funding and exits, and complying with myriad laws and regulations. With the objective of incentivising young Indian entrepreneurs to explore and pursue their business ideas in India, and to avoid the exodus of talented entrepreneurs from India, the Government's 'Startup India' Action Plan introduces a separate regulatory framework for startups, emphasising on promoting innovation and facilitating ease of regulatory compliance. The Government also hopes that the Action Plan will accelerate growth of startups in sectors other than technology such as agriculture, manufacturing, social sector, healthcare, education, etc. across India, including tier 2 and 3 cities, and other semi-urban and rural areas.

The Action Plan broadly deals with: (a) simplification of processes and handholding for startups; (b) funding support and related incentives; and (c) industry-academia partnership and incubation support to boost the startup ecosystem.

Definition of startup

Given that the existing regulatory framework does not identify or recognise startup as a separate category of business entity, the Government has proposed to specifically define a 'startup' to ensure that the regulatory benefits under the policy are only availed by those entities which meet the basic eligibility criteria.

A 'startup' has been defined as an Indian entity (i.e., private limited company, registered partnership firm, or limited liability partnership): (a) that is not more than 5 years old; (b) the annual turnover (as defined in the Companies Act, 2013) of which has not exceeded INR 25 crores in any previous financial year; (c) which is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property; and (d) which:

• is supported by a recommendation from an incubator established in a post-graduate college in India, with regard to the innovative nature of its business;

• is supported by a recommendation from an incubator recognized by the Government, with regard to the innovative nature of its business;

• is funded by an incubation fund, angel fund, private equity fund, accelerator, or angel network duly registered with the Securities and Exchange Board of India (SEBI), and which endorses the innovative nature of such startup's business (Department of Industrial Policy and Promotion (DIPP) may publish a negative list of funds in this regard);

• has been granted a patent by the Indian Patent and Trademark Office in connection with its business;

• is funded by the Government as part of any specified scheme to promote innovation; or

• has a project supported by an incubator funded by the Government as part of any specified scheme to promote innovation.

An entity formed as a result of splitting up or reconstruction of an existing business will not be recognised as a startup. Further, startups will be eligible for various tax benefits only upon obtaining a certification from the Inter-Ministerial Board to be set up by the DIPP.

Further, a business will be covered under the definition of 'startup' only if it aims to develop and commercialize new products, services, or processes, or significantly improve existing products, services, or processes, resulting in creation or addition of value for the customers or the workflow. The mere act of developing products, services, or processes which: (a) do not have the potential for commercialisation; (b) are undifferentiated; or (c) have no or limited incremental value for customers or workflow, would not be covered under the definition of 'startup'.

Key incentives for startups

As fledgling startups face difficulties in complying with the increasingly demanding regulatory framework in India (especially with respect to ongoing compliance, fund-raising, and liquidation), the Action Plan introduces various relaxations for startups in certain key areas as discussed below.

Self-certification based compliance regime: In order to simplify regulatory compliance, startups will be allowed to self-certify compliance with 9 specified labour and environmental laws, through a mobile application to be launched by the Government. With respect to labour laws, no inspections will be conducted for a period of 3 years, unless upon receipt of credible and verifiable complaints of violation. In connection with environmental laws, startups which fall under the 'white category' (as defined by the Central Pollution Control Board) would be eligible to self-certify compliance, and only random inspections would be carried out in such cases.

Income tax holiday period: The Government has announced that startups will be exempted from payment of income tax for a period of 3 years, subject to non-distribution of dividend by the startup. This is to facilitate the growth of startups, and assist in meeting their working capital requirements during the initial years of operations. There are news reports indicating that this period may be extended to 5 years in cases where the startup has had a non-profitable year during the first 3 years. However, no official clarification has been released in this respect yet.

Tax exemptions on investments above fair market value (FMV): The existing exemption available to venture capital funds, in relation to taxation of investments made above FMV, has been extended to incubators investing in startups.

Tax exemption on capital gains: To promote investments into startups, and support existing venture capital funds and alternative investment funds, the Government has announced an exemption from payment of capital gains tax, if the capital gains are invested in the startup fund to be set up by the Government. Further, the existing capital gains tax exemption for investments by individuals in newly formed micro, small and medium enterprises in the manufacturing sector will be extended to startups.

Relaxations with regard to patent applications: Various initiatives have been announced for protection of the intellectual property involved in the products and innovations created by startups. Patent applications submitted by startups will be fast-tracked for examination and disposal, and startups will be provided an 80% rebate of the filing fees. Further, the Government will also provide a panel of facilitators to assist in the filing of intellectual property related filings. This scheme is launched initially on a pilot basis for 1 year, and further steps will be taken by the Government at a later stage.

Relaxations with regard to public procurement: To encourage the growth of startups in the manufacturing sector, eligibility requirement of prior experience or turnover in tenders floated by Government entities and public sector undertakings will be waived for startups. However, there will not be any relaxation on the quality standards or technical parameters, and the startups will have to demonstrate capability and should have its own manufacturing facility in India.

Liquidating startups: The Action Plan states that the Insolvency and Bankruptcy Bill, 2015, which was tabled in the lower house of the Parliament in December 2015 includes provisions for fast-tracking the voluntary closures of businesses. Startups with simple debt structures or those meeting such criteria as may be specified, may be wound up within a period of 90 days from making of an application for winding up on a fast-track basis. An insolvency professional will be appointed for liquidating the startup's assets, and paying its creditors within 6 months from the date of appointment.

Launching of mobile application and portal:  A mobile application and portal will be launched by 1 April 2016 to provide on-the-go accessibility for startups to assist in: (a) incorporating/registering with relevant agencies of the Government, and tracking the status of applications submitted; (b) accessing/downloading the registration certificate; (c) filing for compliances and obtaining information on various clearances, approvals and registrations required; (d) collaborating with various partners (including venture funds, incubators, academia mentors, etc) in the startup ecosystem; and (e) applying for various Government schemes under the Action Plan.

Launch of startup fund:  In order to provide adequate funding support for startups, a fund has been launched with an initial corpus of INR 2,500 crores (and a total corpus of INR 10,000 crores over a period of 4 years) which will invest in venture funds registered with SEBI. The fund will be managed by a board of private professionals drawn from industry bodies, academia, and successful startups. Life Insurance Corporation of India will be a co-investor in the fund.

Credit guarantee fund: To encourage initial funding by way of debt for startups, the Government has envisaged a credit guarantee mechanism through the National Credit Guarantee Trust Company or Small Industries Development Bank of India, with a budgetary corpus of INR 500 crores per year for the next 4 years.

Harmonisation of holding period for long term capital gains (LTCG): Prior to the launch of Action Plan by the Prime Minister, the Revenue Secretary stated that the gap between the holding period of high-risk unlisted securities (3 years) and relatively low-risk listed securities (1 year) to qualify for LTCG will be "bridged" in the Union Budget. One hopes that by this the Revenue Secretary meant reducing the holding period of unlisted securities to 1 year, and not any increase in the holding period of listed securities.

Other proposals: In addition to the above, the Action Plan sets out various others proposals for encouraging and handholding the startups. These include establishing the startup hub, organizing startup fests, annual incubator grand challenge, etc.

Comment

Innovation and entrepreneurship are cornerstones of sustained economic growth. The Government's 'Startup India' Action Plan is, therefore, a step in the right direction. This will contribute significantly to the growth of entrepreneurship and solution oriented businesses in India. Simplified regulatory procedures and relaxations with respect to legal compliance will go a long way in encouraging entrepreneurs, and creating a congenial startup ecosystem. The policy changes should, therefore, give entrepreneurs more reasons to remain and operate out of India.

Having said that, there is lack of clarity on many policy initiatives announced by the Government. The eligibility criteria prescribed under the definition of startup seem very onerous and subjective, and the requirement to obtain certification from the Inter-Ministerial Board will increase bureaucratic interaction, thereby causing delays for startups. It is noteworthy that, at the event, both the Prime Minister and the Finance Minister repeatedly emphasised upon the need to have minimum regulatory intervention in the conduct of business by startups (or for that matter, any business). However, the above requirement of making all exemptions subject to prior approval of the Government, and other items such as Government involvement in the conduct of the proposed startup hub, leads one to believe that while the Government's intention appears to be correct, the manner in which the Action Plan is proposed to be implemented may be counterproductive.

Further, incentives for attracting foreign monies in startups (both by equity and debt) are strangely missing. For instance, various exchange control issues that deter/prohibit foreign investors from investing in, or lending to, Indian startups have not been touched upon. Also, both the capital gains tax exemption (which is restricted only to investments made by individuals) and the FMV exemption (which is extended only to incubators) do not cover majority of investments into startups.

Thus, in our view, the Government will need to add more exemptions/incentives (such as those addressing exchange control issues) and remove/clarify certain items (such as the requirement to obtain prior approval of the Inter-Ministerial Board) in the Action Plan. Needless to add, all of it must be swiftly implemented to ensure its effectiveness.

Sources - Mondaq