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Tax Exemption
(80IAC & 56)

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Tax Exemption for Startups Under Section 80-IAC of
the Income-tax Act, 1961

Section 80-IAC of the Income-tax Act, 1961, was introduced on April 1, 2017, to provide a significant tax incentive for eligible startups. This provision allows qualifying startups to claim a 100% tax deduction on their profits for three consecutive assessment years, provided certain criteria are met.

This section applies to companies or Limited Liability Partnerships (LLPs) engaged in eligible businesses, facilitating tax exemptions on profits derived from businesses involved in innovation, development, or improvement of products, services, or scalable business models with high potential for employment generation or wealth creation.

Purpose of Section 80-IAC

Section 80-IAC aims to encourage the growth and development of startups in India during their initial phases by offering substantial tax benefits. By reducing the tax burden, this provision fosters innovation, incentivizes research and development, and promotes a dynamic entrepreneurial ecosystem. It also encourages young entrepreneurs to operate as legitimate taxpayers, contributing to the overall business climate in India.
This section provides tax relief to domestic companies investing in eligible businesses, reinforcing the government's commitment to developing a robust startup ecosystem.

Benefits of Section 80-IAC

  • 100% Tax Deduction: Startups can claim a deduction of 100% of the profits and gains from their eligible business for up to three consecutive years, effectively reducing the overall tax burden during the early stages of operation.
  • Advance Tax Relief: The tax liability for startups claiming this benefit is zero, eliminating the need to pay advance tax for the applicable years.
  • Streamlined Financial Pressure: The deductions under Section 80-IAC reduce taxable income, easing the financial strain startups typically face in their early years, allowing for better resource allocation and business growth.
  • Simplified Process: The application for tax exemptions is simple and online, with no government fees, making the process accessible and straightforward for eligible startups.

Eligibility Criteria for Tax Exemption under Section 80-IAC

To be eligible for the tax exemptions under Section 80-IAC, startups must meet the following criteria:

  • Eligible Business: The startup must be engaged in innovation, development, or improvement of products, processes, or services, or in the adoption of a scalable business model with substantial potential for job creation or wealth generation.
  • Incorporation Date: The startup must be incorporated after March 31, 2016, and before April 1, 2025.
  • Turnover Limitation: The startup's annual turnover should not exceed INR 100 crores in the year preceding the assessment year in which the deduction is being claimed.
  • New Business Formation: The startup should not be a result of splitting or restructuring an existing business. However, startups formed after the discontinuation of a business due to unforeseen circumstances (such as natural calamities, civil disturbances, or accidents) are eligible.
  • No Transfer of Assets: The business should not be established by transferring assets like plant or machinery from an existing business.
  • Government Recognition: The startup must be recognized by the Ministry of Commerce and Industry (DIPP), Government of India.
  • Certification: The startup should have a certificate of eligibility from the Inter-Ministerial Board of Certification as issued in the Official Gazette by the Indian Central Government.

How to Apply for Exemption Under Section 80-IAC?

To claim the tax exemption under Section 80-IAC, the startup must follow these steps:

Step 1: Register on the Startup India portal and apply for DPIIT (Department for Promotion of Industry and Internal Trade) recognition as per the registration process.

Step 2: Select the "claim tax exemption" option and fill out the required details, including:

  • Name of the startup
  • Date of incorporation
  • Business address
  • Incorporation/registration number
  • Nature of business (LLP or Private Limited Company)
  • DIPP number
  • Contact details (email, phone number, PAN)

Step 3: Submit the following documents in PDF format:

  • LLP Deed (for LLPs) or Memorandum of Association (for Private Limited Companies)
  • Board Resolution (if applicable)
  • Certified balance sheet and Profit and Loss statements by a Chartered Accountant
  • Financial statements for the last three years or since establishment
  • Income Tax Returns for the last three years or since establishment
  • Video pitch link
  • Pitch Deck in PDF format

Note: If the startup has received angel tax exemption, relevant details should also be provided.

What is Section 56 Exemption for Startups?

Section 56(2)(viib) of the Income-tax Act, commonly known as "Angel Tax," applies to the premium received by startups when issuing shares to investors. However, eligible startups recognized by DPIIT can avail of exemption from this tax, provided they meet specific criteria. The startup must file a declaration with DPIIT, ensuring that the investment received does not exceed INR 25 crores, excluding investments from specified investors.
This exemption helps reduce the financial burden on early-stage startups and encourages more investors to support innovation and entrepreneurship.

Why Choose Targolegal for Your Startup Registration?
Targolegal provides expert guidance in securing your Startup India Exemption.We ensure compliance with affordable fees, paving the way for your startup’s growth and success

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FAQ

What is Section 80IAC of the Income Tax Act, 1961?

Section 80IAC of the Income Tax Act, 1961, provides tax exemptions for startups that meet certain eligibility criteria. The primary benefit under this section is the tax holiday, which allows startups to claim a 100% tax exemption on their income for 3 consecutive years within the first 7 years of their operations. This exemption aims to promote innovation and the growth of startups in India.

Who is eligible for the benefits under Section 80IAC?

The eligibility criteria for availing of the tax exemption under Section 80IAC are:

  • The startup must be incorporated as a Private Limited Company or Limited Liability Partnership (LLP).
  • The startup must be less than 10 years old from the date of incorporation.
  • The startup must have an annual turnover not exceeding ₹100 crore.
  • The startup must be working towards innovation, development, or improvement of products, processes, or services.
  • The startup must be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) under the Startup India scheme.

What is the duration of the tax exemption under Section 80IAC?

Startups recognized under Section 80IAC can avail of a 100% tax exemption on their income for 3 consecutive years out of the first 7 years from the date of incorporation. The selection of the 3 years can be done based on the startup's financial performance.

How does Section 80IAC benefit startups?

The benefits under Section 80IAC include:

  • 100% tax exemption on the profits and gains derived from the startup's business for the first 3 years (subject to turnover limit).
  • Reduced tax liabilities for eligible startups, which can help reinvest profits into scaling up the business.
  • Support for startups in the initial years, which are often marked by lower profitability and higher operational costs.

How does a startup apply for the tax exemption under Section 80IAC?

To apply for the tax exemption under Section 80IAC:

  • The startup must be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) under the Startup India Scheme.
  • After obtaining the recognition, the startup must file its Income Tax Return (ITR) and claim the exemption under Section 80IAC while submitting the necessary documents, such as the Startup India Certificate.
  • The exemption will be granted based on the financials and the eligibility criteria outlined above.

What is Section 56 of the Income Tax Act, 1961?

Section 56 of the Income Tax Act, 1961, deals with the taxation of income from other sources. One of the key provisions under Section 56(2)(viib) is related to tax treatment of funds raised by startups. It exempts startups from the tax on premium received on issuance of shares (also known as share premium), provided the following conditions are met:

  • The funds raised by the startup are invested by angel investors or other investors in exchange for equity.
  • The startup is recognized by DPIIT.
  • The value of the shares issued to investors does not exceed the fair market value.

How does Section 56(2)(viib) benefit startups?

Section 56(2)(viib) provides exemption on taxation of share premium for startups. Typically, when a startup raises funds by issuing shares at a price higher than their face value, the difference is considered as share premium. Without this exemption, the premium amount could be treated as income and subject to tax. However, under this provision:

  • Startups can raise capital without having to pay tax on the premium received from investors.
  • This helps startups in attracting funding from angel investors and venture capitalists without the added burden of additional tax liabilities.

What are the eligibility criteria for availing the benefits under Section 56(2)(viib)?

The key criteria for availing benefits under Section 56(2)(viib) are:

  • The startup must be incorporated as a Private Limited Company.
  • The startup must be recognized under the Startup India Scheme by DPIIT.
  • The value of shares issued must not exceed the fair market value (FMV) as determined by a recognized valuer.
  • The startup must not have been formed for the purpose of generating income through share capital.

Can foreign investors avail of the benefits under Section 56(2)(viib)?

Yes, foreign investors can avail of the benefits under Section 56(2)(viib) if they invest in a startup that meets the DPIIT recognition and other eligibility criteria. The provision allows foreign direct investment (FDI) in startups without taxing the share premium, subject to the valuation norms and other conditions.

How does the fair market value (FMV) affect Section 56(2)(viib)?

The Fair Market Value (FMV) refers to the value of the startup's shares as determined by a qualified valuer. For the exemption under Section 56(2)(viib) to apply, the startup must issue shares at a price that is either equal to or lower than the FMV as determined by a valuer. If the shares are issued at a price higher than the FMV, the excess amount could be treated as taxable income under Section 56.

What is the process for determining the Fair Market Value (FMV) of shares?

The Fair Market Value (FMV) of shares is typically determined by a Valuation Report issued by a registered valuer. The valuer uses methods such as the Discounted Cash Flow (DCF) method or Net Asset Value (NAV) method to calculate the FMV of shares. The FMV helps in ensuring that the startup's share issuance complies with the provisions of Section 56(2)(viib).

What happens if a startup does not comply with the FMV requirement?

If a startup issues shares at a price higher than the Fair Market Value (FMV), the excess amount will be treated as income under Section 56(2)(viib) and will be subject to tax. The startup could also face penalties if the valuation process is not properly followed.

Is there a limit on the amount of investment a startup can receive under Section 56(2)(viib)?

There is no upper limit on the amount of investment a startup can receive under Section 56(2)(viib), provided the FMV of the shares issued is properly determined and the startup adheres to the legal and regulatory requirements. The exemption is valid as long as the share issuance complies with the rules and does not exceed the fair value.

How can a startup claim the benefits of Section 56(2)(viib) and 80IAC?

To claim the benefits of Section 56(2)(viib) and Section 80IAC, the startup must:

  • Be DPIIT recognized under the Startup India Scheme.
  • Ensure compliance with the FMV and share issuance guidelines for Section 56(2)(viib).
  • File the Income Tax Return (ITR) and claim the exemptions while providing the necessary documentation such as Startup India recognition certificate, Valuation Report, and financial statements.
  • Follow the proper process of filing returns and availing deductions under Section 80IAC, such as providing the relevant certificates and documents along with the tax returns.

Can a startup apply for tax exemptions under both Section 80IAC and Section 56(2)(viib)?

Yes, a startup can apply for tax exemptions under both Section 80IAC (tax holiday) and Section 56(2)(viib) (exemption on share premium). These exemptions are independent and can be availed simultaneously, provided the startup meets all the eligibility criteria for both provisions.

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