The Central Board of Direct Taxes (“CBDT”) vide circular (“Circular”) dated August 08, 2019 has simplified the process of income tax assessment for start-ups. The Circular is applicable only on start-ups recognized by the Department for Promotion of Industry and Internal Trade (“DPIIT”) and applies only in cases where scrutiny assessment of start-up entities is pending.
The DPIIT had issued directions for recognition of an entity as a “start-up” by way of a notification (“Notification”) released on February 19, 2019. As per the Notification, a start-up is any entity which:
(i) Is less than 10 years old;
(ii) turnover of the entity for any financial year since incorporation does not exceed Rs. 100 crores; and
(iii) the entity is engaged in an “eligible business” i.e. it is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
This notification specified that a start-up may claim exemptions prescribed under Section 56(2)(viib) the Income Tax Act, 1961 (“Act”) [Tax on issue of shares at a premium by a company in which the public is not substantially interested] if –
(i) the start-up has been recognised by DPIIT;
(ii) the start-up’s aggregate amount of paid up share capital and share premium of the start-up after issue or proposed issue of share, if any, does not exceed, twenty-five crore rupees not including share capital and share premium in respect of shares issued to a (a) non-resident, venture capital fund; (b) venture capital company or (c) specified company (as defined in the Notification); and
(iii) the start-up has not invested in the class of assets specified in the Notification.
To seek exemption under Section 56(2)(viib), a start-up fulfilling conditions mentioned above has to file a duly signed declaration in “Form 2” (annexed with the Notification) to DIPP, stating that it fulfils the conditions mentioned in the Notification. On receipt of such declaration, the DPIIT has to forward the same to the CBDT.
This Notification applies irrespective of the dates on which shares are issued by a recognized start up from the date of its incorporation, except for the shares issued in respect of which an assessment order under Section 56(2)(viib) has been passed before the date of issue of this Notification (Paragraph 6 of the Notification).
The Circular has relaxed the applicability of Paragraph 6 of the Notification and made it clear that this Circular will also be applicable to start-ups where assessment order under section 56(2)(viib) has been passed and a recognized start-up has subsequently filed Form No. 2.
The Circular has laid out a simplified procedure for income tax proceedings against DPIIT recognized start-ups in the following cases –
(i) In case of start-ups which have filed Form-2 to the DPIIT and whose cases are under “limited scrutiny” on the single issue of applicability of Section 56(2)(viib) of, the contention of the start-up will be summarily accepted.
(ii) In case of start-ups which have filed Form-2 and whose cases have been selected under scrutiny to examine multiple issues including the issue of section 56(2)(viib), this issue will not be pursued during the assessment proceedings and inquiry on other issues will be carried out by the Assessing Officer only after obtaining approval of the supervisory authority.
(iii) In case of start-ups which have not filed Form-2, but have been selected for scrutiny, the inquiry in such cases also will be carried out by the Assessing Officer only after obtaining approval of the supervisory authorities.
Section 56(2)(viib) imposes tax on share capital issued at a premium by a company (in which the public is not substantially interested), this section does not apply when the consideration for such shares is received by a (a) venture capital undertaking from a venture capital company or a venture capital fund; or by a (b) company from a class or classes of persons as may be notified by the Central Government in this behalf.
This Circular was issued in wake of notices being issued by Income Tax Assessing officers to start-ups for matters under Section 56(2)(viib) before the issue of the Notification, and even afterwards for matters which are presently pending for disposal. This is a welcome move for start-ups, as it requires tax officials to seek permission of their supervisory authorities before proceeding against start-ups.
Also, this Circular has made provisions of the Notification applicable retrospectively, all start-ups aggrieved by notices sent to them before the date of the Notification (February 19, 2019) and are presently under scrutiny. Such start-ups can subsequently file Form 2 and claim the benefit of exemption provided under Section 56(2)(viib).
Disclaimer: This post has been prepared for informational purposes only. The information/or observations contained in this post does not constitute legal advice and should not be acted upon in any specific situation without seeking proper legal advice from a practicing attorney.