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Start-Up Certification - Time to brood over!

THE POLICY LAB (TPL-05)
AUGUST 08, 2022

By J B Mohapatra

THE often unseen hand of government in organising the start-up ecosystem in India, right from assisting in germination of an 'idea', to nurturing and hand-holding through birth and growth phases, to matchmaking with a reciprocating commercial interest and journey to its expansion phase have been addressed across departments and their specific directed programs for mentoring, networking, facilitating infrastructure and funding support under schemes and institutionalised work processes. Incubator programs in cutting edge niche areas under many departments such as BIO-NEST in Department of Biotechnology (DBT), NIDHI in Department of Science and Technology (DST), TIDE in Ministry of Electronics and Information Technology (MEITY) and Atal Innovation Mission (AIM) of Niti Aayog provide the first essential toehold to the potential entrepreneurs to satiate their demand for physical and technical resources, and making available knowledge about entrepreneurial finance, government policy and commercial/legal framework of the relevant sub-sector of the start-up ecosystem. Institutions such as BIRAC of DBT and Technology Development Board (TDB) of DST, and special purpose projects such as IDEX of Ministry of Defence provide direct financial assistance to promote creation of a new class of entrepreneurs attempting to engage in socially or strategically relevant technologies, and catalyse interactions among industry, scientists, technocrats and specialists to a commercially viable product innovation. Finally, institutions such as National Research Development Corporation (NRDC) of Department of Scientific and Industrial Research (DSIR), Agrinnovate of Department of Agriculture Research and Education (DARE), and initiatives such as AGNIi of Principal Scientific Adviser (PSA) forge that final link between an innovator and the market for commercialising technologies/ knowhow/ inventions/ patents/ processes that the innovator brings to the fore.

While operational strategies to catalyse a successful start-up vary trans-nationally across jurisdictions depending on the requirements of the economy and readiness of institutional arms, start-up models in pure innovation- driven economies such as Israel, Japan, South Korea, Taiwan, Span, Sweden, USA or UK relying solely on their business and technology sophistication are not necessarily replicated in the models of developing and emerging economies, who rely more on quality of their infrastructure and institutions for harvesting an innovation/idea and to principally develop heightened efficiency in production and improvement in product quality.

Similar to adoption of a suitable strategy for working the start-ups, defining a start-up for legal and regulatory compliance is substantially rooted in the context where the start-up is expected to grow. In India, Department for Promotion of Industry and Internal Trade (DPIIT) in its notification dated 19-2-19 defines a start-up as an entity which is "working towards innovation, development or improvement of products and processes or services or if it is a scalable business model with a high potential of employment generation or wealth creation." Explanation below section 80IAC (4) of Income Tax Act (IT Act) exactly in parimateria with DPIIT's notification currently defines an eligible business, which a start-up is mandated to follow if it were to be entitled to 100% tax holiday (for 3 consecutive years out of 10 years from the date of incorporation), as an entity engaged in 'innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation." Prior to amendment through Finance Act, 2018, eligible business for the purpose of section 80IAC of IT Act was defined as a business which "involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property." Incorporation of the clause "scalable business model with a high potential of employment generation" and replacement of that part of the old legislation "innovation, development, deployment or commercialisation of new products, processes or services" with "innovation, development or improvement of products, processes or services" are perfect adaptation of legislative intent conveyed in a language to capture and address the existing and projected trajectory of technology road map and realities of small business economics in India.

Included among others for affording relaxation from regulatory rigour to start-ups, a slew of administrative and quasi-statutory instructions issued by CBDT since 2019 - Notification 13/2019 dated 5-3-19, Notification 16/2019 dated 7-8-19, Circular 22/2019 dated 30-8-19- principally provided relief from imposition of tax determined under section 56 (2) (viib) of IT Act in respect of shares of start-ups issued higher than their fair market value (the angel tax ), and relaxation in some measure from rigours of compliance requirements in cases under scrutiny, and more importantly setting up of a start-up cell to address recurrent and emergent issues of the sector. While administrative counter-measures to alleviate the angel tax burden is one part of the regulatory reliefs which could have been triggered by CBDT all by itself, the other salient part of promotion initiatives for start-ups, that is tax holiday under section 80 IAC of the IT Act does remains a coordinated effort of CBDT and DPIIT. The very legislative design to configure tax holiday to eligible start-ups renders entitlement to the tax holiday claims contingent upon submission of an eligibility certificate from the Inter-Ministerial Board (IMB) of Certification (comprising representation from DPIIT, DST and DBT) much in the manner that income tax deduction claims for in-house R&D under section 35 of the IT Act is contingent upon a successful certification of the claims by DSIR. This inter- departmental interface for entertaining tax holiday claims under section 80IAC of the IT Act is undoubtedly the foremost driver to realise the legislative intent behind promotion of start-up initiatives in India. IMB's technical prowess and the pace at which it delivers its analytical appraisal reports are catalytic to growth of the sector. While in FY 2018-19, final success tally of tax holiday claims out of 3,224 applications appraised by IMB was 2.5%, manifold alterations to IMB's work processes since then including down-sizing IMB's own membership structure would surely have contributed to a positive momentum. This is inter alia reflected in the expanding number of cases who have lodged tax holiday claims in their IT returns from 12 in AY 2017-18 to 279 in AY 2021-22. But viewed against the universe of 41,317 DPIIT recognised start-ups as in January 2022, the number of successful IMB certification does appear disproportionate to the gross numbers.

IMB's core functions, apart from checking on the technical conditions for eligibility of a start-up,which are (i) the date of incorporation, (ii) legal status of the entity and (iii) gross turnover, are examining and validating tax holiday applications in the context of the 2 significant components in DPIIT's notification as copied in provisions of section 80IAC of the IT Act: (a) innovation, development or improvement of products and processes or services and (b) scalable business model with a high potential of employment generation or wealth creation. These are the 2 significant areas requiring utmost care and attention in conduction of appraisal of tax holiday claims. Among 3 applications for example, one engaged in designing online and land based casino game, the second engaged in developing AI based multi-lingual chatbot, and the third offering waste management solutions for industrial sectors, it falls within the exclusive jurisdiction of IMB and the experience and technical expertise of its 3 member Board to adjudicate whether all or none or any of the 3 applications deserve its certification.

Re-designing IMB's certification processes to make those faster and lend utmost objectivity to its appraisal in order to catch and collate all technical inputs across all relevant forums and without recourse to any large scale legislative changes would be a meaningful first step to realising the true legislative intent behind promotion of start-ups besides directly amping up IMB's own technical capacity. Categories of tax holiday claims, for example, drawn from existing and already-graduated incubatees in government funded incubator platforms embedded in higher education technical institutions, entities supported through SIDBI's Fund of Funds, entities receiving assistance through departmental schemes such as DBT's Biotechnology Ignition Grant (BIG) or IDEX or from TDB, BIRAC or category 1 and 2 SEBI registered AIF, and in all such cases where technical and financial wherewithal of applicants have already been scrutinised and validated through vigorous screening measures at credible forums, could be fast-tracked with an automatic IMB certification without the requirement of a further scrutiny by IMB at its own end of already proven credentials of those applications. Re-orienting work processes for certification including de-duplicating some components for conducting validation exercise would be adding thrust to the early stage entrepreneurial activities.

India's start-up ecosystem is built around specialities of its factor-driven economy leveraging on its labour and productivity, technical skills, competitive and large size market, and strength of its institutions and infrastructure. Coupled with a supportive commercial and legal framework, easy availability of entrepreneurial finance and physical infrastructure, meaningful changes to the work processes for certification of start-ups for statutory tax breaks would be catalytic for the sector.


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