In Search of Zebras, Unicorns and Decacorns - Government's Modest Push to the Start-up Ecosystem in India

A lot has been said about what is largely perceived to be a pro-growth Union Budget 2021 (Budget) and a lot more about the unprecedented viral precursor accompanying this fiscal outlook for the financial year 2021-22. What has however remained unchanged from the pre-COVID era to the near term-after is the Government’s continued push, albeit modest, for start-ups. The Government got to business by offering extended year-bound tax reliefs, unshackling the monetary limitations and reducing the compliance framework for small businesses.

In relation to tax reliefs, the Budget has sought to appease start-ups by extending the capital gains tax exemption for investments in an eligible start-up company and extending the 100% tax rebate on profits, the “tax holiday”, in an eligible start-up - both by an additional financial year. These tax exemptions should help attract investments and create tangible benefits for eligible start-ups.

In the regulatory sphere, beginning with the definitional change of the micro, small and medium enterprises (MSME) effective from July 2020, the redefinition spree has now been extended to small companies under Companies Act, 2013 (2013 Act), by increasing the eligibility limits of INR 50 lacs (Paid up capital) and INR 2 crores (Turnover) to INR 2 crores (Paid up capital) and INR 20 crores (Turnover). The result is the slashing of the compliance burden to almost half and lesser paperwork, in comparison with a private company, benefitting new start-ups seeking a more formalized legal structure. Regulatory flexibility has also been extended to the underperforming “one person companies'' under the 2013 Act, by removing conversion and turnover restrictions, reducing the residency limit for Indian citizens from 182 to 120 days and allowing Non-Resident Indian (NRI) participation. The amendments to the 2013 Act were followed by the decriminalization of the Limited Liability Partnership (LLP) Act, 2008 and putting forth policy intent to introduce “Small LLP’s” and to permit LLPs to raise capital through the issue of non-convertible debentures. Given that one of the eligibility conditions for start-up recognition under the Start-up India Action Plan is the incorporation as a private limited company, registered partnership firm or a limited liability partnership, these regulatory changes should result in more start-ups seeking to formalize their setup as well as promote domestic individual entrepreneurship. The extension of incorporation rights for “one person companies” should incentivise offshore NRI led start-ups to set up shop in India.

Social impact driven financial inclusion is another theme of this Budget, which along with the complementary Startup India Seed Fund Scheme (SISFS) with a target corpus of INR 945 crores envisaging a staggered disbursement over a period of 4 years, beginning from April 1st 2021, to support an estimated 3,600 start-ups. With the SISFS, the Government is seeking to prioritize start-up culture in public welfare sectors such as healthcare, agriculture, social impact, waste management, water management, food processing and financial inclusion, amongst others. Under the SISFS guidelines, only start-ups complying with conditions such as recognition by Department for Promotion of Industry and Internal Trade (DPIIT), incorporated not more than 2 years from date of application, having a market fit business idea with viable commercialization and scaling and early-stage inclination to the use of technology, are eligible. These eligibility requirements may limit the number of actual beneficiaries of the scheme, leaving out the informal and yet to be tech-savvy start-ups, especially in the public welfare sectors. While the real-world impact of SISFS and its performance assessment are yet to be seen, the selection criteria set out in the guidelines seem to incorporate unbridled discretionary authority and bureaucratic involvement in the review and disbursement process.

Despite all the above-mentioned measures, the Budget has not been all sunshine and subsidies for start-ups. The Budget has overlooked resolving some of the critical issues currently faced by start-ups, such as the difference in treatment between DPIIT recognized and non-recognized start-ups, loss of benefits such as the ‘Angel Tax’ exemption to non-recognized start-ups, delinking of ESOP exemption from requiring Inter-Ministerial Board approval exemption from surcharge on gains from sale of unlisted securities and exemption from GST under reverse-charge for start-ups, amongst others. The Government needs to address these issues and arrive at workable solutions which are practical and beneficial to the start-up ecosystem.

While this Budget may seem modest vis-a-vis start-ups, it is nonetheless a push in the right direction and we may see more Unicorns taking root and flourishing in the given growth-conducive environment. Further, with the Government pivoting interest to other areas of importance, it is plausible to see more Zebras gradually rising and contributing to a lasting socio-economic impact. Despite a global pandemic, 2020 alone saw 11 start-ups turning into Unicorns evincing the fact that the Indian start-up ecosystem has come a long way. With the Budget incentives coupled with well-meaning policy initiatives, we can hope to see a further boost in numbers of the much-coveted Indian Unicorns and the existing Unicorns maturing to Decacorns.

Dated: February 16, 2021
Author: Manu Varghese - Partner and Head - General Corporate & Commercial Practice

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