Budget 2020: Startups, investors unimpressed with ESOP tax relaxation

Startups and the investor community were left unimpressed as the Budget skipped the key demands, while offering only what they believe are incremental concessions to boost the entrepreneurial ecosystem.

Harmonization of capital gains tax rate for unlisted securities, removal of double-taxation on employee stock options (ESOPs), and reprieve from tax deduction at source (TDS) were among the key demands that were not taken up.

The Budget proposed to defer tax on ESOPs, extend the gamut of startups eligible for corporate tax concession and set up a new seed fund to help the industry.

“What the government has done is not as significant a move as many anticipated,” said Siddarth Pai, co-founder at venture capital firm 3one4 Capital and an active campaigner against double taxation on ESOPs.

“It has not removed the tax, but only deferred the payment of the tax,” said Pai.

The government has proposed that the payment of tax levied during the conversion of ESOPs into shares be deferred by five years. However, the tax will have to be paid if the employee leaves the firm or sells the shares before five years.

Further, the concession applies to only start-ups that were incorporated after April 1, 2016, and are cleared by the government-appointed inter-ministerial board (IMB), as specified under section 80-IAC of the Income Tax Act.

ESOPs are a key instrument to attract and retain talent in startups. However, currently, the allottee of ESOPs has to pay tax twice—once when ESOPs are converted into company shares (construed as salary income), and when shares are sold off for cash (considered as capital gains).

“It is great to see the Government acknowledging the ambiguity around ESOP taxation but limiting it to factors such as turnover of ₹100 crore, 5 years of employment or when the employee leaves the company might not fully solve the problem,” said Vivek Gupta, co-founder at Licious, a Bengaluru based start-up.

Corporate tax concession, Seed fund

The government also proposed to extend corporate tax concession to eligible startups. A start-up with an annual turnover not exceeding Rs 100 crore can now avail exemption from paying tax on profits for a period of 3 years within a 10-year window. The exemption was earlier for start-ups below Rs 25 crore turnover and had to be availed within 7 years.

The budget also sought to ease some burden on micro, small and medium enterprises (MSME). The minister proposed that businesses with less than Rs 5 crore turnover will not be required to audit their financials through external accountants, a move that will bring down their compliance costs. Earlier, the threshold was Rs 1 crore turnover.

In addition to the Fund-of-Funds (FFS) scheme, which provides money to Indian venture capital firms, a special seed fund has been proposed. Unlike FFS, the seed-fund will directly invest in startups. However, the quantum of this fund, and timeline, among other details, were not announced.

According to government data, Small Industries Development of India (Sidbi), which manages (FFS) has so far put Rs 3,120 cr committed to 47 VC firms.

The many initiatives are welcome for boosting the ecosystem, “however, the government is yet to address some of the key asks of the start-ups such as allowing listing of start-ups in other countries which will give them access to greater capital; providing further impetus to Fintech ecosystem, that is now providing significant outreach and lending platforms to SMEs and consumers alike,” said Ankur Pahwa, partner and national leader for e-commerce and consumer internet, EY India.

Benefits and beyond 
 
Seed fund to support early-stage start-ups 
Start-ups with turnover of ~100 crore to get tax rebate for three years 
Tax payment on ESOPs deferred 
 
Story so far.. 

Rs 3,120 crore committed to 47 VC firms through Fund of Funds 
Govt has invested Rs 2,286 crore in 264 start-ups 
22,000 start-ups recognised by DPIIT