Budget 2020: Tax on ESOPs deferred, dedicated early stage fund key takeaways for startups

In what seems to be a huge boost to the Startup sector, Finance Minister Nirmala Sitharaman proposed a host of incentives for startups including a dedicated early-stage fund, relaxation of taxes levied on employee stock ownership plans (ESOPs) and fresh tax rebates on these firms based on their turnover, in the course of the Union budget 2020. Venture capitalists investing in early-stage startups and startup founders have broadly welcomed these moves.

The relaxation of taxes on ESOPs was a primary demand of companies in the space. To resolve the issue of dual taxation on ESOP shares held by employees, Sitharaman proposed deferring the tax payment by five years, or until employees leave the company, or when they sell their shares—whichever comes earlier. She stated that ESOPs serve as an important compensation initiative for startups to attract and retain the best talent available.

Currently, employees are required to pay tax when they sign up for ESOPs with a vesting schedule and are forced to pay taxes on capital gains when the ESOPs are redeemed.

Sanjay Swamy, Managing Partner, Prime Venture Partners, an early-stage venture fund firm said, " Recognising startups as first-class citizens requiring unique treatment and driving towards ease of doing business is a big step forward. The specific change towards taxing ESOP taxation when gains are realised is significant - but it would've been ideal without the five-year limit or when the employee leaves the company" caveat."

Harsh Jain, Co-founder and COO, of investment firm Groww felt that the move will encourage more startups to get incorporated and create more jobs. "It will make it easier for startups to incentivize good talent and attract more skilled talents towards working in startups"

In another key announcement, the FM said that startup with an (annual) turnover of up to Rs 25 crore will be allowed a deduction of 100% of its profits for three consecutive assessment years out of the first seven years. In case a startup’s total turnover exceeds Rs 25 crores in a year, the turnover limit will be increased from the existing Rs 25 crores to Rs100 crore.

Another key announcement was the proposal to offer seed funding to support ideation and development of early-stage startups in India and setting up a centralised investment clearance cell for “end-to-end facilitation, support, and pre-investment advisory".

Other key announcements included the creation of a policy to enable setting up of data centre parks throughout the country that will be supported by the fibre connectivity project BharatNet, which also plans to cover over 100,000-gram panchayats by 2021 end. A proposal to set up a digital platform to ease registration of IPRs developed by entrepreneurs and startups has also been announced.

Apoorv Ranjan Sharma, co-Founder and Managing Director, 9Unicorns, a startup accelerator fund said, "Like the previous year, the budget focuses on the improvement of ease of doing business for startups. The proposal to set up an investment clearance cell that will provide end-to-end facilitation and support to entrepreneurs is a step in the right direction. Under this initiative, startup owners will receive pre-investment advisory, information on land banks, as well as a faster clearance on the state level. Another positive move in favour of startups is postponing of ESOP taxation for employees for 5 years."