Translating Union Budget 2020 for Startup Space

India's Union Budget for the financial year 2020-21 is finally here, and despite Finance Minister Nirmala Sitharaman's generally cautious approach, a few ambitious plans have found their ways into her statement.

While the stock market reacted quite negatively to the freshly unveiled budget, the startup community was given several reasons to rejoice.

In her second Budget speech, Mrs. Sitharaman has introduced some promising policies to turn Startup India from a mere promotional headline to a tangible possibility. She has also followed a strategy of bringing in consistent policy upgrades, while fixing mistakes of the past.

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Changes in Personal Tax Regime

My expectations from this year's budget were centred around the need to boost consumer demand.Without a reasonably high rate of consumption, there is little point for startups to innovate and deliver unique value propositions to the market. Even though last year's policies did bring down the corporate tax rate from 30% to 22%, little explanation was offered to help us understand how the government would cover up the resulting fiscal deficit and how it would affect reforms and public services.

Since supply side policies are only one side of the coin, the lack of demand side reforms has been sticking out like a sore thumb all this while, with a striking failure to revive the slump in consumer economy. Perhaps in a bid to boost demand, Mrs. Sitharaman has used her second Budget speech to focus on the needs of the middle class, one of the key demographics targeted by startups.

Introducing a simplified direct tax regime, she has made sure that consumers are able to plan their taxes better, and express minimal hassle in settling their dues.

Moreover, for those prepared to forego exemptions and deductions, she has introduced new income tax slabs to facilitate lower payments. In addition, a new tax amnesty scheme has been introduced with a view to bringing down the number of tax litigations that are currently underway. 

While these measures are interesting last ditch attempts to infuse the market with some much-needed fiscal buoyancy, they are far from being adequate. The projected rate of fiscal deficit for FY 20-21 has been taken up to 3.8%, which seems rather high. Moreover, even though Sitharaman's ministry seems committed to managing the deficit efficiently, the higher percentage can prove to be a problematic pain point for the government, and consequently, the people.

Dividend Distribution Tax Abolished

The introduction of dividend distribution tax (DDT) had been a dicey move, instituting a 15% charge on all incomes against investments distributed by companies. The abolition of this "surrogate tax" comes at an opportune time, when the Indian market has been clamouring for adequate foreign direct investments to power the economy forward. For startups, this change will make equity investments more attractive for potential investors, and increase the rate at which capital is infused into the startup ecosystem.

Ever since the corporate tax rates were reduced in September 2019, the market was eager to see this DDT regime go as well. In fact, the direct taxes task force had also submitted a recommendation to abolish it for promoting greater investments in Indian businesses.

The Dividend Distribution Tax was unique to India for so long, adversely affecting the investment potential present in the market, and lowering the possibility of equity investments.

The revenue that is lost by the abolition of DDT will not make any significant dent in the government's treasury as shareholders will be taxed for incomes earned on their investments.

Relaxation on ESOP Taxes

The relaxation of rules imposed on Employee Stock Ownership Plan (ESOP) Taxes is a key measure introduced by this year's Union Budget to provide support to startups. Startups often recruit and retain highly skilled and suitably talented employees by incentivising them with stock owning options. It is a form of compensation that gives workers an increased stake in the business, and encourages them to stay in the firm.

Till now, a system of dual taxation was in place, affecting the efficacy of the compensation tool. To resolve this problem, Nirmala Sitharaman introduced a policy whereby tax payments can be deferred, for five years, or when they sell their shares or leave the company (whichever is earlier). This will allow the employees holding stocks to feel more secure in their position and reduce the possibility of losses if the startup in question fails to take off. 

Before the new scheme is put in operation at the beginning of the coming fiscal, the employees will continue to pay a tax whenever they accept an ESOP, or clear the dues of a capital gains tax if they choose to redeem it.

With the new rule in place, they will be allowed greater flexibility and reduced losses.

Proposal of Seed Funding for Startups

In a promising step that marks one of the first clear commitments to the highly advertised causes of Startup India and Make in India, Mrs. Sitharaman proposed the setting up of a seed funding mechanism by the government. To provide financial support to early stage ventures that are the "growth engines" of our economy, she suggested that the government directly advance funds to startups.

Moreover, she also proposed that a centralised investment clearance cell be set up at both state and central levels to facilitate smooth and simple funding processes, right from the point of application to providing financial support, and other types of guidance. 

Although a clear framework for such a seed fund was not apparent in the budget proposals, the fact that she has proposed it in the first place gives us great reason to celebrate.

This indicates that the government is finally ready to take Startup India to the next stage, from flashy headlines and neon signs to tangible assistance provided to fledgling new enterprises.

Tax Exemption for Startups

Nirmala Sitharaman's budget speech has outlined two key proposals to reduce the taxation levels of new startups. Presently, startups with annual turnover up to 25 crores are allowed 100% tax deductions for three consecutive assessment years out of the first seven years from its inception.

In her brand new budget speech, Mrs. Sitharaman has suggested that the turnover amount be increased to 100 crores and the duration of applicability be stretched to ten years.

This will allow more startups to enjoy the benefits of this exemption as they are often unable to earn enough profits in the first few years, to take advantage of the existing policy. 

Infrastructure Development to Aid Startups

The Finance Minister also discussed potential policies that will transform the infrastructural landscape of the startup ecosystem.

She mentioned the National Infrastructure Pipeline that currently has over 6500 projects and added that the government would soon undertake a clear policy for the setting up of data centre parks by private companies all over the country.

Such a policy would also boost the use of artificial intelligence, data analytics, the internet of things and allied technologies, she added. Since most startups today rely on robust digital and technological frameworks to fuel their operations, the government's attention in this regard creates a favourable situation for them to flourish.

In addition, Mrs. Sitharaman announced the allocation of 8000 crore rupees to National Mission on Quantum Computing and Technology.

Besides helping startups expand their technological base, it will also boost the demand side by introducing tech-enabled public service reforms and increasing employment opportunities for the youth (a leading demographic targeted by startups).

Moreover, the Finance Minister also outlined a plan for developing a unified digital platform for handing intellectual property registrations.

Startups usually bring unique products and services to the market, which are meant to be patented and copyrighted for adequate protection of the intellectual property thus formed. The creation of this new platform and a knowledge centre will help in conveniently managing the intellectual property rights of vulnerable new businesses.

While these were the salient contributions of the latest Union Budget 2020-21 to the startup ecosystem, some other policies, are bound to benefit startups and other businesses in the longer term.

• Improved education can expand the available talent pool for startups

• Infrastructural development can allow them to take advantage of better cost economies and scale sustainably.

The new budget introduced limited reforms for the agricultural sector, measures were restricted to instituting tax cuts for farming cooperatives, increasing allocation to animal husbandry and dairy and a few more. No clear policies were put forward to enhance farm income. However, even the scanty measures introduced can potentially pay off in the long term, triggering cascading effects in our agro-centred economy.

If such a chain reaction is observed in the economy at large, startups stand to gain from the overall improvement. However, no direct links can be seen between these policies and the startup ecosystem as they don't directly improve farmers' purchasing power or enhance the demand side of the rural economy.