Imports and Exports are like two eyes to Foreign Trade Policy of India. The Balance of Trade and Balance of Payments position in India is governed by the quantum of imports and exports and related Foreign Exchange Earnings and Payments. RBI from time to time have been bringing about changes in regulations relating to Import and Export Trade for easing the entire process and encouraging it.
Various procedures with respect to Imports and Exports which were manually handled resulting in huge time consumption and procedural delays were revived with the introduction of EDPMS (Export Data Processing and Monitoring System) and IDPMS (Import Data Processing and Monitoring System). In this Article we will focus on understanding the concept of Merchanting Trade and the relevant guidelines prescribed by RBI for conduct of such Merchanting Trade.
WHAT IS A MERCHANTING TRADE?
A Merchant is meant to be any person who is involved in Buying and Selling of Goods and he usually does it earn a profit out of such Act. For Example, when a Person buys a product from Mr.X in Mumbai and Sells it at a margin to Mr.Y in Chennai, he is a Merchant. Hence, within India there is movement of goods from one State to another.
In International Trade, there are opportunities and situations wherein the buyer of a commodity and seller of a commodity are both located outside India, but the Trade who is the intermediary in this transaction is located in India. Such Trade that is effected by a Trader in India is termed as Merchanting Trade or Intermediary Traded under FEMA.
Hence for a Trade to be termed as a Merchanting Trade, the following conditions must be satisfied:
- Goods acquired should not enter the Domestic Tariff Area
- The state of the goods should not undergo any transformation (should be pure trading)
It should also be noted that the goods involved in a Merchanting Trade should be the ones that are permitted for exports /imports under the prevailing Foreign Trade Policy as on the date of shipment and all the rules, regulations and directions applicable to exports (except Export Declaration Form) and Imports ( except Bill of Entry) are complied with for the export leg and import leg of the transaction.
AD BANKER TO COMPLIANCE
- AD bank should be satisfied with the bonafides of the transaction. KYC and AML guidelines should be observed by the AD Bank while handling such transactions.
- Both the import and export leg of the transaction should be routed through the same AD Banker.
- The Banker should verify the documents like Invoice, packing list, transport documents and insurance and satisfy themselves about the genuineness of the same. (in case of non-availability of original documents, Non-negotiable copies duly authenticated by the bank handling documents may be taken).
- Any Advance received against exports; the AD should ensure the same is earmarked for making payment for the respective import. AD Bank may allow short-term deployment of such funds for the intervening period in an interest-bearing account.
- Payment for Import leg may be allowed to be made out of balance in Exchange Earners Foreign Currency Account (EEFC Account) of the Trader.
- AD Banker should ensure one-to-one matching in case of Merchanting Trade and report defaults in any leg to the concerned Regional Office of RBI on a half yearly basis within 15 days from the end of each half year i.e. June and December.
- The names of defaulting traders where outstanding reaches more than 5% of their annual export earnings would be caution-listed.
- The Merchanting Traders should be genuine traders and not mere financial intermediaries. AD Banks should satisfy themselves about the capabilities of the trader to perform the obligations under the Order.
- The Overall Merchanting Trade should result in reasonable profits to the Trader.
TIME PERIOD FOR COMPLETION OF MERCHANTING TRADE
Entire Merchanting Trade transaction should be completed within an overall period of 9 months, and there should not be any outlay of foreign exchange beyond 4 months.
| COMMENCEMENT DATE | COMPLETION DATE |
|---|---|
| Date of Shipment or Export Receipt or Import Payment Whichever is first | Date of Shipment or Export Receipt or Import Payment Whichever is last |
CREDIT FACILITIES FOR MERCHANTING TRADE
- Short Term Credit facilities either by way of supplier’s credit or buyer’s credit will be available to the extent it is backed by advance remittance for export, including discounting of export leg LC by an AD Banker
- Advance Payment for Import may be allowed on demand by the overseas seller. In case the inward remittance is not yet received from overseas buyer, the for making an advance payment for import, the AD Banker may provide facility based on commercial judgement. However, it must be ensured that for any such payment exceeding a sum of USD 2,00,000/- per transaction, the same should be against bank guarantee/LC from an International Bank of repute.
- Letter of Credit to the supplier is permitted against confirmed export order keeping in view the outlay and completion of transaction within 9 months.
MERCHANTING TRADE TO NEPAL AND BHUTAN
As Nepal and Bhutan are landlocked countries, there is a facility of transit trade whereby goods are imported from third countries by Nepal and Bhutan through India under the cover of customs transit declarations in terms of Government of India Treaty of Transit with these two countries. In consultation with Government of India, it is clarified herein that goods consigned to the importers of Nepal and Bhutan from third countries under Merchanting Trade from India would qualify as traffic-in-transit, if the goods are otherwise compliant with the Treaties signed with respective countries.
CONCLUSION
Though the timelines for completion of a Merchant Trade was extended, credit facilities were allowed and other changes and clarifications were brought in to ease out the difficulties, instructions to put names of merchant traders in a caution list where dues reach 5% of their annual exports seems to be too harsh.
Regular Indian Exporters placed in a similar position are not subject to such treatment. There is a general suspicious feeling that seems to be there in case of Merchanting Trade transactions by RBI and Bankers.
Companies Act 2013
CARO 2020
-Karan Surana
In Continuation to the previous articles under the Companies Act Section relating to Company Audits, this issue is an attempt to cover another important topic CARO, 2016 which mandates an Auditor to report on the compliance of Companies Act and other specified areas.
The MCA has issued the Companies (Auditor’s Report) Order, 2016 (CARO 2016), on 29th March 2016. This order has been issued in supersession of the Companies (Auditor’s Report) Order, 2015, and is applicable for reporting on financial statements of companies for financial year commencing on or after 1st April 2015. The MCA has relaxed the applicability of CARO 2016 to certain private companies by increasing the applicability thresholds.
CARO 2016 will not apply to the auditor’s report on consolidated financial statements and it is required only for Standalone Financial Statements. There are totally 16 clauses in CARO 2016 and each of the clause specifies an area on which the compliances have to be reported. Through, CARO 2016, the auditor’s reporting requirements is enhanced in certain areas, such as related party transaction and managerial remuneration.
CARO 2016 applicable to every company including a foreign company as defined in clause (42) of Section 2 of the Companies Act 2013 except the following:
The following classes of companies are outside the purview of the CARO 2016:
- Banking company as defined under Section 5 (c) of the Banking Regulation Act, 1949.
- Insurance company as defined under the Insurance Act 1938.
- Company licensed to operate under Section 8 of the Companies Act 2013 (companies registered with charitable object).
- A one person company (OPC) as defined under clause (62) of Section 2 of Companies Act 2013 (OPC means a company which has only one person as a member).
- IA small company under Section 2 (85) of the Companies Act, 2013.
- As per sec 2(85) of Companies Act 2013 small company means a company, other than a public company:
- Paid up share capital of which does not exceed 50 lacs or such higher amount as may be prescribed which shall not be more than 5 crore
- Turnover of which as per its last profit and loss account does not exceed 2 crore or such higher amount as may be prescribed which shall not be more than 20crore.
- holding company or a subsidiary company.
- A company registered under Section 8 of the Act.
- A company or body corporate governed by any special act Private Limited Company which fulfills the following criteria
- A private company which is not holding or subsidiary company of a public company,and
- A private company having a paid up capital and reserve and surplus not more than 1 crore as on the balance sheet date,and
- A private company which does not have total borrowing exceeding 1 crore from any bank and financial institution at any point of time during the financial year, and
- ) A private company which does not have total revenue exceeding 10 crore during the financial year.
Note: Revenue is defined as revenue as disclosed in scheduled III to the Companies Act, 2013 and includes revenue from discontinuing operation.
Thus, CARO 2016 is applicable to all Public Companies and Private Companies not exempted as above. Let’s discuss the 16 clauses of CARO one by one.
Fixed Asset
With respect to Fixed assets, an auditor has to report the following:- Whether the company is maintaining proper records showing full particulars including quantitative details and situation of fixed asset. It is the responsibility of the auditor to verify whether the Company is in possession of such records which has the details of all the assets capitalized in the books of account with quantitative details and where the fixed assets are located. The auditor has to report non-compliance in case of non maintenance of such records by the Company.
- Whether these fixed assets have been physically verified by the management at reasonable intervals. The auditor is expected to obtain reasonable evidence on the physical verification carried out by the Management.
- Whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of accounts. The auditor has to verify whether the discrepancies found out during the physical verification by the management has been accounted for in the books of accounts.
Inventory
With respect to Inventories, an auditor has to report the following:- Whether physical verification of inventory has been conducted at reasonable interval by the management. The auditor is expected to obtain reasonable evidence on the physical verification carried out by the Management.
- Whether any material discrepancies have been noticed on such verification and if so, whether the same has been properly dealt with in the books of accounts. The auditor has to verify whether the discrepancies found out during the physical verification by the management has been accounted for in the books of accounts.
Loans to related parties
The Auditor has to report whether the company has granted any loans, secured or unsecured to companies, firms, LLP or other parties covered in the registered maintained under Section 189 of the Companies Act, 2013 i.e., it’s Related Parties. If so,
- Whether terms and conditions of the grant of such loan are not prejudicial to the company’s interest.
- Whether the schedule of repayment of principal and payment of interest has been stipulated and whether the repayments and receipts are regular.
- If the amount is overdue, state the total amount overdue, state the total amount over due for more than 90 days and whether reasonable steps have been taken by the company for recovery of principal.
Any loan provided to a related party has to be verified by the auditor with the terms and conditions on which such loan was granted and any irregularity in repayment of principal or interest which is overdue for more than 90 days has to be reported under this section.
Loan to director and investment by the company [Clause 3 (iv)]
Auditor has to report, in respect of loan, investment, guarantees and security whether provision of Sections 185 and 186 of the Companies Act, 2013 has been complied with. If not, provide the details thereof.
In our previous issue, we have discussed in detail about loans given by Company, any non compliance of Section 185 and 186 has to be reported under this section. Eg: Granting of loans in excess of the threshold limits specified in Section 186 without approval of Shareholders in General Meeting has to be reported under this section.
Deposits [Clause 3 (v)]
In case, the company has accepted deposits, auditor has to report whether the following has been complied with:- Directives issued by the Reserve Bank of India
- The provision of sec 73 to 76 or any other relevant provision of Companies Act, 2013 and the rules framed there under
- If the order has been passed by company law board (CLB) or National company law tribunal (NCLT) or RBI or any court or any other tribunal.
However, if any of the above not complied with, the nature of contraventions should be stated.
Cost Records [Clause 3 (vi)]
Under this section, the auditor has to verify if Central Government has specified maintenance of cost records under sec 148 (1) of Companies Act,2013 for the Company, if yes, whether such accounts and records have been made and maintained. There are no expectations on the part of the auditor to verify such reports and it has to be reported only whether there are cost records maintained by the Company.
Statutory Dues [Clause 3 (vii)]
- Whether the company is regular in depositing undisputed statutory dues with the appropriate authorities including Provident fund, Employees State Insurance fund, income tax, sales tax, service tax, duty of custom, duty of excise, value added tax, cess or any other statutory dues. If it is irregular, the extent of arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they become payable, shall be indicated by the auditor.
- In case dues of income tax and sales tax or service tax or duty of custom or duty of excise or value added tax have not been deposited on account of any dispute, then the amount involved and the forum where dispute is pending shall be disclosed.
Repayment of Loan [Clause 3 (viii)]
The auditor has to verify whether there are any irregularities in repaying its borrowings from Banks or Financial Institutions and where there is a default by the Company, the period and amount of default to be reported under this section.
Utilisation of IPO and further public offer and Term Loans [Clause 3 (ix)]
Whether money raised by way of initial public offer or further public offer and the term loans were applied for the purpose for which those are raised. If not, the details together with delays and defaults and subsequent rectification, if any, as may be applicable, to be reported by the auditor.
Reporting of Fraud [Clause 3 (x)]
Whether any fraud BY the company or any fraud ON the company by its officers and employees has been noticed or reported during the year: if yes, the nature and the amount involved has to be reported by the auditor.
Approval of managerial remuneration [Clause 3 (xi)
Whether managerial remuneration has been paid or provided in accordance with the requisite approvals mandated by the provision of Section 197 read with schedule 5 to the Companies Act, 2013. If not, the Auditor should state the amount involved and step taken by the company for securing refund of the same. This is not applicable to private limited companies as Section 197 is applicable only for Public Limited Companies.
Nidhi Company [Clause 3 (xii)]
If it is a Nidhi company, the auditor has to report whether it has complied with the net owned funds to deposit in the ratio of 1:20 to meet out the liability and whether the Nidhi company is maintaining 10% unencumbered term deposit as specified in the Nidhi rules 2014 to meet out the liability.
Related Party Transaction [Clause 3 (xiii)]
Whether all transaction with the related party is in compliance with Section 177 and 188 of the Companies Act, 2013 where applicable and the details have been disclosed in the financial statement etc., as required by the applicable accounting standard AS 18 Related Party Disclosures. In our previous issue, we have discussed in detail regarding the disclosures with respect to Related Party Transactions, auditor has to report in case of non-compliance of Section 188 or non disclosure of related party transactions.
Private Placement of Preferential Issues [Clause 3 (xiv)]
If the company has made any preferential allotment or private placement of shares or fully or partly convertible debentures during the year under review, whether the requirement of Section 42 of Companies Act, 2013 ie., the procedures to issue shares under private placement by issuing offer letters and the timeline therein have been complied with and the amount raised has been used for the purpose for which the funds were raised. If not, the amount involved and the nature of non-compliance has to be reported.
Non Cash Transaction [Clause 3 (xv)]
Whether the company has entered into any non-cash transaction with the director or person concerned with him and if so, whether the provision of Section 192 of Companies Act, 2013 has been complied with and verification of approvals as mentioned under section 192 for such transactions has to be carried out.
Register under RBI Act 1934 [Clause 3 (xvi)]
Whether the company is required to be registered under Section 45 IA of Reserve Bank of India Act, 1934 and if so, whether the registration has been obtained has to be reported.
CONCLUSION
Every single point in CARO has to be carefully understood, interpreted and necessary procedures have to be followed to verify the applicability, correctness of the clauses. Proper documentation to substantiate a clean opinion and also a non-compliance has to be in place. With number of Corporate Financial Scams getting unearthed one after the other, Auditor’s have been facing the brunt for not bringing up the issues in the Audit Reports.
The need to verify the existence of Fraud and reporting in the Audit Report is of high significance. The diligence with which an Audit Report is prepared and presented is of utmost importance.
TAXATION
ICDS 2 - Valuation of Inventories
-Nethrashree
Preamble
This Income Computation and Disclosure Standard is applicable for computation of income chargeable under the head “Profits and gains of Business or profession” or “Income from other sources” and not for the purpose of maintenance of books of accounts.
In the case of conflict between the provisions of Income Tax Act, 1961 the Act and this Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that Extent.
Definitions:
a) Net Realisable Value| Estimated selling price in the ordinary course of business Less: Estimated costs of completion (Applicable only in case of WIP) |
XXX |
| Less: Estimated costs necessary to make a sale (Cost of Disposal) |
XXX |
| Net Realisable Value | XXX |
b) Inventories
"Inventories" are assets :| (i) | held for sale in the ordinary course of business; |
| (ii) | in the process of production for such sale; |
| (iii) | in the form of materials or supplies to be consumed in the production process or in the rendering of services |
Scope
The ICDS 2 shall be applied for Valuation ofInventories, except
| (a) | Work-in-progress arising under 'construction contract' including directly related service contract which is dealt with by the Income Computation and Disclosure Standard on construction contracts (ICDS 3); |
| (b) | Work-in-progress which is dealt with by other Income Computation and Disclosure Standard; |
| (c) | Shares, debentures and other financial instruments held as stock-in-trade which are dealt with by the Income Computation and Disclosure Standard on securities; |
| (d) | Producers' inventories of livestock, agriculture and forest products, mineral oils, ores and gases to the extent that they are measured at net realisable value; |
| (e) | Machinery spares, which can be used only in connection with a tangible fixed asset and their use is expected to be irregular, shall be dealt with in accordance with the Income Computation and Disclosure Standard on tangible fixed assets. |
Measurement of Inventory
Cost of Inventories
I. Inclusions in the cost of inventories
1. Inventories shall be valued at cost, or net realisable value, whichever is lower.
2. Cost of Inventories shall include all purchase costs, service costs, conversion costs and other costs which is incurred to bring the inventories to their present location and condition.
- Purchase cost:Purchase cost shall include purchase price inclusive of duties and taxes, freight inwards and other expenses directly related to purchase. Trade discounts, rebates, etc. will not be included
- Service cost:Service cost shall consist of labour and other costs of personnel directly engaged in providing the service.
- Conversion Cost: Conversion cost of inventories shall include costs directly related to the units of productionand a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods.
Allocation of Fixed Production Overheads
The allocation of fixed production overheads for the purpose of their inclusion in the costs of conversion shall be based on the normal capacity of the production facilities. Normal capacity shall be the production expected to be achieved on an average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production shall be used when it exceeds the normal capacity.
Incase of production in normal capacity
Example: Suppose that, Company A has the normal capacity production of 40,000 Units per annum and the actual production also approximates to 40,000 units. The fixed production overhead(FPOH) is Rs.5,00,000 and there is no abnormal expense incurred during the year. Hence the FPOH is wholly absorbed in the cost and the cost per unit is Rs.12.5 (5,00,000/40,000).
Incase of production in excess of normal capacity
Example: In the above example, Company A has produced 60,000 units. The fixed production overhead is Rs.5,00,000 and there is no abnormal expense incurred for the year. Hence the FPOH is wholly absorbed in the cost and the cost per unit is Rs.8.33 (5,00,000/60,000).
Incase of production in short of normal capacity
Example: In the above example, Company A has produced 20,000 units. The fixed production overhead is Rs.5,00,000 and there is no abnormal expense incurred for the year. The FPOH is not fully absorbed in the cost and the cost per unit is Rs.12.5 (5,00,000/40,000).
Treatment of unallocated Overheads
Unallocated overheads shall be recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above the cost. Variable production overheads shall be assigned to each unit of production on the basis of the actual use of the production facilities
Determination of Cost in case of Joint/By-Product
Where a production process results in more than one product being produced simultaneously and the costs of conversion of each product are not separately identifiable, the costs shall be allocated between the products on a rational and consistent basis. Where by-products, scrap or waste material are immaterial, they shall be measured at net realisable value and this value shall be deducted from the cost of the main product.
3. Interest and other borrowing costs shall not be included in the costs of inventories unless they meet the criteria for recognition of interest as a component of the cost as specified in the ICDS IX on borrowingcost.
II. Exclusions from the cost of inventories
Abnormal amounts of wasted materials, labour, or other production costs.
Demurrage if demonstrated to be normal cost, then it can be included in cost of inventories
2. Storage costs, unless those costs are necessary in the production process prior to a further production stage
3. Administrative overheads that do not bring the inventories to their present location and condition
4. Selling costs
C) Valuation of Inventories:
i.Cost Formulae:
ICDS II (New) prescribes only three cost formulae for determination of costs of inventories:
Methods of valuation of Inventory
| Specific Identification | FIFO & Weighted Average |
|---|---|
| Applicable only where items are not fairest possible Interchangeable approximation of the cost Used for Specific projects | Reflects the most |
ii. Techniques for measurement of Cost
Techniques for measurement of Cost
| Standard Cost Method | Retail Method |
|---|---|
| Standard costs take into account account normal levels of consumption use FIFO/Weighted average,consumption of materials and Retail method can be used. | a) Where it is impracticable to |
| b)They are regularly reviewed and, if necessary, revised in the light of the current conditions. | b) Cost = Sales –GP Margin |
Dissolution of Partnership/AOP/BOI
In case of dissolution of a partnership firm or association of persons or body of individuals, notwithstanding whether business is discontinued or not, the inventory on the date of dissolution shall be valued at the net realisable value.
However, the Delhi High court struck down ICDS II in its entirety since, IT Act permits assessees to follow method of accounting regularly employed for inventories and hence ICDS II in this case is not in line with Judicial pronouncements. IT Act Prevails over ICDS.
E) Disclosure in Form 3CD:
- Accounting policy adopted in measuring inventories and the cost formulae used
- Total carrying amount of inventories and its classification appropriate to a person
- The effect of increase or Decrease in the entity’s Profit for the compliance of Provisions in ICDS 2.
| Sr. No. | Points of comparison | ICDS-II Inventories | AS 2 Valuation of Inventories | Ind AS 2 Valuation of Inventories |
|---|---|---|---|---|
| 1 | Applicability | This Income Computation and Disclosure Standard is applicable for computation of income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" and not for the purpose of maintenance of books of account | AS 2 applies for the purpose of preparation of financial statements | Same as AS |
| 2 | Costs of purchase | The costs of purchase shall consist of purchase price including duties and taxes, freight inwards and other expenditure directly attributable to the acquisition. | The costs of purchase shall consist of purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. | Same as AS |
| 3 | Valuation of inventories of service provider | Same as AS | The costs of services in the case of a service provider shall consist of labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads. | Inventory of service providers is measured at cost of production. These will generally include labour and other cost of personnel directly engaged in providing the services, including supervisory personnel and attributable overhead. Sales and administration expenses, profit margin and non attributable overheads shall not be included. |
| 4 | Valuation of inventory on dissolution of a partner-ship firm or association of person or body of individuals | Same as AS | In case of dissolution of a partnership firm or association of person or body of individuals, notwithstanding whether business is discontinued or not, the inventory on the date of dissolution shall be valued at the net realisable value. | Same as AS |
| 5 | Application of retail method | Where retail method is used in retail trade, an average percentage for each retail department is to be used. | An average retail percentage for department is often used. AS 2 merely refers to a practice often used without making it mandatory. | Same as AS |
| 6 | The same cost formula for all inventories having a similar nature and use to the entity. | No such stipulation. | No such stipulation. | An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. For example, inventories used in one operating segment may have a use to the entity different from the same type of inventories used in another operating segment. However, a difference in geographical location of inventories (or in the respective tax rules), by itself, is not sufficient to justify the use of different cost formulas. |
| 7 | Reversal of write-down of inventories | No respective provision | No respective provision | Reversal of write down shall be reduced from the inventory expense when such NRV increases. |
| 8 | Measurement of inventories held by commodity broker-traders who measure their inventories at fair value less costs to sell. | No exclusion of such inventories | No respective provision | This Standard does not apply to the measurement of inventories held by commodity broker who measure their inventories at fair value less costs to sell. |
Trending Topics
Startup India
-CA Santhipriya SStartup India is an initiative implemented by Government of India with an aim to build a strong eco-system for innovation and entrepreneurship in India that will drive sustainable economic growth and generate employment opportunities. If you have an innovative idea for developing a product or service for the benefit of a larger public, the Government through its Startup India initiative and the 19 point action plan released in 2016, can guide you on setting up your business, assisting you in getting the funds required, incentivising with tax benefits, providing legal support and allowing you to faster exit from the business etc., In this article, lets discuss on who is a startup and how to register a startup and what are the tax benefits available for a Startup entity.
Who is a Startup?
It is an entity established in India not older than 10 years from the date of Incorporation/registration and it is incorporated as a private limited Company/Limited Liablity Partnership/registered Partnership firm, the annual turnover of any financial year since incorporation has not exceeded 100 crores and working towards innovation, development or improvement of new products or processes or services or if it is a scalable business model with a high potential of employment generation or wealth creation.
And an entity shall cease to be a Startup if in any financial year the entity has a turnover exceeding 100 crores or the entity has completed 10 years from the date of it’s incorporation. In addition to the above mentioned requirements, the entity should have obtained a certification from Inter-Ministerial Board to be eligible for tax benefits available to a Startup entity.
How to Register?
- A Startup entity shall make an online application either through mobile or web portal setup by Department for Promotion of Industry and Internal Trade (DPIIT)
- The application has to be submitted along with Incorporation/Registration certificate and a brief writeup of the nature of business carried out by the Startup and how it is working towards innovation, development or improvement of new products or processes or services or if it is a scalable business model with a high potential of employment generation or wealth creation.
- The DPIIT after calling for any further information if required shall recognise the entity as Startup or reject the application providing reasons thereof.
Thus, registration of a Startup is a simple procedure as it is completely online and as on 23rd November 2018, 14,036 startup applications has been recognised as Startups by DIPP.
What are the tax benefits to be available to a Startup are listed below?
Section 80-IAC:Section 80-IAC provides for a deduction of 100% of profits or gains earned by the Startup for a period of any three consecutive years out of seven years from beginning from the year the entity was incorporated/registered.
To avail the benefit:
- The startup should have been incorporated on or after 1st April 2016 but before 1st day of April 2021.
- The total turnover does not exceed 25 crores* in the previous year relevant to the assessment year in which the deduction is claimed
- It holds a certificate of eligible business from Inter Ministerial Board of certification.
The Inter-Ministerial Board (IMB) is setup by Department of Industrial Policy and Promotion (DIPP) which validates start-ups and grants tax related benefits. The board will validate start-ups for the Income Tax exemption on profits u/s 80-IAC of Income tax Act. A startup entity fulfilling the above eligibility criteria shall make an application in Form I to the board for obtaining the certification for the purpose of claiming deduction u/s 80-IAC.
The Ministry of commerce and Industry has revised the cap on turnover to be eligible as Startup to 100 crores as per the notification issued dated January 16,2019 whereas there are no other corresponding amendment brought in the Income tax Act,1961 for the purpose of claiming deduction under section 80-IAC.
Section 56(2)(viib)
Under Section 56(2)(viib) of the Income Tax act, where a company received any consideration for issue of shares in excess of the fair market value of shares issued, the aggregate consideration of shares as it exceeds the fair market value of shares shall be taxable in the hands of the Company as Income from other sources. As per clause (ii) to proviso of the Section 56(2)(viib), this clause is exempted when a company receives consideration from a person or class of persons as may be notified by Government in this behalf. A startup shall be eligible for the exemption provided that it fulfils the following conditions:
- It has been recognised by DPIT
- Aggregate paid up capital and share premium of the Startup after the issue of proposed issue of Shares does not exceed 25 crore rupees. In computing the aggregate amount of paid up share capital, in respect of shares issued to any of the following persons shall not be included─
- A non-resident;
- A venture capital company or a venture capital fund;
Further considerations received for shares issued or proposed to be issued to a company whose shares are frequently traded within the meaning of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and whose net worth on the last date of financial year preceding the year in which shares are issued exceeds one hundred crore rupees or turnover for the financial year preceding the year in which shares are issued exceeds two hundred fifty crore rupees, shall also be exempt and shall not be included in computing the aggregate amount of paid up share capital and share premium of twenty five crore rupees.
It has not invested in any of the following assets,─
- building or land appurtenant thereto, being a residential house, other than that used by the Startup for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
- land or building, or both, not being a residential house, other than that occupied by the Startup for its business or used by it for purposes of renting or held by it as stock-in trade, in the ordinary course of business;
- ) loans and advances, other than loans or advances extended in the ordinary course of business by the Startup where the lending of money is substantial part of its business;
- ) capital contribution made to any other entity;
- ) shares and securities;
- ) a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the Startup for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
- ) jewellary other than that held by the Startup as stock-in-trade in the ordinary course of business;
- ) any other asset, whether in the nature of capital asset or otherwise, of the nature specified in sub-clauses (iv) to (ix) of clause (d) of Explanation to clause
- )of sub-section (2) of section 56 of the Act.
Provided the Startup shall not invest in any of the assets specified in sub-clauses (a) to (h) for the period of seven years from the end of the latest financial year in which shares are issued at premium;
A startup fulfilling the above conditions shall make an application in Form 2 to DIPP that it fulfils the conditions and on receipt of such declaration, the DPIIT shall forward the same to CBDT.
To sum up, a Startup can avail the following tax benefits
- Deduction of 100% of its profits for tax calculations for three years.
- Exemption on taxes when shares are issued at premium to raise funds for the business of the Startup.
Through various amended notifications issued in the last two years, the number of years eligibility has been increased to 10 years from 5 years initially provided, considering the long gestation period required for Startups and the registration process has been simplified by removing the necessity to provide the recommendation letter from an incubator. Thus, it is easier to register an entity and recognise it as Startup and avail the tax benefits and various other benefits available to a Startup.