#Budget2016, regulatory policy & more: What Indian Start ups need to know

The Indian government has recently notified the definition of ‘startup’ and the criteria for ‘startup’ in pursuance to its ‘Startup India Action Plan’. Bar & Bench speaks with the team at GameChanger Law Advisors. Set up by Amrut Joshi, GameChanger Law Advisors also shares their thoughts on Budget 2016 and what it means for startups..Pallavi Saluja: What do you make out of the definition of startup? .The Ministry of Commerce and Industry (Department of Industrial Policy and Promotion), on February 17, 2016, issued a formal notification, defining what constitutes a “startup”, and the qualifications required to be satisfied by a startup to avail of the benefits proposed under the Startup India Action Plan, 2016 (the “Plan”). The definition stipulates that an entity shall be considered as a ‘startup’-.(a) Up to 5 years from the date of its incorporation/registration;.(b) If its turnover for any of the financial years has not exceeded Rs. 25 Crores; and.(c) If it is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property..The Notification also stipulates that an entity formed by splitting up or reconstruction of a business already in existence is not to be considered as a startup..The objective of the Plan is to create a conducive environment for startups in India. As one of the fastest growing startup hubs in the world, India is home to a variety of startups across different sectors offering a wide range of products and/or services..Therefore, it could be argued that in order for the benefits of the Plan to reach the maximum number of startups, the definition of a ‘startup’ would have to be equally wide..However, the current definition as per DIPP’s notification may result in many startups not qualifying for the benefits under the Plan. A qualifying venture has to be a private limited company, a registered partnership, or a limited liability partnership firm. Therefore startups registered as one person companies or sole proprietorships will not qualify under the current definition..Further, the current definition requires an entity to demonstrate that it is working towards “innovation, development, deployment or commercialization” of a new product or a service “driven by technology or intellectual property” if it aims to develop or commercialize a new product or service or process or significantly improve on a product or service or process which will add significant value for customers or workflow..The focus is largely on products or services driven by technology or intellectual property. Therefore, while a startup may be innovative and provide a product that introduces significant value–addition for customers, it may not get recognized for the benefits of the Plan if its reliance on technology or intellectual property is marginal..The notification is also not clear on what might qualify as being “innovative” and requires startups to obtain recommendations or letters of support from specific bodies certifying the innovative nature of their business. There is no guidance on what parameters these bodies are required to use in determining whether a startup is “innovative”, making it a largely subjective process..The notification also excludes entities formed by splitting up or reconstruction of a business already in existence from being defined as a “startup”. Practically speaking, there are several instances of new ideas emerging from within an established business. This is particularly true of large technology companies globally as well as in India, where companies have encouraged incubation of ideas from within, and have extended support to employees by seed-funding their ideas, and allowing employees to subsequently spin their ideas off into a separate business entity altogether..Pallavi Saluja: Can you explain the riders/conditions to qualify as a startup?.In addition to the “innovation, development, deployment or commercialization” mentioned above, the notification has also stated that the process of obtaining recognition as a startup shall be through the mobile application/ portal of Department of Industrial Policy and Promotion (“DIPP”), by filling a simple application form along with either:.a recommendation from an Incubator established in a postgraduate college in India certifying that the entity is in “innovative business”; or.a letter from any incubator which is funded by the State or Central Government as part of any specific scheme to promote innovation; or.a recommendation from any incubator recognized by Government of India certifying that the entity is in “innovative business”; or.a letter of funding of not less than 20% in equity by any Incubation Fund/Angel Fund/Private Equity Fund/Accelerator/Angel Network duly registered with Securities and Exchange Board of India that endorses the “innovative nature of the business”; or.a letter of funding by Government of India or any State Government as part of any specified scheme to promote innovation; or.a patent filed and published in the Journal by the Indian Patent Office in areas affiliated with the nature of business being promoted..The notification has clearly laid a lot of importance on the business being “innovative” in nature, but the parameters for defining such “innovation” has not been clearly spelt out..Pallavi Saluja: What do you think of the condition requiring funding of not less than 20 per cent in equity by any incubation fund/angel fund/private equity fund/ duly registered with SEBI? .The DIPP Notification outlines that one of the documents required to be submitted along with the application for being certified as a start-up is “a letter of funding of not less than 20 per cent in equity by any Incubation Fund,/Angel Fund/Private Equity Fund/Accelerator/Angel Network duly registered with Securities and Exchange Board of India that endorses innovative nature of the business. The Notification also specifies that the DIPP may include any such firm in a negative list for “such reasons as it may deem fit.”.This letter of funding is ‘one of the’ various documents that may accompany an application for being certified as a start-up which can take advantage of the Startup India Initiative..However, the quantum of funding being pegged at 20% does create multiple problems for start-ups as there are several instances where angel investments are made for stakes lower than 20%. For example, a start-up which has raised money from an Angel Network for 15% stake, may qualify under all the various criteria of turnover, age of the company, innovation etc., but as the funding was only for 15% they will not be in a position to avail of the benefits of the Plan..Further, going forward, the promoters of a start-up, which has not involved itself in a government operated or recognized incubator and which raises money from such Incubation Fund,/Angel Fund/Private Equity Fund/Accelerator/Angel Network duly registered with Securities and Exchange Board of India, would be required to divest 20% of its equity to such Funds in order to avail of the benefits of the Plan..Divesting such a large chunk of equity at an early stage in the growth of the Company may not be feasible from a Promoter’s perspective..Therefore, it is our view that the 20% funding condition provided for by the DIPP, will not be very helpful for start-ups, and may actually turn them away from availing the benefits provided under the Plan..Pallavi Saluja: What do you think of the self-certification of labour laws by startups? .It is a business reality that most companies find labour law compliances to be time consuming and cumbersome in nature, and that they are often unaware of the various nuances of different labour regulations. Recognizing this reality, the Government has proposed a self-certification mechanism to reduce the regulatory burden and simplify the compliance process for start-ups..Pursuant to the Plan, start-ups will be allowed to self-certify their compliance (through the proposed Start-up mobile app) with 6 labour legislations namely: (i) The Building and Other Construction Workers (Regulation of Employment & Conditions of Service) Act, 1996; (ii) Inter – State Migrant Workmen (Regulation of Employment & Conditions of Service) Act, 1979; (iii) Payment of Gratuity Act, 1972; (iv) Contract Labour (Regulation and Abolition) Act, 1970; (v) Employees’ Provident Fund and Miscellaneous Provisions act, 1952; and (vi) Employees’ State Insurance Act, 1948..On a plain reading, it appears that the Government had the manufacturing and construction sectors in mind, while proposing this self-certification measure. Considering that the definition of a startup also emphasises “innovation, development, deployment or commercialization” of a new product, it remains to be seen whether manufacturing startups would be avail of such self-certification benefits, if they are not seen to be manufacturing an innovative new products..The Plan further proposes that there will be no inspection for a period of three years for entities that self-certify their compliance with the aforementioned labour legislations. However, this comes with a caveat that a credible complaint can still be investigated by the concerned labour authority..Further, while such self-certification measures would be welcomed by the start-up community in India, the employees who are employed in such entities stand to lose out, should they be faced with any work hazards or non-payment of statutorily mandated benefits or non-compliance with any of the aforementioned legislations during the “exempt period” proposed by the Plan..Pallavi Saluja: Budget 2016 and what is means for the start-ups?.On first glance, the Finance Minister appears to have made all the right noises – a 100% deduction of profits for 3 out of 5 years for startups, starting April 01, 2016, has been mooted..He has also re-iterated his commitment to enable incorporation of companies within one day. If implemented, it would go a long way in establishing that the Government is serious in its efforts to ease doing business in India..However, the Finance Minister has only lowered the corporate income tax rate payable by small enterprises to 29% plus surcharge and cess. He could have probably looked at exempting startups from paying corporate income tax for a limited duration of time..The Budget speech stipulates that capital gains will not be taxed if invested in regulated/notified Fund of Funds and by individuals in notified startups, in which they hold majority shares. This should be welcomed by both the startup and investment community as it seeks to ensure that the startup ecosystem continues to have liquidity..The FM has also outlined a special patent regime with 10% rate of tax on income from worldwide exploitation of patents developed and registered in India. Whether this will lead to an increase in patent filings in India is moot..Lastly, there is a proposal for entrepreneurship education and training to be provided in 2200 colleges, 300 schools, 500 ITIs and 50 vocational institutes through massive online courses. This should be viewed as an excellent opportunity for startups that operate at the intersection of the technology and education sectors..Amrut Joshi and Aditya S of GameChanger Law Advisors can be contacted at amrut@gamechangerlaw.com or aditya@gamechangerlaw.com respectively.