Investors seek capital gains exemption upon exiting start-ups

The Department for Promotion of Industry and Internal Trade (DPIIT) is considering alternatives for providing an income-tax exemption to investors looking to exit from start-ups. After granting tax relief from angel tax, the Government is examining various regulatory and taxation issues to boost the start-up ecosystem.

Upon exit, an investor who earns a capital gain would be liable to capital gains tax under the Income Tax Act (‘Act’). DPIIT is considering providing a limited exemption from capital gains tax to such investors similar to tax benefits offered in the United Kingdom.

Investors are currently allowed two types of income tax benefits for fresh investments in the start-up ecosystem.

A capital gains tax exemption is allowed under section 54GB of the Act to an investor who sells a residential house or plot and invests the net consideration in equity shares of a start-up company, which company, in turn, has to use the amount to purchase a new asset.

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The purchase should be made within one year from the equity investment and must be in a new plant and machinery subject to certain exceptions. This exemption is available for investments made until 31 March 2019.

Under section 54EE of the Act, a capital gains tax exemption is allowed to investors who sell any long term capital asset and invest the capital gains not exceeding Rs. 50 Lakhs in units issued by a fund notified by the Government. This exemption is available in respect of units issued until 31 March 2019.

While the income-tax benefits mentioned above are for the investment of personal funds into a start-up, the DPIIT is now considering allowing a capital gains exemption upon exit of such investments. The DPIIT is considering granting this benefit either as a complete exemption, or an exemption conditional upon reinvestment of funds into another start-up. DPIIT is also considering giving benefits to non-resident investors.

With this proposal, the DPIIT seeks to minimise fraud and boost capital investment in start-ups. The full-fledged budget for the financial year 2019-20 is due in July 2019 after the new Government assumes office likely in late May 2019. The DPIIT is accordingly looking to propose the capital gains tax exemption after the new Government is elected in India.