A tax guru explains everything wrong with the Indian government’s latest requirement for startups to disclose source of income from creditors
- All startups will now have to disclose the source of capital from the creditor they are borrowing from.
- This means that a startup should prove the authenticity and creditworthiness of said creditor.
- The income tax department is empowered to tax this loan or borrowing if it is unable to provide a satisfactory explanation.
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While the Indian government has presented the “trust-based governance” agenda, it has also made a counter-argument by making startups responsible for their creditors’ source of revenue.
According to the latest amendment to Section 68 of the Income Tax Act, all startups will have to disclose the source of capital of the creditor from whom they are borrowing. The amendment was highlighted in the latest Finance Bill released by the government on February 1, the day the Indian Union budget for 2022-2023 was announced.
This means that a startup should prove the authenticity and creditworthiness of said creditor. This is a problem because several startups borrow money from high net worth individuals and family offices.
Rahul Charkha, a partner at Economic Laws Practice, told Business Insider that tax authorities are perfectly entitled to treat loans and borrowings as unexplained cash credits if one cannot prove the source. income.
It can then “tax the same at 60% (plus surtax and cess) without providing any basic exemption limit and slab benefits and would also attract criminal consequences”, he added.
Even though Finance Minister Nirmala Sitharaman mentioned that “startups have become a growth engine for our economy”, the latest amendment is seen as a step back from the same ecosystem.
Tax experts like Deepak Shenoy, founder and managing director of Capitalmind, have pointed out that the responsibility for this type of verification should lie with the tax authorities and not with the startup. The regulations essentially urge startups to request investor tax returns when the government can simply track it with a pan card number, he explained.
In its current form, the Income Tax Act only mentions that investments of venture capital funds or companies registered with the Securities and Exchange Board of India (SEBI) would not need such disclosure. . “So technically if a bank gives you a loan, you have the right to go to the bank and ask them about their source of income,” Shenoy told Business Insider.
Previously, the government was preoccupied with Angel Tax trying to determine a startup’s valuation and that had its own problems, he said.
If an entrepreneur friend of mine wants to borrow capital from me to pay the salaries of his company’s employees and I donate that capital for a short period of 15 days, the government will still require the startup founder to disclose the source of my income, Shenoy explained. I say I inherited this money from my father, then I show my father’s proof of income,” he added.
“How easy is it to do business here?” he added.
But it seems that the government’s simple logic here is to avoid tax evasion.
“The simple mechanism to avoid tax is that if I pay you, you have to charge me 18% GST [goods and services tax]. If you don’t want to pay that GST, instead of giving you the money, I say invest in you or buy your shares. Let’s say you give me 0.0001%, saying the shares are sold at ₹75,000 per share and you avoid taxes. You don’t have to pay income tax and GST, and you can use the money however you want,” Shenoy explained why the government started looking at startup valuation in the first place.
He also pointed out that the government must take into account that not all startups engage in activities such as tax evasion.
According to Paras Nath, Tax and Regulatory Services Partner at TR Chadha and CO LLP, it has not always been possible for the Revenue Department to review creditors’ books with reference to these credit transactions due to multiple challenges – including difference in jurisdiction, inability to review due to different valuation years involved and more. The government added a compliance layer at the end of the startup to further strengthen Section 68 of the Income Tax Act and prevent tax evasion.
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