Budget 2021 Expectations for MSMEs and startups: Lower taxes, forex overhaul, simplified GST, more on MSMEs, startups wishlist

Union Budget 2021-22 Expectations for MSMEs, startups: As per the data released by the MSME ministry, India has close to 6.8 million Udyog Aadhar registered MSMEs and close to 63 million MSMEs in total. MSME related products accounted for 49.81 per cent of the total exports made during the FY 2019-20 and the sector provided employment to close to 110 million people in India. As per an estimate, currently, there are close to 30 unicorn Indian startups, and 18 out of the 30 unicorns have major foreign direct investments. India had a record $73 billion FDI during the FY 2019-20 as per the Commerce Ministry. As per the Startup India portal, India has more than 40,000 DPIIT registered startups. These numbers show the level of importance and impact MSMEs have on the Indian economy and the importance of FDIs to make unicorn startups in India.

Schemes, benefits in place

In the last several years, the MSME ministry, Commerce and Industry Ministry, and the Finance Ministry of the Government of India, through various budgets, schemes and notifications have come up with various schemes and incentives to boost Make in India and boost the local industry, MSMEs and startups like:

• Schemes specifically for registered MSMEs:

1. Interest Subvention and Credit Support Program
2. Solar Charkha Mission
3. MSME Sampark and Sambandh
4. Khadi, Village and coir Industry development
5. Amendment in MSME Act and expansion of the MSME definition to cover a larger number of enterprises
6. Entrepreneurship and skill development programs

• Profit Linked Incentive Scheme for Electronics Manufacturing and now for 10 other key sectors like automobile, pharma, telecom, textile, food processing, and steel
• Reduced base Corporate Income tax to 22 per cent and 15 per cent for the new manufacturing sector
• E-governance and online e-assessment and e-appeal introduced by the Income Tax department through the National E-assessment centre
• Benefits given to DPIIT registered startups under the Startup India Initiative:

1. Income tax exemption for three years and from angel tax
2. Patent application and IPR protection rebates
3. Self-Certification
4. Easy winding up
5. Easier public procurement norms for startups

Expectations for Budget 2021

Finance Minister Nirmala Sitharaman has raised the Budget 2021 expectations by stating that this budget shall be ‘unlike anything in past 100 years’, however, there are still some real pain points that MSMEs and startups expect to be addressed urgently in Budget 2021:

Easing FEMA Laws & inflow-outflow of foreign exchange funds inside, outside India

All inflows and outflows of funds into and outside India must go through stringent RBI Scrutiny, reporting, and limits. They become a blocker for foreign investments into India as investors worry about the extant compliance not only during inflows but also when the funds are to be repatriated back, either the original investment amount, interest, or dividend. The institutional investors and investees still have the resources at their disposal to carry out the compliances, however, many times it becomes a deal ‘breaker’ for smaller investors impacting the smaller MSMEs / startups seeking such funds.

The same applies to compliances around the import and export of goods and services. Compliances around regularisation of export revenue and filings required for foreign payments for import of services, including CA certification requirements, increase compliance time and cost at times making business non-viable for small business. For instance, if a business makes a small monthly subscription fee to a foreign service provider, they cannot do it directly from a credit card/debit card through an auto-debit facility, without non-complying with the income tax provisions. They will have to undergo a bank visit and a CA visit before making even a small payment for say $10 subscription fee to be paid outside India. This is a real pain faced by many small and large businesses, but especially to small and medium enterprises. At times, the foreign service provider, whose services are critical for running the Indian business, do not even give options or provide documentation to carry out such compliances at the India level. In the end, the Indian business has to either let go of the critical service or live with a risk of non-compliance, interest, and penal liabilities.

A complete overhaul of the system of foreign exchange inflows and outflows is required to ensure that Indian MSMEs and startups can seamlessly work with global customers, suppliers, investors, and other stakeholders and are able to compete globally.

Also read: Budget 2021 Expectations: Should common taxpayer expect major rationalization in income tax slabs and rates?

LTCG taxes on unlisted shares, dividend taxes & additional surcharge

Companies, businesses, and individuals pay income tax on their income. Again, charging capital gain taxes (On capital appreciation over a period from tax paid money) or dividend taxes (On the distribution of tax paid profits) are nothing but double taxation on the same profit. Many global business centres like Singapore do not have capital gains and dividend taxes at all.

India has an extremely high rate of capital gains taxes and dividend taxes. Resident individuals and HUF’s end up paying dividend taxes at an effective rate of 35.88 per cent and non-residents at a rate of 23.92 per cent. Long term Capital Gain taxes also attract an effective rate of 28.50 per cent taxes for high-income groups and short-term capital gains taxes at 42.74 per cent. Taxes which were already higher have been increased by surcharges for super-rich from last year onward. Similarly, taxes are on the higher side for investment funds, REIT’s AIF’s and FPI especially for unlisted shares, which is the most common case for smaller and medium-sized businesses.

These higher taxes demotivate the domestic/foreign investors either to not invest at all in Indian businesses or they force the Indian business to move to a structure wherein the Intellectual Property (IP) and other core ownership moves to some other low tax jurisdiction. Again, for India to attract more foreign investors and a booming MSME and startup sector and to retain the talent and ownership of know-how, patents, and other important intellectual property in India, the tax rates must be low and the avenues attracting double taxes like capital gain taxes and taxes on dividends should either be done away with or reduced considerably. This will stop the IP and capital drain and attract more capital investments both domestic and foreign.

Simplification of GST & labour laws

With every passing day, GST laws are becoming more draconian instead of being simplified. As per the latest government notification, if the monthly taxable sales are more than Rs 50 lakhs, it has been made compulsory to pay 1 per cent of GST liability in cash (with few exceptions) and not allowed to be set-off against input tax credit. The time limit of allowing GST registration has also been increased with a requirement of physical verification of office address by the GST officer. GST officers have also been provided additional powers to cancel GST registration in several cases. Several state governments are also coming with GST department audits and scrutinies as per respective State GST laws.

These amendments and newer requirements shall not only increase time and compliance costs for MSMEs and startups but will also give rise to harassment and corruption. MSMEs and startups are expecting more simplified and automated tax laws and not such complicated and officer driven laws.

ESOP Taxes on unlisted Companies

Employee Stock Option Plans (ESOP) are not only a cost-effective tool for startups and MSMEs who have limited financial resources and still want to tap the best talent in the industry, but it also increases the sense of ownership and entrepreneurship for the employees of the Company.

Shares of companies allotted under an ESOP plan attract taxes as perquisites (salary) at the time of allotment of shares, based on the difference between the Fair Market Value (FMV) and the actual exercise price. However, those unlisted shares do not have an available market for resale. Hence, the employees end up paying taxes on such share valuation without getting direct cash inflows and with the absence of short/medium term liquidity of such shares.

Budget 2020 deferred tax deducted at source (TDS) requirement for such ESOPs share allotment for registered startups. However, this deferment comes with two riders that again makes this deferment un-attractive. First, deferment is limited to five years. Most of the time, startups take more than five years to list themselves in the stock exchange and become a listed company or carry out an exit or sell-out. Second, it does not apply to an employee who is exiting a company as an employee. So, a person who has invested several years in a company and wants to change the company, his ESOPs earned during employment will not be eligible for deferment of taxes.

The startup Industry and its employees expect the riders to be removed and be made more inclusive. Also, this benefit of deferment of taxes should be rolled out to more MSMEs in the traditional sector and not just to the registered startups.

We are confident that the government and its various ministries are working hard to make Budget 2021 one of the best in more than 100 years and take the pandemic-stricken country and economy to a fast-paced bounce back and sustained long term growth. This is to make India an economic superpower and a supply chain hub. We hope these suggestions will also be taken into consideration to bring down the practical difficulties and ensure seamless global integration and competitiveness.

Alok Patnia is Managing Partner of TaxMantra Global. Views expressed are the author’s own.