The legislature has, time and again, introduced various income-tax benefits and incentives to encourage fresh investments and stimulate the economic growth. These incentives are generally given to new businesses in form of tax holidays, concessional tax rates or additional deductions. One recent example of such incentive is the tax holiday given to start-ups under Section 80-IAC of the Income Tax Act, 1961 (‘IT Act’).

Section 80-IAC of the IT Act provides for profit-linked tax holidays to eligible start-ups for a period of any three consecutive years within 10 years from the year of their incorporation. The start-ups are required to be incorporated between April 1, 2016, and March 31, 2022.^[1] In addition to the above, the taxpayers are also required to satisfy a few additional conditions, such as:-

a.     The start-up should not be formed by splitting up of or reconstruction of a business already in existence; and

b.     The start-up should not be formed by the transfer of machinery or plant previously used for any purpose, to a new business.

A common bone of contention between the taxpayers and the Income Tax Department (‘Department’) has been with respect to the ascertainment of whether an eligible business has been formed as a result of ‘splitting-up’ or ‘reconstruction’ of an existing business. Although these terms have been used extensively under the IT Act, they have not been specifically defined under the IT Act. Their context and meaning have, however, been elucidated under numerous judicial pronouncements wherein courts have interpreted similar language employed in the provisions of the IT Act to deduce the meaning of these terms.

The phrase ‘reconstruction of a business already in existence’ has been interpreted as the continuation of the same business in some altered form, by a new entity in such a manner that the identity of the original business is not lost or abandoned.^[2] The phrase ‘splitting-up of a business already in existence’, on the other hand, can be understood as a break-up or division of an integral part of the existing business/ assets between the old and new business.^[3] It is worth noting for taxpayers that the determination / satisfaction of the above-mentioned pre-condition(s) is an entirely factual exercise and would solely depend upon objective analysis of facts and circumstances of each case.

Another probable issue that the taxpayers might face whilst claiming deduction under Section 80-IAC of the IT Act could be with respect to the definition of ‘eligible start-up’. The term ‘eligible start-up’ has been defined under the Explanation to Section 80-IAC of the IT Act as well as in subsequent circulars issued by the Department of Industrial Policy and Promotion (‘DIPP’).^[4]  While the DIPP by way of notification dated February 19, 2019^[5]  has restricted the scope of ‘eligible start-up’ to mean and include only private limited companies and limited liability partnerships (‘LLP’), and have thereby excluded public limited companies from the scope and ambit of ‘eligible start-ups’, the Explanation to Section 80-IAC of the IT Act does not envisage any such exclusion and plainly defines ‘eligible start-up’ as companies and LLPs fulfilling the prescribed conditions. This inconsistency between the definition of ‘eligible start-ups’ could be a cause of concern for public limited companies and their subsidiaries (which are deemed public limited companies). In such a scenario, the taxpayer may contend that (a) Circulars cannot restrict the scope of the provisions enshrined in the statute; and (b) assessing officer / tax authorities are not bound by Circulars issued by the DIPP, Ministry of Industry and Commerce.

Keeping in mind this dichotomy in the interpretation of the various condition(s), the taxpayers must be extremely vigilant while claiming tax deduction under Section 80-IAC of the IT Act. This is especially pertinent in two cases: (i) when new enterprises engaged in similar businesses which have been previously undertaken by already existing enterprises are seeking deduction; and (ii) when public limited companies / their subsidiaries are seeking deduction. This is because such cases are highly prone to scrutiny by the Department. Needless to say, the fulfilment of this condition must be examined keeping in mind the objects and purposes for which a specific tax benefit provision has been inserted.

[1] It is pertinent to note that the sunset date for claiming deduction under this provision has been proposed to be extended to March 31, 2023 by the Finance Bill, 2022.

[2] CIT v. Gaekwar Foam and Rubber Co. Ltd., [1959] 35 ITR 662 (Bombay High Court); Textile Machinery Corporation Ltd. v. CIT, [1977] 107 ITR 195 (Supreme Court); CIT v. Travancore Rayons Ltd., [1986] 50 CTR (Kerala High Court) 51; Nagardas Bechardas & Bros. (P.) Ltd. v. CIT, [1976] 104 ITR 255 (Gujarat High Court); CIT v. Ganga Sugar Corpn. Ltd., [1973] 92 ITR 173 (Delhi High Court).

[3] Smt. Sangita Agarwal v. CIT, [2012] 18 taxmann.com 97 (Calcutta High Court); T. Satish U. Pai v. CIT, [1979] 1 Taxman 123 (Karnataka High Court).

[4] Any start-up desirous of claiming benefit under Section 80-IAC of the IT Act has been mandated to obtain necessary approvals and recognition from the DIPP.

[5] Published in Gazette Notification No. G.S.R 127(E) on February 19, 2019.