A tax guru explains all that is wrong with Indian government’s latest requirement for startups to disclose creditors’ source of income

• All startups will now have to disclose the source of capital of the creditor they are borrowing from.
• This means a startup would have to prove the genuineness and creditworthiness of the said creditor.
• The Income Tax department is empowered to impose tax on this loan or borrowing if it is unable to offer a satisfactory explanation.
• You can see Business Insider’s budget coverage here.

While the government of India has set forth the agenda of “trust-based governance”, it has also issued a counter-argument by making startups responsible for the source of income of their creditors.

According to the latest amendment of Section 68 of the Income Tax Act, all startups will have to disclose the source of capital of the creditor they are borrowing from. The amendment was highlighted in the latest finance bill issued by the government on February 1, the day India’s Union Budget for 2022-23, was announced.

This means a startup would have to prove the genuineness and creditworthiness of the said creditor. This is an issue as several startups do borrow money from high networth individuals and family offices.

Rahul Charkha, Partner at Economic Laws Practice, told Business Insider, the tax authorities are well within their right to treat the loans and borrowings as unexplained cash credits if one is unable to prove the source of income.

It can then “tax the same at 60% (plus surcharge and cess) without providing any benefit of basic exemption limit and slabs and would also attract penal consequences,” he added.

Even though Finance Minister Nirmala Sitharaman has mentioned that “startups have emerged as a driver of growth for our economy”, the latest amendment is being seen as a set back to the same ecosystem.

Tax experts like Deepak Shenoy, founder and chief executive of Capitalmind, have highlighted that the onus of this sort of verification should be with the income tax authorities and not on the startup. The regulation is basically urging the startups to ask for the investor’s income tax returns when the government can simply track it with a pan card number, he explained.

In the current form, the Income Tax Act only mentions that investment from Securities and Exchange Board of India (SEBI)-registered venture capital funds or companies 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 their source of income,” Shenoy told Business Insider.

Earlier the government was concerned over Angel Tax by trying to determine a startup’s valuation and that had issues of its own, he said.

If one of my entrepreneur friends wants to borrow capital from me to pay salaries of their company's employees and I do give that capital for a short span of 15 days, the government would still require the startup founder to disclose the source of my income, Shenoy explained. I say I inherited that money from my father, then I show my father’s income proof?, he added.

“What is the ease of doing business here?,” he added.

But it seems like 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 I invest in you or I buy your shares. Let’s say you give me 0.0001%, saying that the shares are sold at ₹75,000 a share and avoid taxes on it. You don’t have to pay income tax and GST, and you can use the money however you like,” Shenoy explained why the government had started scrutinising startup valuation in the first place.

He also emphasised that the government needs to take notice that not all startups engage in such activities like tax evasion.

According to Paras Nath, Partner of Tax and regulatory Services at TR Chadha and CO LLP, it was not always possible for the revenue department to scrutinise the books of creditor with reference to such credit transactions due to multiple challenges — including difference of jurisdiction, inability to scrutinise due to different assessment years involved and more. The government has added a compliance layer on startup's end to further strengthen Section 68 of the Income Tax Act and avoid tax evasion.

SEE ALSO
Zomato founder Deepinder Goyal sells all his shares in Blinkit to Tiger Global
HDFC, ITC, Titan, Zee Entertainment and other hot stocks on February 3
WhatsApp India banned over 2 million accounts in December 2021