Navigating the world of startups can be both exciting and challenging. Among the many hurdles that entrepreneurs face, legal compliance frequently stands out as the most complex and daunting issue. Ensuring your startup adheres to all the relevant laws and regulations is crucial for avoiding penalties, lawsuits, or other legal troubles that could possibly derail your business. Understanding the legal requirements for your startup is not just about avoiding pitfalls, but also positioning your business for success. One can create a solid foundation for growth, innovation and success by being proactive and informed about legal compliance. From choosing the right business structure, to protecting your intellectual property, all aspects become important while setting up any business. This guide will walk you through all the critical steps and considerations for ensuring your startup is legally sound.
According to the Government of India, under the Department of Industrial Policy and Promotion (DIPP) Notification dated April 2018, an entity is recognized as a ‘Startup’, if it meets the specific criteria such as the entity being a sole proprietorship, a private limited company, a registered partnership firm, or a Limited Liability Partnership (LLP). Secondly, it shall be within seven years from the date of incorporation or registration. However, for startups in the biotechnology sector, this period extends to ten years. Thirdly, the entity’s turnover shall not exceed ₹25 crore in the last five financial years. Lastly, the entity shall be working towards innovation, development, and improvement of products, processes, or services, or it must have a scalable business model with high potential for employment generation and wealth creation. Merely developing a product or rendering a service without this focus on innovation and value addition does not meet the criteria for being recognized as a startup.
After establishing their business, startups as a rule need to obtain several statutory licenses to ensure compliance with legal requirements. These include a Permanent Account Number (PAN) for tax purposes and a Tax Deduction Account Number (TAN) for deducting tax at the source. Additionally, a Goods and Services Tax Identification Number (GSTIN) is necessary for businesses involved in the supply of goods and services. An Importer Exporter Code (IEC) is required if the startup is involved in the import or export of any product or service. Registration under the Shops and Establishments Act is mandatory as per the respective state legislation. Furthermore, if the startup employs more than 20 people, it shall comply with the Employee Provident Fund (EPF) Act, and if it employs more than 10 people, it shall adhere to the Employee State Insurance (ESIC) Act.
Startup companies must also adhere to the regulatory compliances as stipulated by the Companies Act, 2013. This includes submitting Form INC-1 for the reservation of the company name and Form DIR-12 for the appointment of directors. They should also maintain Form CHG-7 to confirm that no charges have been created on the company’s properties. Additionally, Form MGT-1 and Form MGT-2 should be kept as registers of members and debenture holders, respectively. The company also needs to file Form DPT-3 for the return of deposits and submit the annual returns using Form MGT-7, which can now be signed by a director in the absence of a company secretary. Furthermore, maintaining a Minutes of Meetings Book is essential to record the proceedings of all company meetings.
The Government has introduced a mobile application and a dedicated web portal to streamline the Incorporation process by recognizing all the inefficiencies and delays, as well as the general lack of awareness among startup founders about the necessary formalities. This online platform allows for a very simplified registration form to be submitted to various government agencies and is directly integrated with the Ministry of Corporate Affairs for seamless processing. Additionally, the app provides a comprehensive checklist of all the applicable laws, licenses, and FAQs to help the startup founders to understand compliance requirements. It also enables the filing of compliances and offers real-time updates on the status of various clearances and approvals.
The Government has also introduced a self-certification mechanism for startups by acknowledging the time-consuming nature of labour and environmental law compliances. Through a mobile application and a dedicated web portal, called the “Shram Suvidha”, startups can complete this self-certification process. Following this certification, there will be no inspections for three years unless specific violations are reported. Additionally, startups that are classified under the ‘white category’ by the Central Pollution Control Board, can self-certify their compliance, with only random checks conducted to ensure adherence to regulations.
In lieu of adhering to these compliances, the government has offered incentives to startup founders. The RBI has announced measures to foster a more conducive environment for startup growth as a part of the “Startup India” initiative. These measures include allowing Foreign Venture Capital Investors to invest across all sectors, easing restrictions on deferred payments, escrows, indemnities in transactions, and to simplify the process for delayed FDI reporting by incorporating penalties. The RBI enabled online submission of A2 forms for outward remittances and electronic reporting of investments on the e-Biz platform thereby eliminating the need for physical forms. It is also considering further reforms such as allowing startups to access rupee-denominated loans under a relaxed External Commercial Borrowing (ECB) framework and issuing convertible notes under the FDI regime. These initiatives aim to provide startups with additional funding options without equity dilution and streamline overseas investment operations. Ultimately, the RBI must clarify certain ambiguities that are seen regarding sweat equity issuance and payments on behalf of overseas subsidiaries.
Other incentives include a full capital gains deductions under section 80-IAC of the Income Tax Act, 1961 and can get up to 100% tax exemption for three out of seven years if they are a newly formed private limited company or limited liability partnership, incorporated between April 1st of 2016 and 2021, and should not be created by splitting up of existing businesses or transferring used machinery. They must submit Form-1 with all the necessary documentation. Another exemption is from angel tax that is applicable to investments above fair value, provided their paid-up share capital and share premium do not exceed ₹10 crores; the investor’s average returned income should be at least ₹25 lakhs over the past three years and they should obtain a fair market value report from a merchant banker.
Additionally, Section 54EE provides capital gains exemption if the startup invests its gains in specified funds within six months with a limit of ₹50 lakhs per financial year. Section 54GB offers exemption on long-term capital gains from residential property sales if the gains are reinvested in shares of qualifying small or medium enterprises, including investments in technology-driven startups certified by the Inter-Ministerial Board of Certification. Startups can definitely benefit from the new patent box regime that is designed specifically to encourage local research and development. Under this, all the worldwide income earned from royalties on patents that are developed and registered in India will be taxed at a reduced rate of 10%. Resident inventors with patents filed abroad will not be eligible for this benefit. The government has also appointed examiners to fast track the patent applications by Startups and to provide 80% rebate.
Coming to the post-incorporation relaxations under the Companies Act,2013, it allows startups to not include cash flow statements in their financial statements. They are permitted to hold two board meetings per calendar year, with a minimum gap of 90 days between consecutive meetings. Interested directors are counted as quorum for board meetings if they disclose their interest beforehand. The annual return will only include the aggregate remuneration drawn by directors excluding the key managerial personnel. Additionally, startups can accept deposits from their members for up to five years from their incorporation.
Finally, once a startup is incorporated, it must handle essential documentation such as non-disclosure agreements, employment contracts, non-compete/non-solicitation agreements, HR policies, Employee Stock Option Plans, and various other contracts, leases, and insurance policies. Drafting a term sheet and information memorandum is crucial if the startup seeks funding and investment. Effective risk management is vital for any business. For any internet or e-commerce startup, compliance with the IT Act 2000 is necessary and minimizing liability depends significantly on the nature of representations, such as terms and conditions and other agreements. Following these best practices will help establish a solid foundation for sustainable growth and long-term achievements.
Article by Samarthana Suresh
For more information and assistance with Start-Up registration and compliances, contact us now.
Sources:
Research Papers-
Chitrapu, Dr. (2017). Startups and Legal Compliance in India. Startups in India.
Government notifications-
Bare acts-
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