A Legal Guide for Start-ups in India

The Author, Smita Singh is a student of 2nd Year, BA.LLB, National Law University of Delhi. She is currently interning with LatestLaws.com.

Introduction

India is the world’s third largest start-up ecosystem[1]. In the past decade, there has been a spur of start-up initiatives from entrepreneurs, businessmen and students across the country. The market and the customer base are the key elements to focus on while carrying on such initiatives. However, it is also very pertinent to have a rudimentary level of understanding of the basic laws, government schemes and the legal requirements that are applicable for an effective running of the start-up. The following sub-headings highlight the different legal requirements:

1. Defining the nature of the business and drafting a founders’ agreement

Clarifying the nature and type of the business is the first step in establishing a business. The business must be incorporated as one of the following: sole proprietorship, private limited company, public limited company, partnership, limited liability partnership, etc. It is crucial to have this clarity at the outset, as it will be fundamental to the business's overarching vision and short- and long-term objectives. Each type of business has its own set of legal requirements and the basic requirements are as follows[2]:

In addition to this, the startup must have a well-structured and elucidative founders’ agreement. The agreement must have clauses defining the rights, responsibilities, ownership and methods of dispute resolution among other things.

1. Registration

Under the Startup India Initiative, the Department of Promotion and Industry and Internal Trade (DPIIT) of India would recognize your business as a startup. You can register yourself online at StartupIndia.gov by providing the required information and papers and uploading them. The approval then comes from the inter-ministry board.[16]

2. Acquiring Business Licenses and other Legal Requirements

There are certain generic requirements to be complied by every start-up along with certain specialized requirements subject to the nature of the start-up. Generic requirements include acquiring a GST registration[17]; a PAN number; a Tax Account number; a bank account; and, a Shop and Establishments License, if physical premises of the start-up business needs to be established.[18] 

Specific requirements such as the FSSAI license (for food business) and the IEC Code (for import-export business) are also to be complied with depending on the nature of the start-up.[19]

3. Understanding the Taxation Laws

The government of India has enacted a Presumptive Taxation Scheme[20] for HUFs and sole proprietors, requiring them to file income tax on their earnings. Under this programme, if your annual revenue is less than 2 crores, you can declare it as:

1. 50% of the value of the services rendered (only for service providers);
2. 8 % of non-digital transactions;
3. or 6% of digital transactions (only for goods' suppliers).

As per the Startup India initiative, Post getting recognition a Start-up may apply for Tax exemption[21]. Post getting clearance for Tax exemption, the Start-up can avail tax holiday for 3 consecutive financial years out of its first ten years since incorporation. Eligibility Criteria for applying to Income Tax exemption[22]:

1. The entity should be a recognized Start-up  
2. Only Private limited or a Limited Liability Partnership is eligible for Tax exemption under Section 80IAC
3. The Start-up should have been incorporated after 1st April, 2016

The start-up may also apply for angel tax exemption[23]. Eligibility Criteria for Tax Exemption[24]:

1. The entity should be a DPIIT recognized Start-up
2. Aggregate amount of paid-up share capital and share premium of the Start-up after the proposed issue of share, if any, does not exceed INR 25 Crore.

4. Complying with certain Labour Laws and Environmental Laws

Whether a business is large or small, adhering to labour rules is essential. Regardless of the size of your organisation, you are subject to a number of labour rules after your firm has been founded and employees have been hired. As per the Startup India initiative, start-ups shall be allowed to self-certify with 9 labour laws, namely[25]:

1. The Industrial Disputes Act, 1947
2. The Trade Unit Act, 1926
3. Building and Other Constructions Workers’ (Regulation of Employment and Conditions of Service) Act, 1996
4. The Industrial Employment (Standing Orders) Act, 1946
5. The Inter-State Migrant Workmen (Regulation of Employment and Conditions of Service) Act, 1979
6. The Payment of Gratuity Act, 1972
7. The Contract Labour (Regulation and Abolition) Act, 1970
8. The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952
1. The Employees’ State Insurance Act, 1948.

The Indian government has created a uniform Shram Suvidha Portal[26] to streamline the reporting of inspections and the submission of yearly returns for compliance with labour rules. The online solution enables start-ups to self-certify in accordance with applicable labour rules and avoid inspections for five years. The following labour laws will be covered by this[27]:

1. The Employees Provident Funds and Miscellaneous Provision’s ACT (EPF) Act, 1952.
2. Employees’ State Insurance Act (ESI), 1948.
3. Contract Labour (Regulation and Abolition) Act, 1970.
4. Building and Other Construction Workers (BOCW) Act, 1970.
5. Inter-State Migrant Workmen (ISMW) Act, 1979.

Additionally, the Ministry of Environment, Forest and Climate Change has released a list of 36 white category industries[28]. Startups in the "White category" would be able to self-certify their compliance with three environmental statutes, namely[29]:

1. The Water (Prevention and Control of Pollution) Act, 1974.
2. The Water (Prevention and Control of Pollution) Cess (Amendment) Act, 2003.
3. The Air (Prevention and Control of Pollution) Act, 1981.

5. Contract Management

Contracts with employees, vendors, suppliers, etc. would ensure timely and effective management of the business. The Indian Contract Act is applicable on every formal contract. As per the act, all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration with a lawful object, and are not expressly declared to be void.[30]

Other than formal contracts, the entrepreneurs could find valuable to have Non-Disclosure Agreements (NDAs). Startups frequently thrive in a crowded market with fierce competition and they regularly engage in discussions with a plethora of people from possible investors to staff to customers. As important this activity might seem to be, it exposes the novel ideas of the startups to misappropriation and theft. Thus, having NDAs for such qualified information would protect the interests of the start-ups.

In case, the start-up has a website which provides online services to the customers, it is mandatory to put the startup’s Terms and Conditions (T&C), Privacy Policy[31], Anti-Corruption and Anti-Money Laundering Policy on the website itself. This would avoid confusion and mismanagement of any dispute which could arise in the future.

6. Protection of Intellectual Property (IP) and Trade Secrets

IP rights are crucial for the following reasons:

1. distinguishes a firm from competition;
2. be sold/licensed, creating a vital cash stream for companies;
3. provides customers with something novel and distinct;
4. become an integral aspect of marketing or branding;
5. serves as collateral for loans.[32]

Startups can also reap the benefits of the Scheme for Startups Intellectual Property Protection (SIPP)[33] under the Startup India program, which fosters and mentors unique and developing technologies and aids in the protection and monetization of their intellectual property.

7. Winding up Process

As per Section 2(94A) of the Companies Act, 2013, “winding up” actually means winding up under this Act or also liquidation under the Insolvency and Bankruptcy Code, 2016. When seen from a legal perspective, a start-up company can be shut down in one of 3 primary ways:

1. Fast Track Exit Mode[34]
2. Court or Tribunal Route[35]
3. Voluntary Closure[36]

The Fast Track Exit Mode is the best suited winding up procedure for any start-up. It enables a Registrar

 of the Registrar of Companies (RoC) to send a notice to the directors of the company to wind up if the

 following two conditions are fulfilled:

1. The company did not undergo any business operation in the past one year
2. The company did not have any assets and liabilities.[37]

Apart from fast-track exit, winding up by way of courts/tribunals is the conventional method, which can result in protracted legal proceedings and is often unsuitable for a startup. In the voluntary closure, the stakeholders must be on the same page with regards to the nitty-gritties of the closure, which makes it difficult to be initiated in the first place.

Additionally, “The Insolvency and Bankruptcy Board of India ("IBBI"), in exercise of its power conferred by sections 58, 196, and 208 read with section 240 of the Code, has notified the Insolvency and Bankruptcy Board of India (Fast Track Resolution Process for Corporate Persons) Regulations, 2017 (hereinafter referred to as "the Regulation"). These Regulations provide the process from initiation of insolvency resolution of eligible corporate debtors till its conclusion with approval of the resolution plan by the Adjudicatory Authority. The time period given for the completion of Fast Track Resolution Process is 90 days, as against 180 days for Corporate Insolvency Resolution Process (“CIRP”). However, the Insolvency Resolution Professional may apply to Adjudicating Authority for the extension of time for a further period of 45 days in case of Fast Track Process and 90 days for CIRP.[38]”.

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