In post, Ritvik Kulkarni our Spicy IP Fellowship applicant brings us his analysis of this year’s Union Budget. This is Ritvik’s third submission for the fellowship.
Union Budget 2016: The Finance Minister proposes Tax Sops on IP exploitation and Sobs on R&D Expenditure (Part-I)
The Finance Minister (“FM”) has announced favourable policies for the innovation industry in this year’s Union Budget. FM Arun Jaitley has announced four main IP-based tax developments in the budget. They are briefly :
- 100% tax deduction on profits of innovation based startups for the first 3 years.
- Concessional 10% tax rate to be imposed on income received from exploitation of Indian patents anywhere in the world.
- 10% tax rebate for Indian pharmaceutical companies on earnings from global patent filings.
- 50% tax reduction in the 200% weighted tax deduction for R&D expenditure.
India has recently not been faring well at various international IP appraisals. For instance, the US Global Intellectual Property Chamber (GIPC) has placed India at the second-last spot in its Annual Global IP Index. The Financial Times has reported on GIPC’s IP Index and Report here and I have blogged about it here. The Indian Government is now trying to make a genuine effort to reverse this by introducing a fresh batch of incentives for innovation entities and startups.
In part one of this two part post, I will deal with the tax exemption and tax rebates which have been introduced. In the second post I will be analyzing the concessional tax proposed to be levied on income from patent exploitation and the reduction in the super deduction for R&D expenditure.
Start Tax-free
The FM has proposed to offer a 100% tax deduction for 3 years on profits made by innovation based startups. This means that there will be no income tax levied on a startup’s profits for 3 years. However, startups will be required to pay the Minimum Alternative Tax (“MAT”). To this effect, the FM has proposed under Clause 41 of the Finance Bill, 2016 the insertion of a new Section 80-IAC in the Income Tax Act, 1961. It provides as follows:
80-IAC (1) Where the gross total income of an assessee, being an eligible start-up, includes any profits and gains derived from eligible business, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction of an amount equal to one hundred per cent of the profits and gains derived from such business for three consecutive assessment years.
According to subsection (3) to Section 80-IAC, this benefit will not be applicable to startups which, subject to other conditions:
- Are formed by splitting up, or reconstruction, of a business already in existence, or
- Are formed by the transfer to a new business of machinery or plant previously used for any purpose.
To be eligible for this 100% exemption from income-tax liability, a startup has to satisfy all the conditions laid out under sub-section (4) of Section 80-IAC. It requires that a startup has to be engaged in a business which “involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property”. Further, it lays down that a startup will be “eligible” only if:
(a) it is incorporated on or after the 1st day of April, 2016 but before the 1st day of April, 2019;
(b) the total turnover of its business does not exceed twenty-five crore rupees in any of the previous years beginning on or after the 1st day of April, 2016 and ending on the 31st day of March, 2021; and
(c) it holds a certificate of eligible business from the Inter-Ministerial Board of Certification as notified in the Official Gazette by the Central Government.’.
This benefit can be claimed by an eligible startup “for any three consecutive assessment years out of five years beginning from the year in which the eligible start-up is incorporated”.
This proposal is much in consonance with the Prime Minister’s ambitious Startup India Plan which was announced on January 16, 2016. This has been reported here. Under the Startup India Action Plan (Plan) Plan, a startup is defined as follows:
“Startup means an entity, incorporated or registered in India not prior to five years, with annual turnover not exceeding INR 25 crore in any preceding financial year, working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.
Provided that such entity is not formed by splitting up, or reconstruction, of a business already in existence.
Provided also that an entity shall cease to be a Startup if its turnover for the previous financial years has exceeded INR 25 crore or it has completed 5 years from the date of incorporation/ registration.
Provided further that a Startup shall be eligible for tax benefits only after it has obtained certification from the Inter-Ministerial Board, setup for such purpose.”
It is clear that to this extent, the proposed Section 80-IAC has almost entirely covered the requirements laid down in the Plan. However, it seems that the a few key points from the Plan have not been formally incorporated in the proposed Section 80-IAC. One of which is mentioned below. In order for a “Startup” to be considered eligible under the Plan, the Startup should:
have a patent granted by the Indian Patent and Trademark Office in areas affiliated with the nature of business being promoted.
Since the above condition has not been included in the proposed Section 80-IAC, a startup is not legally required to have a patent registration to be eligible for the 100% exemption from income tax liability. Nevertheless, Section 80-IAC(4)(i) requires a startup needs “to be working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property”. It is possible to argue that this provision requires a startup to have a registered patent, since a technological base is a sine qua non.
In such circumstances, it could be argued that this benefit can be enjoyed only by startups which have obtained a patent registration from the Indian Patent Office latest by March 31, 2021. This is because the benefit will last for any three consecutive assessment years of the five years from the year in which the startup is incorporated and the last date for such incorporation is April 1, 2019. Accordingly, the last of these three consecutive years for an eligible startup to take benefit of this provision should be from April 1, 2021 to April 1, 2024.
In its post on Mondaq, noted IP Firm S.S. Rana & Co. has suggested that a requirement of patent registration will defeat the purpose of this scheme as it takes a fairly long time to obtain a patent in India. For instance, Business Standard has in this comprehensive piece reported that “as many as 98% of patents granted in 2015 were for applications more than five years old. Compared to that, only 42% of patents granted in 2009 were for applications five years old or older”.
Ordinarily this would be a genuine concern however it isn’t in the present scenario for two reasons. First, the startup will have time till at least until March 31, 2019 to secure patent registration. 3 years might as well be enough to get a patent registered. Similarly, if the startup is incorporated on March 31, 2019 it will have until March 31, 2021 to secure such patent registration. For example, a startup entity begins R&D in early 2016 and applies for a patent by the end of 2017. Subsequently, it gets incorporated on March 31, 2019 and secures patent registration on March 31, 2021. Assuming that patent registration is a necessary requirement, the startup will become “eligible” under Section 80-IAC on March 31, 2021. In this case, a startup will have had a total of 4 years, from 2016 to 2021, to register its patent. However, it is unclear if the deduction will be applicable when a patent has been granted for an application filed before March 31, 2021. This is because under Section 43 of the Patents Act, 1970 the term of the patent starts from the date of application or the priority date.
Second, the Indian Prime Minister has assured that patent prosecution is going to be made cheaper and faster. To this effect, the Prime Minister has proposed an 80% reduction in patent filing fees for startups. Additionally, the DIPP’s Startup Intellectual Property Protection Scheme (SIPP) provides that “the patent application of Startups shall be fast-tracked for examination and disposal”. If this works out, then the 100% deduction will most certainly be a glorious incentive for creating innovation based startups.
A Pharmaceutical Pleaser
The FM has also announced a 10% rebate to pharmaceutical companies on the earnings from global patent filings. A rebate is essentially a discount which deducted from the gross income of an assessee. To be eligible for this benefit, the pharmaceutical assessee must operate from India and must have obtained a registered patent from a foreign patent office. This measure is going to highly benefit Indian pharmaceutical firms and push them towards securing patents across the globe.
The term “earnings from global patent filings” has not been clarified by the FM in his announcement. However, it is most likely to refer to royalty amounts received from exploitation of patents registered with a foreign patent office. Ideally speaking, this rebate should also cover the colossal costs involved in patent prosecution outside India. IP Watchdog has noted that in the US it can cost more than $30,000 to get a patent registered for a complex invention in the US. This includes an estimated $16,000 in attorney’s fees and $2,500-$3000 for patent searches and filings. This does not include costs incurred after prosecution which may exceed $7000. Therefore pharmaceutical companies, which deal with immensely complex inventions, should be offered some kind of rebate in relation to foreign patent prosecution as well.