Legal Compliances for Startups in India

India is one of the largest startup ecosystems in the world with a large majority of startups emerging in the technology sector. Flourishing start-ups are driven by passionate entrepreneurs who are focused on building unique solutions to deliver complete customer satisfaction. But with the increasing complexity of technology and the multi-faceted and global nature of transactions, it is paramount for new and emerging enterprises to have a strong legal base to survive. Before setting up a start-up, having thorough knowledge about the legal requirements of a start-up and being compliant with all applicable laws and regulations is mandatory.

The last few years have seen a significant rise in the development of start-ups. Numerous start-up companies have emerged in the Indian corporate structure and are continuously working towards establishing their name globally. Legal compliances and regulations are essential for the growth of any start-up business and it is important to follow them indefatigably. 

Eligibility Criteria for Startups

Though there is no comprehensive definition for start-ups that have been provided under Indian laws, the Government of India (GoI) under its start-up schemes define start-ups as:

An entity shall be considered as a startup(meaning of Startup) if it satisfies all the following conditions:

  1. If it is incorporated/registered as any of the followings:
    • Private Limited Company (as defined in Companies Act, 2013).
    • Partnership Firm (registered under Partnership Act, 1932).
    • Limited Liability Partnership (registered under Limited Liability Partnership Act, 2008).
    • One Person Company (as defined in Companies Act, 2013).

Provided that such an entity is not formed by splitting up or reconstruction of a business already in existence.

  1. It has not completed ten years since incorporation/registration as above.
  2. Its turnover for any of the financial years has not exceeded INR 100 Crore.
  3. It satisfies any of the following conditions:
  • It is working towards:
    1. Innovation of new products/processes/services or
    2. Development of new products/processes/services or
    3. Improvement of existing products/processes/services
  • It is a scalable business model with a high potential of:
    1. Employment generation or
    2. Wealth creation.

Legal Aspects and Compliances That Every Startup Should Know

The primary goal of any start-up is to maximize its profit. While doing so, they tend to ignore the mandatory legal requirements which may affect their business adversely in the longer run. Legal compliance is an essential wheel that keeps a check on any going needs of a business. Following are the documentation and formalities to be followed by a start-up to become legally compliant:

1. Incorporation related compliance

Each structure has its own set of rules and regulations that decided whether registration is required or not, how much tax a company must pay and what kind of licenses does it require? For instance, sole proprietors do not need any registration whereas it is optional in partnership firms, however, it is compulsory for LLPs and private limited companies.

Companies have a mandatory registration requirement under the laws of India. A company may be registered as a legal entity under:

a) The Companies Act, 2013 – for private, public, not-for-profit and one person companies
b) Indian Partnership Act, 1932
c) Limited Liability Partnership Act, 2008

Various companies also opt to register their businesses under different government schemes and laws to avail the benefits and concessions provided under the laws. Companies, depending on the nature of the business may be registered under the MSME Act, the GST Act or under the Start-up India Scheme.

2. Applying for business licenses

Licenses are integral for running any business. Based on the nature and the size of the business, start-ups may be required to register their business under various licenses applicable under different statutes in India. The common license that applies to many businesses is the Shop and Establishment license which is applicable on all premises where trade, business or profession is carried out. 

Other business licenses vary from industry to industry. Various environmental, food and safety, labour and employment laws and import-export laws, FDI Policy, FEMA, SEBI/RBI regulations in India impact the procurement of licenses.

For instance, an e-commerce company may need to fulfil additional requirements like VAT registration, Service Tax Registration, Professional Tax etc. while a restaurant may need licenses like a Food Safety License, Certificate of Environmental Clearance, Prevention of Food Adulteration Act, Health Trade License etc. along with the above-mentioned licenses.

3. Documentation requirements

A lot of emerging businesses do not pay much attention to formalize the structure of the contracts and basic incorporation related documents. This can create a plethora of legal complications in case, a dispute arises or while raising investment, at any stage of a start-up’s growth. Some basic documentation that every start-up should take care of are:

a) Drafting the incorporation documents such as;  Founder’s Agreement, Shareholder’s Agreement, Memorandum of Association and Articles of Association for registered companies under the Companies Ac, 2013 etc.

b) Contracts such as; Non-Disclosure Agreement (NDA), Confidentiality Agreement, Memorandum of Understanding (MoU)s, Letter of Intent and others. 

c) Work Agreements such as; Employment Agreements, Lease/Rent Agreement, Service Agreement, Consultancy Agreements and others.

d) Technical Agreements such as; Technology Assistance Agreement, Licensing and Assignment Agreement, Outsourcing and Hosting Agreements and others.

e) Company policies such as; Sexual Harassment Policy, Employee Grievance Management Policy, Data Privacy and Protection Policy, Whistleblower Policy and others.

f) Intellectual Property Management – Registration of intellectual property like Copyrights, Patents, Trademarks etc. in India and internationally, Licensing and Assignment Agreements related to their Intellectual Property and others.

4. Company law-based Compliances

For start-ups registered under the Companies Act, 2013 there are certain mandatory compliances that need to be completed. Some of the compliances include:

4.1 Annual General Meeting (AGM)

There should be one AGM every year and there must be a gap of at most 15 months between 2 AGMs. Approval of financial statements, the appointment of auditors, declaration of dividends, etc. is the main objective for such meetings. The annual general meeting needs to take place in the city where the company’s registered office is located.

4.2 Board Meetings

The first board meeting of the Board of Directors should take place within 30 days of the incorporation of the company. Apart from that, four board meetings are supposed to take place every financial year such that the gap between two consecutive board meetings isn’t more than 120 days.

4.3 Mandatory filing of forms

a) Appointment of Auditor (E-Form ADT-1)

The first Statutory Auditor should be appointed within 30 days of the company’s incorporation in the first board meeting. However, in an AGM the subsequent auditors could be appointed for 5 years. An applicant is required to file form ADT-1 for a 5-year appointment. After that, every year shareholder endorses the auditor in AGM, but there’s no requirement to file ADT-1.

b) e-Form MGT-7

MGT-7 is an electronic form issued to the companies by the Ministry of Corporate Affairs (MCA) to fill their annual return details. Every private limited company must file the form MGT-7 every year.

c) e-Form AOC-4

Form AOC-4 is used for filing the financial statements for each financial year with the ROC. Generally, the primary means of communication between the shareholders and the Board of Directors is through the financial statements. Hence, every company registered under the Companies Act, 2013 is required to file the form AOC-4.

d) Directors’ Report

As per the Companies Act, 2013 every company is required to prepare a board report containing the details of the state of the company, operations during the year, dividend declaration, net profit, corporate social responsibility standards, etc in compliance with section 134.

e) Form MBP-1

The form MBP-1 is required to be filed by the directors of the company in the first meeting of the Board of Director in every financial year where they would disclose their interest in other entities. Fresh MBP-1 must be filed, whenever there is a change in the interest of the director from the earlier submitted MBP-1.

f) Form DIR-8

Every director is required to file form DIR-8 in every financial year with the Company Disclosure of non-disqualification.

g) Compulsory Maintenance of Certain Registers
  1. Minutes Register; Board meeting minutes book, and General meeting minutes book that could be EGM, AGM, Creditors Meetings,
  2. Debenture holders Meetings, and Postal Ballot.
  3. Statutory Registers;
  4. Books of Accounts or Financial Statements in compliance with Section 44aa
  5. Register of Directors Attendance at Board meetings or Committee.

5. Taxation based Compliances

  • Under Income Tax Act, 1961 – filing Income Tax Returns, Tax Audit Reports, TDS Returns, assessment of tax liability.
  • GST Act, 2017 – Registration of establishment under the GST Act, Filing of monthly, quarterly and annual returns.

Apart from the legal compliance, start-ups can also avail various rebates available to new companies in India.

a) Three years tax holiday in seven years

Under section 80IAC of the Income Tax Act, any startup that is established after 1 April 2016 can avail 100% tax rebate on its profits for 3 years within a block of 7 years. However, if the Company’s annual turnover is more than Rs 100 crore, then the tax rebate is not available.

b) Tax exemption on long-term capital gains (LTCG)

Under Section 54EE of the Income Tax Act, start-ups are exempted from LTCG tax. However, this is only applicable if the capital gains that have been invested in are a part of the fund notified by the Government of India within 6 months from the date of the asset’s actual transfer.

c) Tax exemptions on investments above the fair market value

If an eligible start-up does any investment, the government exempts the tax on the investment above the fair market value.

d) Tax exemptions to individual/HUF on LTCGs from equity shareholding

If an individual/HUF sells their property and then invests that money to subscribe to a minimum of 50% or more of an existing start-up, then they are exempted from tax on these LTCGs. The enterprises must be small/medium ones, as stated under MSME’s Act of 2006.

6. Labour law-based Compliance

India being a welfare state has ensured strict measures to be taken for labour welfare and safety. Some of the major laws that need to be followed are:

  • The Employee’s State Insurance Act, 1948: This act makes it mandatory for some establishments to get themselves registered with the State Insurance Corporation and contribute to the State Insurance Corporation Fund. 
  • Employee Provident Fund Scheme, 1952: This act makes it mandatory for the companies to contribute towards the Provident Fund of the employees.
  • Maternity Benefit Act, 1961: This act makes it mandatory for the company to provide the following benefits:
    1. The Sexual Harassment of Women at Workplace (Prevention, Prohibition, and Redressal) Act, 2013
  • Payment of Wages 1936 /Minimum Wages Act 1948 to regulate basic wages of the labour force
  • Contract Labour (Regulation & Abolition) Act, 1970/ Interstate Migrant Workmen (Regulation of Employment And Conditions of Service) Act, 1979 to regulate the employment of labour hired on a contractual or migration basis.
  • The Industrial Disputes Act, 1947 (the “ID Act”) has been enacted for the investigation and settlement of industrial disputes in any industrial establishment.
  • Trade Union Act. 1926 – An Act to provide for the registration and regulation of Trade Unions

Conclusion

Adhering to legal requirements is crucial for any organization; knowledge and compliance with applicable laws is the initial step to ensure smooth business operations. Compliance with the relevant laws where the startup is doing business is important for the successful setup and efficient growth of startups. Compliance ensures that no penalty is imposed on a start-up at any point in its growth and helps it stay out of any other possible risks/difficulties. One can conclude that the longevity of a stable is dependent on how secure its legal foundation is.

FAQs

1. Whether annual compliance is compulsory?

Annual Compliance is compulsory for all companies and LLPs registered with MCA. Irrespective of the turnover and capital of the business, the annual filing must have complied. Late filing or non-filing of the same can result in additional fee and penalties.

2. Whether Book-keeping and accounting are compulsory for every business?

Yes, bookkeeping is compulsory for all businesses except the sole proprietorship. Even the sole proprietorship has to maintain accounts after earning a certain turnover. Additionally, the companies have to maintain accounts in accordance with the accounting standards prescribed.

3. What is the time frame for obtaining a certificate of recognition as a “Start-up” in the case of an already existing entity?

The procedure of registration in such cases shall be real-time and the certificate of recognition would be immediately issued upon successful submission of the application.

4. If an entity does not have a PAN. Would that entity be allowed to register as a “Start-up”?

Yes. An entity can be registered as a Start-up without a PAN. However, it is advised that a valid PAN of the entity is provided at the time of registration, as each entity is recognised as a separate taxable person.

 

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