Quick Answer
13 min read|Updated: Apr 1, 2026|Income-tax
Quick Answer: DPIIT-recognised startups can claim a 100% profit deduction under Section 80-IAC for 3 consecutive years out of the first 10 years from incorporation (old regime only). Angel tax under Section 56(2)(viib) is abolished under the Income Tax Act 2025.
- Deferral period: Tax on ESOP perquisite is deferred until the earliest of:
- 5 years from the end of the relevant assessment year (i.e., the year of exercise)
- Date of sale of the ESOP shares by the employee
- Date of cessation of employment with the startup (resignation, termination, retirement)
- Eligible employers: Only startups holding valid DPIIT recognition as on the date of ESOP exercise
- TDS obligation: The employer must deduct TDS on the perquisite value at the time the deferred tax becomes payable (i.e., on the earliest trigger date above), not at the time of exercise
- Interest: No interest is charged on the deferred tax amount during the deferral period
- Employee obligation: The employee must disclose the ESOP exercise in the return of income for the year of exercise but need not pay tax until the trigger event
Example: An employee of a DPIIT-recognised startup exercises 10,000 options on 15 January 2026 at Rs 10 per share. FMV on exercise date is Rs 150 per share. Perquisite = (150 – 10) x 10,000 = Rs 14,00,000. If the employee continues with the startup and does not sell the shares, tax on this Rs 14 lakh perquisite is deferred until 31 March 2032 (5 years from end of AY 2026-27). If the employee sells shares on 1 August 2028, tax becomes payable for AY 2028-29.
6. Loss Carry-Forward Relaxation — Section 79 Equivalent
Under the general rule (Section 79 of the 1961 Act / equivalent under the 2025 Act), a closely-held company cannot carry forward and set off losses if there has been a change in shareholding exceeding 51% compared to the year in which the loss was incurred. This is particularly problematic for startups that undergo frequent funding rounds, diluting original shareholding.
Relaxation for DPIIT-recognised startups:
- The 51% continuity condition is relaxed — losses can be carried forward even after change in shareholding
- Alternate condition: All shareholders of the company who held shares carrying voting power on the last day of the year in which the loss was incurred must continue to hold shares on the last day of the relevant assessment year (even if their percentage has reduced)
- This effectively allows dilution through new investor entry without losing accumulated losses, as long as no original shareholder completely exits
- Applicable only to companies (not LLPs) that are DPIIT-recognised startups
- Business loss: carries forward for 8 AYs; capital loss: 8 AYs; speculative loss: 4 AYs
For a detailed guide on set-off and carry forward provisions, see our losses guide.
7. Section 80JJAA — Employment Generation Deduction
Section 80JJAA (equivalent under the 2025 Act) incentivises new employment creation — particularly relevant for scaling startups:
- Deduction: 30% of additional employee cost incurred during the year
- Period: Available for 3 consecutive assessment years beginning from the year of employment
- Eligible employee conditions:
- Monthly salary (total emoluments) must not exceed Rs 25,000
- Employed for at least 240 days during the financial year (150 days for apparel, footwear, and leather industry)
- Must have Aadhaar-linked Employees’ Provident Fund (EPF) contribution by the employer
- Not employed in any business earlier (i.e., first-time formal employment based on EPF records)
- Regime compatibility: Available under both old and new regimes. Also available to companies under 115BAA/115BAB
- Audit requirement: Accountant’s certificate in prescribed form is mandatory
Example: A startup hires 50 new employees at Rs 20,000/month each during FY 2025-26. Additional employee cost = 50 x Rs 20,000 x 12 = Rs 1,20,00,000. Deduction = 30% of Rs 1.20 crore = Rs 36,00,000 per year for 3 years (AY 2026-27 to AY 2028-29). Total deduction over 3 years = Rs 1,08,00,000.
8. Capital Gains on Startup Exit
The Income Tax Act 2025 simplifies capital gains with a two-tier holding period. For comprehensive coverage, see our capital gains guide.
| Exit Scenario | Holding Period for LTCG | LTCG Rate | STCG Rate |
|---|---|---|---|
| Sale of listed equity shares (post-IPO) | More than 12 months | 12.5% above Rs 1.25 lakh exemption | 20% |
| Sale of unlisted shares (secondary sale, M&A) | More than 24 months | 12.5% (no indexation) | At applicable slab rates |
| Buyback by company | N/A — treated as deemed dividend from Oct 2024 | At slab rates (dividend income) | N/A |
| ESOP share sale by employee | From exercise date (12/24 months as above) | 12.5% (cost = FMV at exercise) | 20% (listed) / slab (unlisted) |
Key points for startup founders and investors:
- Indexation is permanently removed under the 2025 Act — LTCG on unlisted shares at flat 12.5% without inflation adjustment
- For ESOP holders: the cost of acquisition for capital gains purposes is the FMV on the exercise date (the amount already taxed as perquisite), not the exercise price paid
- Buyback proceeds from October 2024 are taxed as dividend in shareholder hands; cost of shares bought back is treated as capital loss
- Section 54F equivalent (reinvestment in residential house to save LTCG) remains available on sale of unlisted shares
9. Transfer Pricing Implications
Startups with foreign investors, parent companies, or subsidiaries must be mindful of transfer pricing provisions under the 2025 Act:
- Associated enterprise threshold: 26% shareholding or more, or significant influence through management, control, or capital
- International transactions: Must be at arm’s length price (ALP) — applies to sale of goods, services, IP licensing, management fees, guarantees, and loans
- Domestic transfer pricing: Applies if aggregate value of specified domestic transactions exceeds Rs 20 crore
- Documentation: Contemporaneous TP documentation is mandatory. Form 3CEB must be filed by the due date of ITR filing
- Safe harbour rules: Available for specified categories (IT/ITES, lending/borrowing) — startups meeting safe harbour thresholds face reduced scrutiny
- Advance Pricing Agreement (APA): Startups can apply for APA (unilateral, bilateral, or multilateral) for certainty on TP matters for up to 5 years (extendable by 4 rollback years)
10. Advance Tax Obligations for Startups
Startups must pay advance tax in quarterly instalments if the total tax liability for the year exceeds Rs 10,000. The due dates under the 2025 Act continue as:
- 15 June: 15% of advance tax
- 15 September: 45% of advance tax (cumulative)
- 15 December: 75% of advance tax (cumulative)
- 15 March: 100% of advance tax
Interest under Section 234B (equivalent) at 1% per month applies for shortfall in advance tax (below 90% of assessed tax). Interest under Section 234C (equivalent) applies for deferment of individual instalments. For details, see our penalties and interest guide.
Exception for presumptive taxation: Startups under Section 44AD (equivalent) with turnover up to Rs 2/3 crore may pay entire advance tax by 15 March in a single instalment. For details, see our presumptive taxation guide.
Expert Insight — CA V. Viswanathan
The abolition of angel tax under the Income Tax Act 2025 is a landmark change that removes one of the most contentious provisions facing Indian startups. However, founders must recognise that valuation discipline remains essential — FEMA pricing norms for foreign investment, Companies Act requirements for private placements, and transfer pricing norms for related-party transactions all require robust, documented valuations. For ESOP planning, the 5-year deferral benefit is powerful but requires careful structuring of vesting schedules and exercise windows to maximise employee benefit while managing the company’s TDS compliance. Startups should also evaluate whether the old regime (with 80-IAC) or the new regime (lower rates but no 80-IAC) produces a better tax outcome — this analysis changes as profitability grows. For ESOP valuation, startup valuation, and strategic tax advisory, contact our team.
Key Takeaways
- Section 80-IAC: 100% profit deduction for 3 consecutive years out of 10 — old regime only, requires DPIIT + IMB certification
- Angel tax (Section 56(2)(viib)) abolished under the 2025 Act — no tax on share premium from resident investors
- ESOP perquisite = FMV minus exercise price, taxed as salary. DPIIT startups get 5-year deferral on tax payment
- Capital gains on ESOP sale: cost = FMV at exercise; holding period from exercise date; 12.5% LTCG rate
- Loss carry-forward relaxed for DPIIT startups — 51% continuity not required if original shareholders continue to hold (even at reduced %)
- Section 80JJAA: 30% of additional employee cost for 3 years (employees earning up to Rs 25,000/month)
- Transfer pricing applies if startup has foreign associated enterprise (26%+ shareholding) — arm’s length pricing and Form 3CEB required
- Buyback proceeds taxed as deemed dividend in shareholder hands from October 2024
- Valuation requirements under FEMA, Companies Act, and transfer pricing continue despite angel tax abolition
Frequently Asked Questions — Startup Taxation AY 2026-27
Q: What is the Section 80-IAC tax holiday for startups?
Section 80-IAC provides a 100% deduction of profits and gains from eligible business for 3 consecutive assessment years out of the first 10 years from the date of incorporation. It is available to DPIIT-recognised and IMB-certified startups incorporated as a company or LLP. The turnover must not exceed Rs 100 crore in any FY. This deduction is available only under the old tax regime — not under Section 115BAC (new regime) or Section 115BAA (concessional corporate rate).
Q: Is angel tax abolished under the Income Tax Act 2025?
Yes. Section 56(2)(viib) — the provision that taxed share premium received by unlisted companies above FMV from resident investors — has not been carried into the Income Tax Act 2025. From AY 2026-27, share premium received by startups is no longer taxable regardless of the valuation. However, valuation requirements under FEMA (for foreign investment), Companies Act Section 62 (private placement), and transfer pricing (related parties) continue to apply.
Q: How are ESOPs taxed for startup employees?
ESOPs are taxed at two stages. At exercise: FMV on exercise date minus exercise price = perquisite, taxed as salary income at slab rates. The employer deducts TDS on this perquisite. At sale: sale price minus FMV on exercise date = capital gain, taxed at applicable LTCG (12.5%) or STCG rates. For DPIIT-recognised startups, the tax on perquisite is deferred for up to 5 years from the assessment year of exercise, or until sale/departure, whichever is earlier.
Q: What are the DPIIT recognition requirements for startups?
The entity must be: (1) a company, partnership firm, or LLP; (2) within 10 years of incorporation; (3) with annual turnover not exceeding Rs 100 crore in any FY; (4) working towards innovation, development, or improvement of products/processes/services with potential for scalability and employment generation; and (5) not formed by splitting or reconstruction of an existing business. Application is through the Startup India portal at startupindia.gov.in.
Q: Can startups carry forward losses after a change in shareholding?
Yes. DPIIT-recognised startup companies enjoy relaxation from the Section 79 equivalent under the 2025 Act. Even if shareholding changes by more than 51% (due to fundraising, for example), losses can be carried forward provided all shareholders who held voting shares on the last day of the year of loss continue to hold shares (at any percentage) on the last day of the year of set-off. This allows dilution without loss of tax benefits, as long as no original shareholder completely exits.
Q: What is Section 80JJAA employment generation deduction?
Section 80JJAA allows a deduction of 30% of additional employee cost for 3 consecutive assessment years. Eligible employees must: earn up to Rs 25,000/month, be employed for at least 240 days in the FY (150 days for apparel/footwear/leather), have Aadhaar-linked EPF contributions, and not have been employed in any other business previously. This deduction is available under both old and new regimes and also under 115BAA/115BAB.
Q: Is the 80-IAC deduction available under the new tax regime?
No. The Section 80-IAC deduction is available only under the old tax regime. Startups opting for the new regime under Section 115BAC (which is the default from AY 2024-25 onward) cannot claim this deduction. Similarly, companies opting for Section 115BAA (22% concessional rate) cannot claim 80-IAC. Startups must evaluate whether the 80-IAC benefit under the old regime outweighs the lower tax rates under the new regime or 115BAA.
Q: How is capital gain computed on sale of startup shares?
For shares acquired through ESOP exercise: capital gain = sale price minus FMV on exercise date. For shares purchased directly: capital gain = sale price minus cost of acquisition. Holding period is measured from the exercise date (ESOPs) or purchase date. Listed shares held over 12 months qualify for LTCG at 12.5% (above Rs 1.25 lakh exemption); unlisted shares held over 24 months qualify at 12.5% (no exemption threshold). STCG on listed shares is 20%; on unlisted shares, at slab rates. Indexation is not available under the 2025 Act.
Q: What is the TDS obligation on ESOP perquisite?
The employer must deduct TDS on the ESOP perquisite value (FMV minus exercise price) as part of salary TDS under Section 192 (equivalent). For regular companies, TDS is deducted in the month of exercise. For DPIIT-recognised startups availing the deferral benefit, TDS is deducted at the earliest of: (a) 5 years from end of the assessment year of exercise, (b) date of sale of ESOP shares, or (c) date of cessation of employment. The employer must track these trigger events for each employee.
Q: Are transfer pricing rules applicable to startups with foreign investors?
Yes. If a startup has international transactions with associated enterprises — such as a foreign parent company, subsidiary, or investor holding 26% or more equity — transfer pricing provisions under the 2025 Act apply. All transactions (services, goods, IP licensing, management fees, loans, guarantees) must be at arm’s length price. The startup must maintain TP documentation and file Form 3CEB by the ITR due date. Safe harbour rules provide some relief for IT/ITES and lending transactions. An Advance Pricing Agreement may be considered for long-term certainty.
Disclaimer: This article is for educational purposes and does not constitute legal or tax advice. Consult a qualified chartered accountant for advice specific to your situation. For startup taxation, ESOP structuring, and valuation services, visit Virtual Auditor.
