Experts from Taxmantra shed some light
Last week founder of a technology startup asked me, “Alok, I have already spent substantial amount of my personal finances for furniture, technology, and infrastructure, recurring revenue expenditure for the business before the incorporation of the company and actual start of business operations. How should I go about it? Can I transfer these costs to the company and claim them as expenses for income tax purposes?”
Yes, this is exactly startups should do. The assets that you acquire before the startup and the costs you incurred personally before the startup should be indeed be transferred as assets and expenses to your new company, provided the same were incurred to run your business and have back-up bills for that. Since these assets and expenses were paid by you personally, in reality you advanced a certain amount of money to your business and your business incurred a debt to you.
What are startup expenses?
Startup expenses include all costs incurred for acquiring assets, infrastructure costs or revenue recurring expenses before start of operations of your business. Some of the startup expenses which come to my mind are:
Expenses incurred for drafting of Memorandum of Articles and Association and registration of company.
Expenditure incurred on preparation of project report or feasibility report
Expenditure on market survey or any other survey necessary for business
Trial run/beta run expenses
Expenditure on research and development of software or other similar expenses
Legal expenses for drafting agreement required for setting up of business
Expenditure on issue of shares
Cost of fixes assets/infrastructure costs for the business
Payment of salary
Electricity or rental costs
Other revenue or capital costs associated with the business
Accounting and tax treatment — startup expenses (revenue or capital)
Accounting standard prudence suggests that all expense incurred for the business should be accounted for in the business itself, irrespective of nature of these expenses.
The accounting and tax treatment of an expense would solely depend on whether the same is being identified as a capital expenses or a revenue expense. Let’s take a case of an IT company which is engaged in development of proprietary intellectual applications and also renders other generic software maintenance services. The management should based on the business rationale identify expenses which are integral to the development of application in bringing the same into existence. These expenses are to be capitalised with other costs related to the application and allowed as deduction by way of deprecation over the life period of the application.
Other expenses not intrinsically related to the development of the application would be written off in the year of the expense in the profit and loss account of the business and claimed as expenses for the tax purpose.
Accounting and tax treatment — preliminary expenses
The Indian Income Tax Act, 1961 provides the concept of preliminary expenses, listed down expenses which are incurred upto commencement of business, these are:
Preparation of feasibility report or project report;
Conducting market survey or any other survey necessary for the business;
Engineering services relating to the business;
Legal charges for drafting any agreement in relation to the business
By way of legal charges for drafting the memorandum and articles of association of the company
Printing of the memorandum and articles of association and fees for registering the company under the provisions of the companies Act, 1956;
In connection with the issue, for public subscription, of shares in or debentures of the company, being underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus
The above expenses is to be categorised under deferred revenue expenses or miscellaneous deferred expenses on the assets side of the balance sheet for accounting purposes and the same are permitted to be amortised over a period of five years from the year in which the business is commenced for the tax purpose under the Indian Income Tax Act, 1961.
Thus, to conclude
The startups should make sure that all the expenses irrespective of its nature or whether the same was expensed from personal source of founder or from business are properly accounted. It is also of paramount importance that the startups should apply proper business rationale in identification and segregation of expenses, as the same would determine the accounting and tax treatment of the same.