Startups are about building and selling products, recruiting and managing people, and raising funding. Unfortunately, we live in a world where laws are complex and impact all these activities. Additionally, a startup is generally incorporated as a company and thus laws related to the formation and management of companies also apply to it.
A big company generally has a Chief Financial Officer (CFO) who manages all legal and financial aspects of the company. In a small startup, this role has to be done by one or more founders. Thus as a startup founder, you need to learn a little bit of law and accounts.
Laws in any country are multiple and complex. For running a startup you do not need to learn everything. You just need to focus on a few aspects like corporate laws, tax laws, contract laws, IP laws and employment laws.
To form a company you need to incorporate it under the corporate laws of your country. Corporate laws are generally complex and allow you to form a company with the following:
- Share capital: The capital with which the company will work
- Shareholders: The people who have put in capital and own the company
- Directors: The people who will run the company
- Registered Office: The registered physical place of business of the company
Generally, it is advisable to form a company through a professional who specializes in company laws. In India generally such a professional is a Chartered Accountant (CA) or Company Secretary (CS). In India government has tried to make everything digital and fast but unfortunately, the government does not know product management and digital processes are pathetic sometimes. A big example is that digital signatures do not work on any Apple computer! Thus I really miss the old system of the paper-based company formation process since digital processes are really a pain. I had to courier my digital signature token to the CA physically to make her sign the incorporation documents on my behalf!
The second focus area has to be tax laws. Tax laws are of 2 types. Direct tax laws are laws that apply to you the tax payee directly on your income. Indirect tax laws apply to the tax payee indirectly through the product provider. Income tax is a direct tax law and Goods and Services Tax (GST) is indirect tax law. You pay income tax on your income. You pay GST to the provider of goods or services, who is obliged by the government to collect GST and pay to the government for the goods or services provided.
Income tax is complicated but after being a CA in practice myself I will like to tell you that Income Tax is the best law in India related to taxes. It is relatively straightforward once you start understanding it. Broadly you need to learn about a few major concepts so that you can talk to your CA in a little technical jargon and get the income tax returns (tax documents) filed in a timely manner.
The first concept in Income Tax is the Permanent Account Number (PAN). When you register the company you get a PAN automatically. PAN is easy to apply online also. PAN is the number through which the income tax department and government track all transactions. For techies, it is your primary key value in the government’s database.
Income tax allows multiple types of taxpayers. Some of the prominent types allowed are individual, partnership firm and company. A startup will mostly be incorporate as a private limited company although LLP (Limited Liability Partnership) is also a practical option in the initial phase. The entrepreneur will have to file a separate income tax return from the company.
The income tax return is a tax report you need to file yearly with the income tax department. Unfortunately, our finance ministers have been legal professionals instead of being product managers or UX designers. Thus the tax return software provided by the government is often buggy and very complex. Even as a CA I hate spending hours filing my own return. It took 4-5 hours last time for me to fill in all details in my own personal income tax return. Even though I am a CA, to save time I have outsourced filing of my startup’s return to another CA! Thus please do not file your own returns. Focus on creating and selling a good product instead of wasting time yourself filling income tax returns. Try to find a good income tax professional. Most CAs and many lawyers practice as tax professionals.
Income tax law allows categorizes income into 5 types:
- Income from salary
- Income from house property (rent)
- Income from business or professional
- Income from capital gains
- Income from other sources (interest, dividend etc)
A startup will generally have income from business or profession. Many companies used to make black money white by taking capital from bogus sources at a premium. Thus income tax law has stringent provisions regarding taking of capital by issuing shares at a premium. Unfortunately, this law creates a lot of problems for startups who generally get funding at a high premium. This problem is popularly known as angel tax. Fortunately, the government allows startups registered under Startup India some exemptions from angel tax. Thus please get registered as a startup under the Startup India scheme. It is one of the easiest procedures ever laid by the government and is completely free of any red tape or corruption. You can go to the Startup India website and apply. Some CAs also help in getting this registration.
Finally, you need to also understand the concept of Tax Deduction at Source (TDS). Many taxpayers are obliged by law to collect the tax of the receiving party and deposit such tax monthly. Some of the transactions on which TDS is applicable are payment of salaries to employees whose incomes are taxable, payment above a threshold to professionals or contractors, etc. Payment on rent above a limit also needs tax deduction while paying rent. This is a very important tax law and thus a startup founder should consult a tax professional for the current thresholds and rates. The biggest grievance I have against the income tax department is that they change tax rates and thresholds too often. Thus it becomes nearly impossible for the common man to do anything without consulting a practicing tax professional. A big pain for entrepreneurs running small startups is the monthly deposit of TDS and filing of quarterly TDS returns.
Goods and Services Tax (GST) is also a complex law. You generally need to apply for collecting GST in India if you earn a revenue above a certain threshold. You will get a GST number when you register. Generally, for GST you need to file multiple monthly GST returns. For small taxpayers government allows the option to file returns quarterly also. Generally, GST law is very complex so I will advise you to hire a good CA for this. A big pain for tech entrepreneurs like me is that GST returns for a company cannot be filed without a government-recognized digital signature. Unfortunately, none of them work on an Apple computer and many do not work on Windows PCs also. Thus you may need to physically send the digital signature dongle to your tax professional!
Next, you need to understand the contract law. Contracts are the lifeblood of any business. As per my knowledge you can make contracts orally also without any documentation. The only issue is that in case of a dispute you will not have any proof of the contract. Thus it is advisable to make written contracts. For small things, I personally prefer written emails. For big or important contracts generally, it is advisable to engage a lawyer to create a contract and also attach a stamp paper of appropriate value to the contract documentation. You can also get templates of contracts like a rent agreement, a non-disclosure agreement (NDA), etc online.
Intellectual Property (IP) Laws
Intellectual property (IP) laws are also very important for a startup. Copyright gives you protection from someone using your content, code or design without your consent. Patent refers to monopoly you get over your inventions. Trademark refers to protection you get over your trade names.
You need to understand that you automatically get a copyright on every piece of content, code, or design you make. For content, code or design your employees make you need to have explicit IP assignment to the company in the employment contracts. For work, you get done from contractors or freelancers you need to have a contract in place which has an explicit clause for IP assignment. Generally, it is advisable to get an employment contract or contractor contract template from a good lawyer so that there are no legal issues later on. Copyright need not be applied explicitly but for important content like films, books, game characters, etc it is advisable to apply for copyright explicitly.
Any invention you make can be patented and you can get a monopoly on that for many years. Patents are expensive and difficult to get. Also in the age of lean startup, many times patents are not useful as the startup may pivot before even getting a patent!
Trademark should be registered for your trade name generally. You may also register a trademark for an app name or website name. The government gives a rebate on registration fees if you are registered under Startup India or as an MSME. CAs can help in getting any of these 2 registrations. For registration of trademark, copyright and patents you should contact a good IP lawyer.
Law Related To Employees
Finally, you need to have an employment contract with employees and have proper IP protection built in the agreement. For part-time employees or freelancers also have some sort of legal agreement in place. Beyond a certain number of employees, you need to register under labour laws also. Generally, for a startup with less than 10 employees, you do not need any such registration.
Accounts And Audit
You also need to have someone who can make your accounts as per the double-entry system of accounts. You need to yearly file final accounts like balance sheet, profit and loss account and cash flow statement with the Ministry of Company Affairs (MCA) and Income Tax department.
You also need an auditor. In India, only a practicing CA can be an auditor. Every year an auditor has to audit your accounts and give you an audit report. This report has to be filed with the MCA. Above a certain threshold of revenue, even the income tax department also wants a separate tax audit report for which you will need to hire a CA. Many times same auditor does both audits.
Thus you see it’s not easy to be an entrepreneur. You need to become a semi-legal professional to run your startup. I sometimes find these things complicated even though I am a CA. Thus I will recommend you to get one or more legal professionals who can help you.
Author: CA Saurabh Jain (Follow him on Twitter : @skjsaurabh)
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