Startup tax break misuse under scanner; multiple firms flagged by I-T dept, say sources

India’s tax authorities have stepped up scrutiny of the startup ecosystem after uncovering alleged misuse of tax exemptions, with several entities flagged for claiming benefits without substantive business activity, according to highly placed sources.

The investigation wing of the Income Tax Department has identified multiple startups for irregularities linked to the tax holiday under Section 80-IAC Startup Tax Exemption.

The findings have been escalated by the Central Board of Direct Taxes to the Department for Promotion of Industry and Internal Trade, sources said, flagging concerns around growing instances of alleged fraud in startup recognition and tax claims.

Shell entities, paper operations under lens

Officials familiar with the matter indicated that a number of companies appeared to have been set up primarily to avail tax exemptions, with little evidence of genuine commercial operations.

These entities, sources added, managed to secure DPIIT recognition—an essential condition for claiming the tax holiday—despite minimal or non-existent business activity.

The pattern has raised red flags within the tax department, with authorities now examining the scale of the issue and potential revenue implications.

Tighter checks, possible recovery action

The developments have prompted discussions within the government on tightening the startup approval and verification framework. According to sources, measures under consideration include stricter due diligence at the time of registration, enhanced post-recognition monitoring, and data-sharing between departments.

In cases where misuse is established, authorities may also look at withdrawing exemptions and initiating recovery proceedings, sources said.

What is Section 80-IAC?

Introduced to boost entrepreneurship, Section 80-IAC of the Income Tax Act provides a tax holiday to eligible startups recognised by DPIIT. The provision allows a 100% deduction on profits for any three consecutive years within the first ten years of incorporation, subject to conditions such as turnover limits and the nature of the business.

The incentive was designed to support early-stage ventures and foster innovation, but officials now acknowledge that gaps in oversight may have enabled certain entities to exploit the benefit without undertaking genuine business activity.

Balancing oversight with startup push

The latest crackdown highlights the challenge for policymakers in maintaining a balance between ease of doing business and regulatory vigilance. While the government remains committed to supporting genuine startups, the focus is now shifting towards ensuring that tax incentives reach intended beneficiaries and are not used for arbitrage, sources added.