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India's Startups And Legal Roller Coaster

Startups are relatively new in India; trying to survive, sometimes successful, in the Indian ecosystem. However, the legal challenges to the startups are particularly unique due to its complex and ever changing business policies. Let's explore and examine the complexities of various factors directly impacting the startups in India.

Business Structure:

Many startups face problem in determining what is an ideal business structure for their startup as the business structure may vary from business to business and one business structure could be good for one may be bad for the other in terms of risk, a number of people involved, sharing of profits, liability, taxation, annual meetings, and registration, etc.

The business structure of a startup may be:

  • Sole Proprietorship:
    • It is an ideal business structure for those who like to have total control over their business and enjoy all the profits alone;
    • It has an easier taxation structure based on the revenue earned by the proprietor;
    • It is not taxed as a separate legal entity. Rather, the proprietors file their tax as parts of their individual tax returns;
    • The liability of a sole proprietor is unlimited - as in case the proprietor is unable to pay debts of the business then his personal assets could be sold to meet needs as in its business assets are not classified as private or personal assets;
    • It has very limited capacity to raise capital for business.
  • Partnership Firm:
    • It is suitable when more than one people are involved in the business;
    • It is one of the simplest forms of business structure governed by the Partnership Act, 1932 and the Indian Contract Act, 1972;
    • Its taxation is quite similar to the proprietorship firm;
    • The profit is shared among several partners;
    • There are several issues like conflicts in ideas of different partners may arise.
  • Limited Liability Partnership ('LLP'):
    • It is most suitable when the business is unstable or risky;
    • It is governed by the Limited Liability Partnership Act, 2008;
    • The liability is limited means that the personal assets and business assets are considered separate and the personal assets could not be used up for the recovery of the debts;
    • In LLP at least two members are required and there is no limit on the maximum number of members;
    • The expenses involved in forming it are comparatively higher than sole proprietorship business;
    • The tax authorities treats LLP as a separate legal entity from its owners and is legally required to be registered for taxation purposes with the Income Tax Department;
    • It is an advantageous as compared to private limited company as LLP is easier to start and manage and it has a lesser cost of registration as compared to private limited company.
  • Private Limited Company:
    • It is most suitable when there is possibility of business growth to attract equity investors;
    • It is governed by the Companies Act, 2013;
    • A Private Limited Company is a company that is privately held for small businesses;
    • The liability of the members of a Private Limited Company is limited to the number of shares respectively held by them;
    • The shares of Private Limited Company cannot be publicly traded;
    • The expenses involved in forming a Private Limited Company are comparatively higher than the LLP business;
    • It is important to know that the tax authorities treats it as a separate legal entity from its shareholders and is legally required to be registered for taxation purposes with the Income Tax Department;
    • It is suitable for an entrepreneur who needs external funding and are aiming towards good turnover.

  • Registration and Licenses:
    • The key to a successful startup is to obtain all the documents and licenses pertinent to run a business. Unavailability of license with the business will lead to expensive law suits and settlements. Business registration and firm licences differ fundamentally in that the former are necessary for listing a business with the registrar, whereas the latter are the paperwork needed for a business to operate.
    • If the business meets the requirements set forth by the Department of Industrial Policy and Promotion of India (DIPP), Startup India Registration is another type of registration that is compulsory. Depending on the kind and size of the firm, additional registrations like MSME, GST, Udyog Aadhar, import-export codes, etc., may be needed.
    • In addition to the aforementioned, Startups should keep in mind that, depending on state legislation, they may need additional permits to establish and operate a business.
  • Property Laws:
    • Another significant issue for startups in India is the allocation of property for the purpose of the office, warehouse, service centre, manufacturing plants, etc. Startups should be aware of local state rules governing the commercial use of real estate or land as they differ from state to state and are within the purview of the government. In a residential area, for instance, the local municipal government may establish a regulation barring the use of any property or land for industrial or commercial uses.
    • Ordinarily, a locality is divided into eight sections by the municipal zoning authority. These sections are designated for residential, commercial, industrial, public and semi-public, public utilities, open areas/parks/playgrounds, transport and communication, and agricultural use. The zoning authorities may opt to specify the building's height, location, and map for carrying out commercial work.
    • If a startup intends to run its operations from a property, whether it be for an office, warehouse, service centre, manufacturing units, etc., it must also perform the necessary due diligence for the purpose of any local municipal zoning laws or reservations and obtain the necessary permissions or licences from such authorities to avoid any irregularities in the use of such property, which vary from state to state.
  • Contract Management:
    • The startup should adopt good contract discipline that would manage costs and produce the most value with the least amount of business risk; failing to do so could result in a pricey litigation.
    • The contracts such as Employment Agreements, Non-Disclosure Agreements, Services Agreements, Lease Agreement, Rent Agreement or Leave License etc. are among the crucial contracts required by a business frequently.
    • Startups should avoid using conventional and time-consuming methods for drafting contracts; instead, their contracts should be written in a clear, concise, and simple manner without the use of legal maxims or difficult legal terms, making them easier to understand for common man or anyone without a background in law.
  • Labour Laws:
    • Labour laws can be divided into those that deal with social security programs, salaries, working conditions, and prohibitive labour laws. For new businesses, the rules in India that are designed to protect workers' rights might be somewhat onerous. As a result, the DIPP issued a directive in year 2016 enabling self-certification with respect to nine labour regulations and prohibiting inspections for three years. However, the Ministry amended the law in year 2017 to change the self-certification compliance period from three years to five years and to prohibit inspections under the six labour laws (instead of the nine labour laws) from taking place during the first year of incorporation.
    • Startups must also submit self-certified returns in accordance with nine labour laws that DIPP established in 2016. Startups may only be subjected to inspection beginning in the second year and continuing for up to five years after incorporation if a credible written complaint of a labour law violation has been made and approved by a person one level above the inspecting officer or by the Central Analysis and Intelligent Unit.
  • Taxation:
    There are multiple tax benefits available to the startups in India that can help to save on taxes such as:
    • 100% tax exemption to the startups registered with DIPP, for the first 3 years which gives startups time to build a business with added budget, which they otherwise would have to pay as taxes.
    • Benefits of 20% on capital gain tax to startups registered with DIPP, even though the earnings from stocks, shares, and bonds are taxable.
    • The 'angel investments' are tax-free so that the startups can now collect the funds they require from angel investors without having to worry about added taxation.
    • The startup that has a turnover of under INR 2 crore is eligible to enjoy the benefits of the 'Presumptive Tax Scheme', where the company is not required to maintain any book of accounts.
  • Intellectual Property Rights (IPR):
    • In order to avoid issues like trademark infringement or other IP breaches after investing a significant amount of money in their firm, it is critical for startups to protect their IPR on its priority. Many entrepreneurs share the common dread that their concept or strategy may be stolen by someone.

The Startups should ideally seek to protect the following IPR:

  • Patents:
    In case a startup is dealing with any technical thing or a technical process of performing a thing then it should go for patent of product or method. It is a negative right that will allow the owner to make exclusive commercial use of his invention for the period of 20 years and prohibits others from using it. Anyone can steal the inventor's concept if the inventor disregards the patent registration, which will have a detrimental impact on the inventor's firm by lowering their earnings and goodwill.
  • Copyright:
    The startup may obtain copyright for its software, periodicals, papers, research findings, ideas written down, and other creative or literary works. It will prohibit others from using such a creation for as long as the inventor is alive and for 60 years after his passing.
  • Trademark:
    The trademark or service mark is an identity of a business or a service provider which helps the customers to identify its goods or service in the market. The startups should be careful while deciding their trademarks that their trademarks or tradename should be easy to pronounce, attractive, distinctive, and international implications of the marks should also be considered. The startup should seek registration for a trademark or service mark either for used or proposed to be used.
  • Trade Secrets and Confidentiality Agreements:
    Trade secrets are the most important IP right for the startups. Although, a secret will not be secret anymore if it leaks and gets into the knowledge of many people. In order to protect trade secrets, the startups should adopt a practice or policy of entering into a confidentiality agreement / non-disclosure agreement with their partners and employees or other stake holders.

Advertisement & Marketing:
  • Advertising and marketing are crucial for any startup, but making false claims or running offensive, scandalous, or seditious ads can result in harsh penalties and damage a firm's goodwill and reputation, which can be likened to trampling over a little budding seedling.
  • There are several prohibitions on advertisements such as:
    • The Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Act, 2003 (COTPA): prohibits all kind of direct or indirect advertising of tobacco and tobacco products in all media;
    • The Food Safety, And Standards Act, 2006 (FSSA): prohibits advertising of infant formula in order to encourage breastfeeding of infants;
    • The Prenatal Diagnostic Techniques Act, 1994 (PDTA): prohibits advertising pre-natal sex determination services;
    • The Cable Television Network Rules, 1994 (CTNR): prohibits all kind of direct or indirect advertising of alcohol or alcoholic beverages;
    • The Arms Act, 1959 (TAA): prohibits advertisement of guns and other firearms;

Data Protection & Privacy
  • Startups and other e-commerce companies keep track of and use customer information, including search history. Ideally, startups shouldn't access users' private information without those users' consent or shouldn't request permissions that aren't necessary for the operation of their website or app.
  • Startups should place a high value on user privacy, which can only be achieved by creating privacy policies that are concise, clear, summarised, and available in the user's local / native language. This will allow users to quickly read and comprehend the privacy policies, terms, and conditions before logging in to any app.
  • Additionally, the startup must make a pact with its users that they won't reveal or use their personal information. This will assist the business win the public's respect and trust. The company must specify in the privacy policy agreement what types of personal information are gathered by the website and how they will be shared or sold to third parties.
Tortious Liabilities
  • Startups may be held liable for torts if they fail to take reasonable care to avoid engaging in illegal activity or fail to carry out activities required by law.
  • Startups must exercise caution when handling and managing raw materials, noise, vibrations, fire, and other factors. For instance, if a company is creating and delivering lunchboxes to adjacent businesses and residences when, by chance, a gas cylinder catches fire and burns down the roofs of neighbouring homes, the firm may be subject to severe fines or losses under the notion of "strict liability."

Winding Up
  • Winding up of any business structure whether partnership or company is required when the purpose for which the partnership or company is formed is over or it has become a defunct entity with low or zero assets and/or profits. When such business structure needs or decides to shut down, all the parties or stake holders involved, such as the partners or shareholders, employees, investors or creditors, need to be informed in advance.
  • To windup a startup, the fast track exit method is the most convenient one. The Ministry of Corporate Affairs (MCA), recently released the curtailed procedure of winding up a company through fast-track exit. This new method is not only beneficial for the companies, as the application regarding the winding up shall now be forwarded to the Central Government instead of NCLT.
  • Further, under the Startup India Action Plan, the companies, upon application can be wound up within 90 days, wherein insolvency professionals shall be appointed for the startup.
Although, the government of India has taken several initiatives to encourage the growth of startups in order to promote entrepreneurship and employment by providing easier IPR facilitation, a favorable taxation system, and easier compliance for the setting up company, etc., even then Startups in India have to deal with various obstacles like funding, insufficient skill, lack of marketing strategies, etc. over that startups have obligation to operate in compliance with laws and follow the ethical behavior.

Non-compliance with laws or ethical misconduct may lend the startups to serious troubles like fines, punishments, revocation of licenses, litigation expenses, etc. which may cause an adverse effect on the limited capital of the startups. India's startups must therefore unavoidably ride the legal roller coaster.

"The information provided in this article is for general informational purposes only. While an author tries to keep the information up-to-date and correct, there are no representations or warranties, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information. Any views or interpretations described in this article are the author's personal thoughts and do not constitute legal or other professional advice. You may discover there are other views or interpretations to accomplish the similar end result."

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