In light of the recent funding boom and the pursuit of creating more economic and social value, ‘entrepreneurship’ has emerged as one of the most sought-after professions. Entrepreneurship, in turn, plays a crucial role in finding solutions to problems, uplifting the country’s economy, generating employment and creating a positive impact on the society at large. In their early stages, the organizations set up by these entrepreneurs are commonly termed as ‘start-ups’.
The Department for Promotion of Industry and Internal Trade (“DPIIT”) has laid down the qualifying criteria for organizations to be recognized as ‘start-ups’ with such recognition entailing various incentives and exceptions by the Government. For an organization to be recognized as a start-up, (i) it must have been incorporated / registered as a private limited company, partnership firm or a limited liability partnership (LLP) in India; (ii) it should have been in existence for a term of not more than 10 (ten) years since its incorporation; and (iii) its turnover must not have exceeded INR 100,00,00,000 (Indian Rupees One Hundred Crores). Additionally, the start-up should be engaged in activities relating to innovation, development or improvement or should have a scalable business model with a high potential for generating employment or wealth.[i]
As the start-up ecosystem continues to flourish, entrepreneurs / founders must understand the intricacies of the country’s complex legal and regulatory landscape. This article aims to provide an overview of India’s legal and regulatory framework by addressing key legal and compliance issues that start-ups and founders should consider.
Compliance Checklist
- Incorporation
One should incorporate a legal entity to house the business to commence business operations. The type of legal entity to be incorporated depends on the requirements and scope of the proposed business. A ‘private limited company’ is the most commonly sought after business structure. A start-up can also be incorporated as a one-person company under the Companies Act, 2013, partnership firm under the Partnership Act, 1932 or a limited liability partnership under the Limited Liability Partnership Act, 2008. - Business Specific Registrations And Licenses
The type of licenses and registrations that a start-up is required to procure under applicable legislation is dependent on the nature, size and scope of the business. Founders must have a clear view of the exact nature of their business to help ascertain the type of registrations and licenses that may be required.
Commonly applicable registrations include a certificate of enrolment and certificate of registration under the state- specific professional tax statutes, Permanent Account Number (“PAN”) under the Income Tax Act, 1961, Goods & Service Tax (“GST”) registration under the central, union, integrated or state- specific goods and services tax statutes, shops and establishments registration under the state specific shops & establishments statutes, start-up registration issued by the Department for Promotion of Industry and Internal Trade. Further, there may be certain specific registrations or licenses that apply to particular businesses:- Start-ups involved in exporting or importing services or products must obtain the Importer Exporter Code issued by the Directorate General of Foreign Trade under the Foreign Trade (Development and Regulation) Act, 1992.
- A food business may need approvals or licenses from the Food Safety and Standard Authority of India.
- Start-ups undertaking to manufacture would need to obtain a factory license under the Factories Act, 1948.
- The businesses must also comply with the legislation under which they seek such registrations and licenses.
- Further, businesses may need to adhere to various environmental laws depending on the type of discharge or pollutant. A company that discharges sewage or effluents into a water body or air would need to take “Consent to Establish” or “Consent to Operate” from the respective state pollution control boards under the Air (Prevention and Control of Pollution) Act, 1974 or the Water (Prevention and Control of Pollution) Act, 1974, as the case may be (to be read in conjunction with Point 5 (self-certification para) below). Further, certain start-ups may also need to comply and obtain registrations under the Plastic Waste Management Rules, 2022 and/or Battery Waste Management Rules, 2022.
- The businesses may also need to adhere to the packaging requirements and obtain registration under the Legal Metrology Act, 2009, while packaging their products for retail sale.
- Companies Act Compliances
Start-ups that are registered as private limited companies under the Companies Act, 2013 need to comply with the provisions of the statute. The Ministry of Corporate Affairs issued a notification dated June 5, 2015, that exempted private limited companies from certain provisions / requirements under the Companies Act, 2013. Other than the exempted provisions, private limited companies must comply with the applicable provisions of the said statute. Following are a few common compliances that a private limited company must undertake:- A declaration for commencement of business must be filed with the Registrar of Companies (“ROC”), in Form INC-20A, within 180 (one hundred and eighty) days from the incorporation of the company.
- The company must appoint a minimum of 2 (two) directors of whom at least one should be a resident Indian.
- An annual general meeting (“AGM”) must be conducted once a year within 15 (fifteen) months of the previous AGM.
- Board meetings must be held within 30 (thirty) days of incorporation and a minimum of 4 (four) board meetings must be held in a financial year. The time period between two consecutive board meetings must not be more than 120 (one hundred twenty) days.
- Event- based or yearly filings with the ROC such as form MGT-14 for special resolutions passed by the shareholders, form MGT-7 for submitting annual returns, form AOC-4 for submitting financial statements, form ADT-1 for the appointment of auditors, form PAS-3 upon receipt of funds and allotment of shares undertaken through a private placement process.
- Every company must prepare their financial statement in forms prescribed under the Companies Act, 2013. Financial statements for the previous financial year must be approved by the board and the shareholders and signed by the board of directors before being filed.
- Companies raising investments must comply with the procedural requirements under the Companies Act for the issuance and allotment of shares.
- Start-ups incorporated as LLPs must comply with the provisions of Limited Liability Partnership Act, 2008.
- FEMA Compliances
Start-ups often seek external funding for growth and expansion. Suppose such external funding is intended to be received from a foreign resident in the form of foreign direct investment (FDI), in that case, it needs to be ascertained whether the business sector in which the start-up operates, is allowed to receive FDI under the Foreign Exchange Management Act, 1999 (“FEMA”) (read with the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”) and the Consolidated FDI Policy 2020, as amended from time to time). Further, suppose FDI is allowed in a business sector, in that case, it needs to be ascertained whether FDI is permitted under the automatic route (requiring no approval from the Government) or the approval route (requiring prior Government approval). Further, depending on the business sector in which the start-up operates, there may be other conditions that need to be complied with for receiving FDI including sectoral conditions, pricing guidelines, valuation reports and reporting and filing requirements with the Reserve Bank of India (through the company’s authorized dealer bank[ii]).
Start-ups registered with the DPIIT, irrespective of the nature of the business they are engaged in, can also seek investment from Foreign Venture Capital Investors in accordance with FEMA and the FNDI Rules.
Additionally, if a start-up is incorporated as an LLP, foreign individuals can contribute to its capital only if such LLP is operating in sectors or activities where foreign investment up to 100% (one hundred percent) is permitted under the automatic route and there are no FDI linked performance conditions.[iii] - Labour Laws and Tax Related Compliances
The labour laws applicable in relation to wages include the Minimum Wages Act, 1948, Payment of Wages Act, 1936 and the Equal Remuneration Act, 1976. Additionally, the Payment of Bonus Act, 1965, becomes applicable if a startup employs 20 (twenty) or more persons during any accounting year. These 4 (four) labour legislations were consolidated into a single legislation called “The Code on Wages, 2019”.
Similarly, the Government has amalgamated certain other labour laws into the following Labour Codes: (i) The Industrial Relations Code of 2020 consolidates and amends legislations such as The Industrial Disputes Act of 1947, The Trade Unions Act of 1926, and the Industrial Employment (Standing Orders) Act of 1946, (ii) The Occupational Safety, Health, and Working Conditions Code of 2020 consolidates and amends laws relating to occupational safety, health, and working conditions, including the Factories Act of 1948, Mines Act of 1952, Contract Labor (Regulation and Abolition) Act of 1970, etc, and, (iii) the Social Security Code of 2020 consolidates and amends nine laws related to social security, including the Maternity Benefit Act of 1961, and The Payment of Gratuity Act of 1972, etc. (all the 4 (four) labour law codes are collectively referred as “Labour Codes”).
While the Labour Codes have received the President’s assent and have been notified in the Gazette of India, they have not yet been enforced.
Currently, depending upon the number of employees engaged, start-ups need to comply with certain labour laws, including[iv]:- Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (“EPF Act”): Applicable to establishments having at least 20 (twenty) employees, under this statute, both the employer and the employee are required to contribute 12% of the employee’s basic salary and dearness allowance to a provident fund to build a corpus for the future of the employee.[v]
- The Employee’s State Insurance Act, 1948 (“ESI Act”): Applicable to establishments employing at least 10 (ten) persons (20 persons in some states). Only employees drawing wages less than INR 21,000 (Indian Rupees Twenty-One Thousand) are eligible for benefits under this statute. Applicable entities are mandated to contribute to the State Insurance Corporate Fund. This insurance can then be availed by employees for medical treatment.
*Applicable start-ups must procure registrations under the EPF Act and the ESI Act. - Maternity Benefit Act, 1961: It applies to all establishments employing 10 or more persons and prescribes conditions of employment for women employees, before and after childbirth and other maternity benefits.
- Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013: This statute provides for protection of women against sexual harassment at workplaces. This statute mandates establishments employing 10 or more employees (whether permanent, temporary, ad-hoc, consultants, interns or contract workers) to implement an anti-sexual harassment policy. Also it mandates employers to constitute an internal committee to investigate complaints of sexual harassment occurring at workplaces.
Start-ups registered with the DPIIT, are exempted from detailed compliance and are allowed to self-certify compliance for certain labour laws (such as The Payment of Gratuity Act, 1972, The Employees State Insurance Act, 1948, etc.) and environmental laws (such as The Water (Prevention & Control of Pollution) Act, 1974, The Air (Prevention & Control of Pollution) Act, 1981, etc.) through a simple online procedure for up to a period of 3(three) to 5(five) years from their incorporation. Such registered start-ups may also avail certain tax exemptions under the Income Tax Act, 1961.
- Intellectual Property Registration and Data Protection
Start-ups must register any intellectual property they own, have developed or created, such as trademarks, copyrights, patents, and trade secrets, in accordance with applicable laws. In India, trademarks are protected under both statute (Trademarks Act, 1999) and common law. The Copyright Act, 1957 extends protection to original literary, dramatic, musical or artistic works. Literary works include computer programs and databases, as well. Further, inventions are protected under Patents Act, 1970, provided they are duly registered under the statute.
While specific statutes may not exist for protecting intellectual properties such as trade secrets and confidential information, they still enjoy protection under the common law. Additionally, these can also be protected by way of contractual arrangements.
The start-ups providing tech-based solutions or products must proactively register their solutions or products to ensure appropriate protection under law. Start-ups operating their business through websites must register their domain names. This will prevent others from using identical or similar domain names to deceptively take advantage of such businesses’ goodwill or customer network.
Start-ups should also adopt a robust data protection and privacy policy, in accordance with the Information Technology Act, 2000 and the Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011. Moreover, the data protection law in India is on the brink of a drastic transformation. The Digital Personal Data Protection Act, 2023 (“DPDP Act”) has already received the President’s assent but is yet to be enforced. The law is on par with international standards and is expected to change the data protection landscape of the country significantly. Some of the changes include that entities collecting personal data must provide notice to and obtain consent from the persons (“Data Principals”) before collecting and processing their personal data. The notice should also contain particulars such as the nature of the personal data being collected, how it is being collected, how complaints can be made to the regulatory authority, etc. Consent for collecting and processing personal data should be freely given, specific, informed, unambiguous, and require clear affirmative action.
The DPDP Act also grants various rights to Data Principals, such as the right to correct, complete, update, or erase their personal data, the right to withdraw consent for processing their personal data, and the right to access a summary of the personal data being processed or the identities of all entities involved in data processing, among other rights.
The website of a start-up along with a privacy policy should also have written terms of use which inter alia provide brief details of the product or service offered, terms of use of the website and user guidelines. The details may also include provisions in relation to the refund, subscription, delivery period and price, etc. - Legal Documentation
Founders often start their start-ups without explicitly assigning any responsibilities, duties and roles among them. Commencing the business as a cohesive unit without a formal agreement may seem and feel wholesome initially, but it can later lead to disputes that are challenging to prove. These disputes may subsequently impede the company’s operations, resulting in losses that ultimately harm the enterprise and its stakeholders.
It is advisable to establish a formal arrangement, such as a co-founders’ agreement, which can be later superseded or read in conjunction with the shareholders’ agreement once the company secures external funding. This formal documentation is necessary to define the founders’ roles and responsibilities and the shareholders’ rights and obligations (through a shareholders’ agreement). The legal documents should also outline the exit procedures, if any founder decides to exit the company in the future.
In addition, the founders should formalize all transactions such as leases, services, vendor arrangements, employee / consultant appointments through legally enforceable contracts. This ensures that the founders have a legal recourse in the event of defaults or breaches of such arrangements. Further, to maintain secrecy and confidentiality of the company’s operations, the company should enter into non-disclosure agreements with the third parties they engage with in their operations. - HR Policy / Employee Handbook
Start-ups may adopt policies for efficient internal governance and management. The policies may provide for conditions of employment, code of conduct, data protection and privacy, confidentiality, prevention of sexual harassment, equal opportunity, travel, reimbursement of expenses, working hours, leaves, public holidays, remote working etc. While not mandatory (other than certain policies such as prevention of sexual harassment, privacy policy and equal opportunity policy. which are mandated by law), it is recommended to establish such policies to set out the provisions under which the employees work.
Conclusion
The increasing interest in the start-up ecosystem has drawn attention from both the public and regulatory authorities. Consequently, founders and entrepreneurs must now be aware of legal obligations and regulatory compliances to ensure smooth and efficient business operations. Adhering to these requirements, along with other industry-specific obligations, is crucial in preventing legal penalties and other consequences that could adversely impact start-ups’ reputation and day-to-day functioning.
Authors: Aishwarya H, Rohit Dhingra
Publication Date: March 06, 2024
Endnotes
[i] Department for Promotion of Industry and Internal Trade, G.S.R. 127(E), Ministry of Commerce and Industry, dated 19th February 2019.
https://www.startupindia.gov.in/content/dam/invest-india/Templates/public/198117.pdf
[ii] Authorized dealer banks are banks that are specifically authorized by the Reserve Bank of India under FEMA to deal in foreign exchange or foreign securities.
[iii] Paragraph 3.2.4 of the Consolidated FDI Policy, 2020 read with Rule 6(b) and Schedule VI of the Non-Debt Instrument Rules, 2019
https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020_0.pdf
[iv] Certain qualification thresholds may vary from state to state depending upon their respective rules and regulations.
[v]These contributions are payable on maximum wage ceiling of INR 15,000 (Indian Rupees Fifteen Thousand). Contributions on higher wages can also be made if agreed upon by both the employee and the employer.
