The government is considering exempting investors from tax on capital gains accrued when they exit a startup, in a bid to attract more funds into the sector. The Department for Promotion of Industry and Internal Trade (DPIIT) is weighing two alternatives to deliver this incentive — one, a blanket exemption, and two, a conditional exemption based on funds redeployed. The latter would be on lines of the benefits offered to nascent firms in the UK.

“We want to recommend that they should be exempt from capital gains while exiting,” an official told ET, adding that DPIIT is yet to make this recommendation to the revenue department. DPIIT will moot the idea when the new government takes over. The final budget for FY20 is likely early in July.

After giving investors and entrepreneurs relief from the so-called angel tax, the government now wants to encourage startups and is examining regulatory issues, including taxation, which need to be eased.

At present, startups get two sets of exemptions related to capital gains tax. Under Section 54 GB of the Income Tax Act, they get exemption from tax on capital gains arising from sale of a residential house or plot if the amount of net consideration is invested in equity shares of an eligible startup for purchase of a specified asset.

Further, Section 54 EE of the Finance Act, 2016, provides for exemption of tax on capital gains arising out of transfer of long term capital assets — not exceeding `50 lakh in a financial year — invested in a fund notified by the central government.

These benefits provide relief to those who liquidate personal assets to fund their startups while the next set of incentives under consideration seeks to encourage all investments in startups.

“It is difficult to exempt investors on the basis of income, but we can make them capital gains tax exempt on exit if they invest in our startups,” said the official. “We are also thinking whether this clause should be limited to Indian investors or (include) everyone, along with the conditions of exemption, such as redeployment.”

Experts and startups have lauded the idea. “In the UK, such angel investments get tax breaks if they replough them into startups. This helps minimise fraud and more capital gets deployed,” said an industry watcher.

As per Sachin Taparia, chairman, LocalCircles, the government can give a window of around two years for them to reinvest in the startup ecosystem.