Legal and Ethical Issues Faced By the Start-Ups in India

17th February, 2021 - 9:15 am Categories: TAX 0 Comments

Introduction

Start-ups are small growing companies founded by one or more entrepreneurs, they are at their initial stage of operation with a limited amount of capital and limited experience. The government of India has taken several initiatives to encourage the growth of start-ups 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 Start-ups in India have to deal with various obstacles like funding, insufficient skill, lack of marketing strategies, etc. over that start-ups have obligation to operate in compliance with laws and follow the ethical behavior. Non –compliance with laws or ethical misconduct may lend the start-ups to serious troubles like fines, punishments, revocation of licenses, litigation expenses, etc. which may cause an adverse effect on the limited capital of the start-ups, following are some most common legal and ethical issues which start-ups face in India –

^{[Image Source: creately.com]}

Legal Issues

Licencing and permit issues

The start-ups may require various licenses, permissions, or permits to execute their ideas as due to lack of legal knowledge the start-up may end up paying penalties and may even end up being unethical or illegal. The requirement of licenses, permits, and permits may vary from business to business, so before starting a business the person should be aware of the local laws, rules, and regulations. The other issue with respect to licenses is that sometimes it is not much quick and easy to get licenses from the government authorities and it requires a lot of time and money to obtain licenses. Some of the licenses required by the companies are registration certificates, GST registration, FSSAI license, import and export code, Udyog Aadhar registration, etc.

Dealing with goods or services which requires license like alcohol/ alcoholic beverages, electricity, guns, drugs and medicines, prohibited crops like marijuana or opium, tobacco, food products, human organs, etc. without obtaining proper licenses from the concerned governing bodies may attract criminal charges which may lend the businessmen in jail or suffer heavy fines and penalties.

GST registration – In the current scenario most start-ups are looking at their future as an e-commerce business for such e-commerce businesses GST registration is mandatory, the businesses whose turnover is equal to or more than 40 Lakhs, should get themselves registered, the process of registration is called GST registration, there are certain kinds of business who should get GST registration failure to which is considered as an offense. Following start-ups/businesses should mandatorily get GST registration – Casual taxable persons, Non-resident taxable persons, e-commerce aggregators, those who are paying through reverse charge mechanism, etc.

Permissions – for the smooth functioning of a business should operate in such a manner that it should use its resources in productivity rather than in paying fines and penalties thus it is mandatory that a business should get necessary permissions and permits from the concerned bodies before starting their operations. A Start-up should obtain Fire permits and safety registration. The benefit of obtaining registrations is not limited to protection from legal hindrances but it also benefits in availing various government schemes like MSME registration which can help the start-ups to get subsidies in loans, taxation, and other schemes. A start-up should get registration under the start-up India registration scheme.

Advertisement and marketing

Advertisement and marketing are very important for any start-up or any other forms of business but advertising false claims, obscene, scandalous, or seditious advertisements may give rise to serious criminal penalties and it may blow away the goodwill and reputation of a firm and for start-ups, such mistakes may be like stepping over a small growing seedling. Some examples of prohibited advertisements are – “Tobacco Prohibition Act” prohibits all kind of direct or indirect advertising of tobacco and tobacco products in all media, The food safety, and standards act, 2006 prohibits advertising of infant formula in order to encourage breastfeeding of infants, physicians under Indian Medical Council regulations, 2002, legal services under bar council of India Rules, pre-natal sex determination services under The Prenatal Diagnostic Techniques act, 1994, Alcohol or alcoholic beverages under Cable Television Network Rules, 1994, Guns and other firearms under Arms Act, 1959, medical services and medical devices, religion-related, comparative advertising (which compares one’s product with the competitor), deceptive or misleading advertising.

Example

World Health Organization has also prohibited the sale and marketing of infant formula like Nestle faced a lot of criticism worldwide for being accused of violating ethical marketing codes and manipulating customers with misleading nutritional claims about its baby milk formulas by comparing it with mother’s milk.

Recently Tanishq faced a lot of criticism for violation of ethical marketing norms for hurting the religious sentiments of the people.

Myntra was forced to change the appearance of its “M” logo after an FIR was launched against it that its mark was obscene because it resembles a woman.

Infrastructure related Zonal Laws

Allocation of property for the purpose of the office, warehouse, service center, manufacturing units, etc. is another major challenge for start-ups in India. The start-ups should be aware of local laws regarding the commercial use of agricultural land/ school/ hospital property.

In India land comes under the domain of state government and the laws related to land vary from state to state. The start-up must be aware of the zonal laws, zonal laws are the regulations that deal with the use of land in a particular area. For example – The local municipal authority in an area can pass a law forbidding the use of any property or land for industrial or commercial purposes, as it is a residential area. The zonal authority divides a locality into eight parts which include residential, commercial, industrial, public, and semi-public, public utilities, open areas/parks/playgrounds, transport and communication, agricultural use. The zoning authorities may decide to prescribe the height, location, and map of the building where the commercial work is carried out. The purpose of the zonal laws is to separate residential areas from commercial areas.

In case a person plans to operate a business from his residence he/she may be required to take necessary permissions from the local municipal authority, town planning authority, landlord (if the property is being used by the tenant).

When a residential property is being used for a commercial purpose the property tax also changes when a property is used for commercial purposes then the tax rate will be higher in comparison to the residential property.

Data Protection and Privacy Issues

In the era of digitalization everyone is using any kind of internet device be it a smartphone or pc over that the covid-19 pandemic was like icing on the cakes for the field of digitalization and many businesses, offices courts shifted their work to the online mode which brings huge opportunities for the start-ups. In the digital world privacy is a myth, Consider a real example suppose that if you download and log in to Healthkart to check some supplements you enter your phone number, address, name and check the terms and conditions popup even without reading it, what happens to your details like your phone number, address? And next time when you open YouTube or Google Chrome you will get to see ads based on what you searched on Healthkart. The Startups and other e-commerce businesses record and use personal details including the search history. The conclusion of this example is that the start-ups should not access the private details of the users without their permission or they should not ask for the permissions which are not needed by their website or application. The start-ups should give importance to the privacy of the users. It could be done by drafting a privacy policy in a short, simple, and summarized manner and also in regional language so that before signing in to any application the user may easily read and understand the privacy policy, terms and conditions. The start-ups should also enter into an agreement with their users that they will not share or use the personal details of the users which in turn will help the start-up itself in gaining goodwill and trust of the people. In the privacy policy agreement, the start-up should disclose what personal information is collected by the site, how the information will be shared or sold to the third party.

Protection of Intellectual property rights

Intellectual property rights are like the heart and soul of any start-up. Many start-ups face a common fear that their idea or plan could be stolen by someone so it is important for a start-up to protect their intellectual property rights on a priority basis. And the other issue is that the start-up should also check that what they are planning to do or what they are planning to sell is already been protected. So that they may not face problems like trademark infringement or other IP violations after they invest a big sum of funds in their business.

The requirement of intellectual property rights protection may be different from one start-up to another. Start-ups should seek to protect the following intellectual property rights –

1. Patents – In case a start-up is dealing with any technical thing or a technical process of performing a thing then it should go for product patent or process patent. The patent right is a negative right that will allow the patent owner to make exclusive commercial use of his invention and prohibits others from using it. Once a patent gets registered the owner can make its exclusive use for the period of 20 years and in case he ignores the patent registration then anyone else can copy his idea and which will subsequently cause a negative effect on the business of the inventor by affecting their profit and goodwill.
2. Copyright – The start-up can get copyright of its software application, magazines, articles, research work, or idea presented on paper or other literary or artistic work. It will forbid others from using his creation for the period of lifetime of the creator and 60 years after his death.
3. Trademark/ Servicemark – The start-ups should be careful while deciding their trademarks that their trademarks or tradename should be easy to pronounce, it should be attractive, distinctive, international implications of the marks should also be considered, they should look for the mark they are deciding to choose on the IP India website or simply by making a google search. The start-up should seek registration for a trademark or service mark either for used or proposed to be used. A trademark or service mark is an identity of a business or a service provider. It helps the customers to identify your goods or service in the market.
4. Trade Secrets and Confidentiality Agreements – Trade secrets are the most important IP right held by an entrepreneur, 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 start-ups should enter into a confidentiality agreement / Non-disclosure agreement with their partners and employees.

Contract Management

An agreement enforceable by law is known as a contract. A start-up must be careful while drafting a contract as well as while signing it. A start-up goes through several contracts with suppliers, employees, and others. For purpose of reference, it would be ideal for a start-up to go through the sample contracts available online of pre-existing companies which may help them to draft a good contract.

Agreement with co-founders – The start-ups should make a proper deal with the co-founders/ partners in a written form so as to avoid any kind of dispute in the future. Like what will be the distribution of profits, what will be the capital investment, roles, and responsibilities of the co-founders, what will be the salaries? decision making, percentage of ownership of each founder, how will the sale of business be decided, what will be the dispute resolution mechanism, what are the goals of the business, etc.

Confidentiality agreements – Confidentiality agreements are also known as Non-disclosure agreements (NDAs) they impose a duty on the parties that they will not disclose any secret information or idea of the firm to any outsider. The NDA agreement should also state what will be the consequences in case of a breach of NDA. The start-ups should get into a confidentiality agreement with their employees, co-founders, or whoever holds the confidential information or idea of the start-up in order to protect their ideas.

Contract with service providers – While making any contract with any service provider or supplier the contract must be drafted carefully and it should include all the major and minor details which should include timings, quantity, quality, cost, etc and it should also mention the jurisdiction in case of conflict. While drafting such contracts the Co-founders should keep in mind that they should keep their liabilities limited and the contract must also state what will be the dispute resolution mechanism in case any dispute arises.

Employment Contracts – A start-up should get signed an offer letter with its employee while hiring because hiring someone without any proper agreement may lead to disputes with respect to working hours, salary, etc. The employment contract must contain all necessary directions and information with respect to work, like – what will be the office timings, what will be the salary, what is the job position, who will be the super wiser, terms and conditions for termination of employment.

The start-ups should avoid going through traditional and lengthy methods of drafting contracts, rather their contracts should be simple, summarized, precise manner and the use of legal maxims and tough legal words should be avoided so that they would be easy to understand by a layman or any person not belonging from a legal background.

Tortious Liabilities

Tortious liabilities may arise when someone does an act prohibited by law or omits to do any act which he is obelized to do by law. A start-up may have to face tortious liability if it is not careful about its acts. The relevant tortious liabilities which may arise is Strict Liability – The rule of strict liability was evolved from the famous Rayland v Fletcher case wherein Ryland builds employed laborers on his land to make a reservoir where they found an unused mine shaft and they forgot to seal the mineshaft which later on caused flooding in the adjoining mines and caused the heavy loss. The court held Rayland liable for strict liability. The Startups should take care that they should be careful in handling and management of raw materials, noise, fire, vibrations, smell, etc. For Example- A start-up is involved in making and delivering lunchboxes in the nearby offices and homes and on one unfortunate day the gas cylinder catches fire and burns down the roofs of adjoining houses then the theory of strict liability will arise in this case and the start-up may have to face heavy penalty or even loss of life and property.

The problem is determining the business structure

Many start-ups face problem in determining what is an ideal business structure for their start-up 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 start-up may be in the form of partnership, sole proprietorship, private limited business or LLP, etc. Following are some most common business structures in India.

Sole proprietorship – This structure is ideal for those who like to have total control over their business and the best thing about this structure is that the proprietor enjoys all the profits alone. This structure is very popular because of its easier taxation structure as the tax amount is decided on the basis of the revenue earned by the proprietor. In India, unlike other business structures, a sole proprietorship business structure is not taxed as a separate legal entity. Rather, the proprietors file their tax as parts of their individual tax returns. The tax rate for a sole proprietor business earning less than or equal to 2, 50,000 is zero. The proprietor has to pay 5% tax when its income is more than 2, 50,000. In case the income is five lakh and below 10 lakhs then the taxation rate is 20% and when the income exceeds 10, 00, 000 then it’s 30%. Apart from advantages there are some disadvantages too as the liability of a sole proprietor is unlimited which means in case the proprietor is unable to pay the debts of the business then his personal assets could be sold to meet the needs as in sole proprietorship business the assets are not classified as private assets or personal assets. And one more disadvantage of this structure is that the capacity to raise capital is very limited.

Limited Liability Company – This business structure is most suitable when the business is unstable or risky. The best thing about this structure is that 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 this structure, the company is considered a separate legal entity. In Limited Liability Company, the expenses involved in forming it are comparatively higher than sole proprietorship business.

Partnership firm – This business structure is suitable when more than one people are involved in the business and it is one of the simplest forms of business structure it is governed by The Partnership Act and the Indian Contract Act. The taxation structure in the partnership firm is quite similar to the proprietorship firm. The main characteristic feature of a partnership firm is that in this form of business more than one person is involved and the agreement between them is governed by the partnership deed. The main disadvantage of this structure is that the profit is shared among several partners and there are several issues like conflicts in ideas of different partners.

Further, these business structures are classified on the basis of the incorporation, type of liability, ownership, place where the company is functioning, etc.

Ethical Issues

The purpose of a start-up is to earn profit but while earning profit ethics should not be ignored. The start-ups should comply with the laws and regulations and at the same time, it should not forget their duty towards the community, people, customers, and the company.

1. Duties towards the customers – The start-ups should not indulge in any kind of activity which may be detrimental to the interest of the customers, the start-ups should accept the feedback from the customers and should take care of the after-sale services and assist the customers. A start-up can grow only with the help of satisfied and happy customers.
2. Duties towards the employees – The employees for a start-up are as important as wheels for a car, be it a small or big employee everyone’s contribution is necessary for the proper growth and functioning of a start-up. The start-up should be legally as well as ethically give regard to the rights of the employees. They should be given proper treatment, timely payment of salary and allowances, the Start-ups should have a proper system for hearing the grievances of its employees and it should try to keep its employees motivated in order to maintain healthy growth of the start-up.
3. Duties towards the environment – The Startups should be careful that they obtain all the legal certificates, permissions, and permits from the government bodies and they should not involve in any activity which may have a negative impact on the environment.
4. Duty towards the Start-up – The employees in a start-up should prioritize the interest of the start-up rather than their personal interest. All the employees should work together for the growth of the start-up.
5. Duties towards the community – The Startups should be careful that they should not in any manner cause harm to the sentiments of the people and they must follow a proper pathway for the betterment of the society by keeping provisions of investing in social causes like education, food, environment, etc. Start-ups should be careful about the religious sentiments of the people, especially while advertising.
6. Issues with respect to Labour laws – It would be wise for a start-up or any other company to be well-versed with the labor laws and the local laws because when we are hiring some person to work for us then we have several legal as well as ethical responsibilities towards that person as there are several statutes which protect the rights of the laborers with respect to the working hours, sexual harassment at the workplace, payment of wages, payment of bonus, etc. However, the new start-up, India initiative which was launched by prime minister Narendra Modi in 2015 exempts the start-ups from labor inspection.
7. Use of deceptive or inappropriate marks – Since the launch of the Make in India initiative by the Narendra Modi Government in September 2014. People have connected their patriotic sentiments with the make in India campaign and many businesses and start-ups could be seen using the make in India logo on their products in order to market their products in the name of the country and befooling people. Back in 2016, a Noida-based start-up named Ringing Bells announced the launch of a smartphone named Freedom 251 at exceptionally low cost which gained attention all over the country. It came up with an advertisement on the front page of several local newspapers which consisted of India’s tricolor flag and later on the company ended up merely as a scam.
   The improper use of such marks or emblems is prohibited from use under the Emblems and Names (Prevention of Improper Use) Act, 1950 which prohibits any person from using or continuing to use, for the purpose of any trade, business, calling, or profession, or in the title of any patent, or in any trademark or design, any name or emblem specified in the Schedule or any colorable imitation thereof without the previous permission of the Central Government or such officer of Government as may be authorized in this behalf by the Central Government. The start-ups should keep in mind that they should not use any mark or emblem or logo which is prohibited by law from use.
   The start-ups should not try to befool the customers by using the certification marks without obtaining the certificates from the competent authorities. If any individual for any reason misrepresents any certification mark as registered in regard to any products or services; then he/she by law is punishable with imprisonment for a term which may extend to three years or with fine, or both.

Dealing with counterfeit goods

The start-ups should avoid the sale or promotion of food, beverages, health supplements, medicine, auto parts, clothes, beauty products, pirated software. The US Trade Representative (USTR) offices ‘Notorious Market’ report has marked Snapdeal and Amazon for the sale of counterfeit products. The sale and promotion of such goods are detrimental to the start-up’s reputation, the manufacturer as well as the consumers.

Author:  Anubhav Gupta, Principal Associate- Taxation, and Pranav Dixit an intern, at Khurana & Khurana, Advocates and IP Attorneys.  In case of any queries please contact/write back to us at anubhav@khuranaandkhurana.com