By Sridhar R
India is now the third largest startup ecosystem globally, with 100+ unicorns and over 80,000 startups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) across the country. The sector is witnessing a steady rise in SaaS-based companies, GCCs, as well as several emerging tech companies, including AI, robotics, space-tech, fintech, etc.
According to Venture Intelligence, despite a slowdown in funding, PE/VC funds completed 1,130 startups deals in 2022. If we were to add the 1,215 deals done in 2021, the series of fund-raising deals backing startups and the rise of emerging new-age companies can be seen as significant contributors to the competitiveness of the Indian market. There is a massive amount of dry powder available to support the Indian startup ecosystem, as well as trigger buy-out deals and potential IPOs in 2023.
That said, the country needs to continue its pursuit to promote the startup landscape and facilitate more PE/VC funding into the startup ecosystem. Initiatives taken by the government over the last few years have played a pivotal role in shaping the high-growth sector.
Allocation of Rs. 283.5 crore for the Startup India Seed Fund Scheme, Rs. 1,000 crore for the Fund of Funds for Startups, facilitation of the creation of a fund for AgriTech startups through NABARD, promotion of new-age companies by facilitating drone-as-a-service, and an expert committee to monitor the mobilisation of funds to startups through venture capitalists and private equity were some of the initiatives that gave the startup sector a good thrust.
A lot more can be done to build the startup ecosystem and realise the vision of a five trillion-dollar economy by leveraging the power of “tech” and “digital”.
Last year’s announcement on tax incentives and relaxations, such as capping the surcharge on long-term capital gains (LTCG) on all assets at 15% and extending the period of incorporation for eligible startups by one more year for tax incentives, portrayed a good intent on promoting a favourable startup environment. We hope that this year’s budget will continue to prioritise the startup environment.
To better understand the expectations from the Union Budget 2023, Grant Thornton Bharat conducted a survey for the technology and startup sector. The survey indicated that ease of doing business is the most challenging issue faced by startups. Predominantly, the need for a single-window clearance mechanism dominated the areas of concern, followed by clarity around overseas listing regulations and parity in Long Term Capital Gains (LTCG) tax treatment and rates. Last but not least is the wish for an exemption from capital gains tax for investors into startups.
Some of the recommendations are flushed out in more detail below.
Firstly, there is a need to have a single-window approval mechanism for startups to claim tax and regulatory incentives. Today, it takes a distinct set of applications to (a) get recognised as a startup by DPIIT (with a set of eligibility criteria) and (b) thereafter apply separately to the tax department to claim tax benefits such as the income tax holiday and the exemption from the angel tax (i.e., tax on the company on the premium received for issuing its shares). These tax exemptions must be claimed separately and have distinct conditions that must be monitored separately, resulting in a complex regime. A single-window clearance with a common set of conditions can help companies save a lot of time and effort on compliance and make the benefits more meaningful. This wish list includes issues such as claiming a benefit for tax deferment on an employee of a startup on the issuance of shares under an ESOP scheme. This exemption is fraught with several limitations and conditions that make such a claim impractical for startups and their employees to pursue. This situation is also true for certain benefits extended under Company law such as the issue of convertible notes. All in all, a complex regime to comply with.
Secondly, this budget carries a strong expectation that there will be a harmonisation of the capital gains tax rates. Currently, capital gains on sales of shares of unlisted companies is taxed at 20% or the applicable slab rate, depending on the period of holding of such shares (i.e., more than 24 months or less than that). In comparison, a 10% rate is applicable for long term gains on shares of a listed company if the amount of gain exceeds INR 100,000. The period of holding to qualify for the long term rate is also reduced to 12 months for a listed share. Therefore, there is a natural incentive for investment in listed shares, as investors pay a higher tax with a greater risk on returns if they were to consider investing in startups. A similar disparity exists in the treatment of long term capital gains in case of resident and non-resident investors, with, surprisingly, a lower rate of 10% being offered to non-residents.
Thirdly, investors could find investing in startups to be efficient if they are given an exemption from capital gains tax for reinvestment of sale proceeds of shares of one startup into another startup. This one step could significantly augment investments in the startup landscape in India.
Furthermore, it is expected that this budget will create a more open environment around opportunities to raise funds both within the country and from foreign investors. Measures to clarify that a tax-neutral overseas merger or reorganisation for foreign companies owned by Indian investors will allow for greater acquisitions and overseas listing flexibility. This is an ask that remains unfulfilled, and one hopes that this budget will provide relief in this area.
Furthermore, providing relief to the investor community by lowering effective tax rates for high-income individuals can help Indian startups gain access to capital.
Finally, there is always the possibility of simplifying the current withholding tax regime and having a more effective tax dispute management system, as well as harmonising international tax regimes like the Advance Pricing Agreement, Safe Harbour Rule, Equalization Levy, etc., that will ensure global attractiveness of the country and improve the ease of doing business here.
In addition, strengthening the capital markets for listing of start-ups (high-risk, high-growth companies), creating crowd funding platforms (such as the social stock exchange that is being considered), and promoting investments in setting up state-of-art incubation centres jointly run by industry experts and academia can transform and fund budding ideas into sustainable businesses of the future.
Work in these areas can eventually lead to building a robust platform and ecosystem for startups in India.
(Sridhar R, Partner – Tax, Grant Thornton Bharat LLP. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com.)