StartupS in India, as elsewhere, are in trouble. Venture-capital (VC) investments in January were down by 80%, year on year, according to Inc42, an online publication. Many of the reasons are familiar, too: money is no longer free; local banks pay more on deposits; once-hot business models like food delivery or online learning have not lived up to expectations; and crashing valuations are undermining the credibility of the market. Now Indian firms face another, idiosyncratic hurdle.
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A new tax provision buried in the latest annual budget, which is being debated in parliament, broadens a rule from 2013 that treats most investments from unregistered VC backers, such as rich individuals, family offices and other such “angel” investors, as the recipient’s income if the accompanying valuation is “in excess of fair value”. The tax currently applies to money from Indian sources. The new version would extend to largesse from any foreign investor, including VC firms and pension funds, not registered with India’s securities regulator.
As with many Indian rules, the “angel tax” was born of scandal. Details are murky but a state official in southern India had allegedly got around tax rules by directing money through a shell company and declaring the proceeds to be investment, not taxable income. The levy was an attempt to curb such excesses. For startups with scant revenues today and high valuations predicated on hoped-for future profits—which is to say most young tech companies—it is a considerable burden. Firms must show tax authorities sales projections, along with costly endorsements of fundraising valuations from accountants and bankers. The angels, for their part, get intrusive calls from the taxman about where their money came from. Many simply give up.
The experience of Nikunj Bubna, an entrepreneur from Mumbai, is instructive. His software firm, Whats Extra India, raised $100,000 in 2011 at a valuation of $1.5m, then $200,000 in 2014 at $3m. By 2017 it had products and customers but needed fresh capital. A $500,000 fundraising round, this time valuing Whats Extra at $5m, attracted existing investors and some new ones. After that a notice arrived from the tax authority subjecting the earlier rounds to a 33% income tax and penalties equal to 200% of the total money raised. Appealing against the decision required a deposit amounting to 20% of the full amount owed, plus years in court.
The process suffocated Mr Bubna’s firm, which is now defunct. Not all startups shared its fate: until recently few had problems securing early backing. But the extension of the rules to foreigners, who are believed to account for the lion’s share of those early backers, may put many more in peril. Tushar Sachade of PwC, a firm of accountants and consultants, says he has been flooded with inquiries from foreign investors. Indian founders say money pledged by foreigners has evaporated.
India’s taxmen are notoriously grasping. They have gone after big multinational firms with retroactive tax bills. A case involving Vodafone, a British telecoms giant, dragged on for eight years before it was settled in 2021. This time Indian business elites are alarmed by the potentially devastating consequences of the new rules for ambitious Indian enterprises.
A WhatsApp group created by Mr Bubna to bring attention to the problem, whose 250 members include grandees of Indian VC, casts the new rules as an existential threat to Indian innovation. Siddarth Pai, a venture capitalist, has called it “a shame of a tax” that will drive entrepreneurs abroad. He and others are calling for the budget, which ordinarily takes effect on April 1st, to be amended. The prime minister, Narendra Modi, talks fondly of India as a “startup nation”. He should tell that to his budget-drafters. ■
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Source: Business - economist.com
