India is now the third largest ecosystem for start-ups globally and ranks second in innovation quality among middle-income countries. The number of recognised startups has increased to 84,012 in 2022, up from 452 in 2016, because of investment incentives and easing business compliances. About 48 per cent of Indian startups are now from Tier II and beyond cities.
The Union Budget FY 24 spelt out its vision for the ‘Amrit Kaal’, to be pegged on a technology-driven and knowledge-based economy, with strong public finances and a robust financial sector.
This has mooted ideas to leverage AI ecosystem at educational institutes level, and usage of digital for agriculture. The budget proposes setting up an accelerator fund for agri-startups to increase digital infrastructure in the rural areas and boost startups. A digital public infrastructure for agriculture will be built as open source, open standard and interoperable public good, to develop farmer-centric solutions. This could be a boost for the startups who understand the agrarian economy and processes.
The government has also proposed extending the date of incorporation of startups by a year from March 31, 2023 to March 31, 2024 for income tax benefits. The extension of carry forward period on change in shareholding from 7 years to 10 years makes startup acquistions more attractive, supporting M&A and exits for investors.
Biggest blow – Angel Tax
Angel Tax, was added to the Income Tax act in 2012, to essentially prevent laundering of black money in the form of investments with a large premium into unlisted companies. Unfortunately, it was also applied to Indian startups beginning in 2016.
The startups do their capital raise rounds regularly, and most of these rounds happen at a premium above the face value (and importantly valuation higher than the previous fund raising round). The angel tax application treated this as income, a situation sorely unique to the Indian market. The investments from SEBI-registered Alternative Investment Funds (AIFs) and capital raised from overseas investors were exempted from this.
Why is this a problem ? The startups don’t have sufficient cash to pay the angel tax, let alone the worry if the angel tax should even be applied to the startup community. This Budget has now brought into the angel tax net, the foreign investors. This makes Indian startups less attractive to the foreign investors. Why will any investor want their capital investment to be used up to pay tax liabilities, for a tax that does not make sense at all ?
Hopefully the Government will use the Damodaran committee report on PE/VC ecosystem for quickly acting on these misses, and enable other developmental efforts.
It was expected that the budget would solve for few of the long pending industry asks : to shift tax on ESOPs from the point of exercising the stock optionto the point of sale, to reduce the long-term capital gains from 20 to 10 per cent. But the budget did not address any of these.
Indian startups have been toying with “reverse-flipping” (shifting their domicile back to India) once the Indian ecosystem was encouraging for investments and exits. Tax inefficiencies and value accretion being leaked to policy gaps will worsen the sentiment.
Startups ecosystem needs relatively cheaper and quicker access to capital through an active PE / VC ecosystem. It also needs to simplify its processes around capital flows, without bias towards quantum of funds. If we want to attract capital from around the world, we must allow for those who bring in risk-capital to benefit from the consumption economy, and not block their exit. The Budget could have provided better deals for Indian startups at a time when the global investment winter is becoming more severe.
Dr. Srinath Sridharan – Author, Policy Researcher & Corporate Advisor
Twitter : @ssmumbai