Stay-In-India Checklist – Successes So Far And The Path Forward

Over the past few months, we have witnessed a number of policy changes focused on creating a conducive environment for startups and entrepreneurship in India. Some changes go beyond the startup ecosystem and attempt to resolve the issues faced by companies/investors in general. A common feature in most such changes is iSPIRT’s Stay-in-India Checklist (SIIC). The SIIC comprises 34 issues, which were extracted from a larger list of 120+ issues, put together by the iSPIRT team after extensive consultation with various stakeholders.

With the 29th June notification of the MCA amending the Deposit Rules, a total of 29 SIIC issues have been addresses/acknowledged by various government departments. Some of the key changes that have taken place pursuant to SIIC are as follows:

  • Angel tax: Monies received by a company from certain resident investors (including angel investors) which are in excess of the fair market value of shares issued against such monies, are taxed as income in the hands of such company. This leads to significant hurdles in domestic angel investments (other popular modes of investments are exempted from this tax). Now, startups that are approved by the inter-ministerial board formed by DIPP (“Approved Startups”) have been exempted from this requirement.
  • Harmonisation of tax policy for listed and unlisted equity instruments: There is unnecessary disparity between holding periods for listed and unlisted shares for claiming long term capital gains benefit in relation to them. While the holding period for listed shares is only 12 months, for unlisted shares, it was 36 months. This, despite the fact that investment in unlisted shares, such as those of startups, carry higher risk. Now, this period has been reduced to 24 months. This relaxation is available to all companies, irrespective of them being startups.
  • Favourable tax regime for IPR: In the past several years, India has experienced that the ownership of IPR created in India does not reside in India, as tax regime for IPR in other jurisdictions is more favourable. Now, income by way of royalty in respect of a patent developed and registered in India will be taxed at 10%. This relaxation is available to all companies, irrespective of them being startups.
  • Convertible notes: One of the most popular instruments abroad for startups to raise early stage funds, convertible note, is not expressly recognised in India, and could be considered to be a form of ‘deposit’ which can be taken by a company only from its existing shareholders/ directors. Now, convertible notes of up to INR 25 lakhs per person have been permitted for startups that have registered on the StartupIndia portal (“Registered Startups”).
  • Indemnity escrows and deferred consideration: In FDI transactions, use of escrow mechanisms for indemnity arrangements and payment of deferred consideration required prior approval of the RBI. This created significant hurdles in acquisition of Indian companies by non-residents (since these terms are standard in acquisition transactions globally, and all acquires expected them in Indian acquisitions as well). Now, these mechanisms have been permitted for a period of up to 18 months and for an amount of up to 25% of the consideration under the automatic route (without the prior approval of the RBI). This relaxation is available to all companies, irrespective of them being startups.
  • Transfer from FVCI to non-resident: There is uncertainty around the transfer of shares of an Indian company by an FVCI entity to a non-resident entity. While certain custodians allow such a transfer without an approval of the RBI, other custodians require prior approval of the RBI before proceeding with such transfer. Although there is no specific regulation that requires FVCI entities to obtain prior approval of the RBI for such transfers, given the aforesaid difference of opinion among custodian (which results in delays in M&A transactions), there was a need for the RBI to clarify this issue. Now, Registered Startups have been exempted from this requirement.
  • Restriction on FVCIs from investing in all sectors: Foreign venture capital investors (FVCIs) are permitted to invest in only certain specified sectors. This is largely owing to the list of permitted sectors set out in registration certificates issued by authorities to FVCIs. Now, FVCIs are permitted to invest in all Registered Startups, regardless of the sectors they have been engaged in.

In addition to the above, the following issues have also been recognised by various government departments. The changes to resolve these issues have either been notified, or have been announced to be notified in due course:

  • Collection of foreign monies by residents in India on behalf of non-residents
  • Online filing of forms for cross border transactions
  • Simplification of incorporation process
  • Share swaps in FDI transactions
  • Venture debt not be categorised as deposits
  • Acquisition of overseas company with an existing subsidiary in India
  • Foreign subsidiaries of Indian companies investing back into India
  • Relaxation of external commercial borrowing guidelines for startups
  • Simplifying process of conversion of LLP into a company
  • Exclusion of private companies from the term ‘listed company’
  • Grant of ESOPs to promoters and independent directors
  • Single window agency for closure of failed startups
  • Permitting outbound mergers
  • Simplifying the process of private placement
  • Applicability of provisions relating to insider trading on private companies

As one would note, a significant number of material issues have either been addressed or are in advanced stage of being addressed. iSPIRT continues to interact with the government to get further relaxations on these issues, as some relaxations are restricted only to Approved Startups or Recognised Startup, or are simply limited in scope. iSPIRT also continues to push for resolution of other issues which have either not been addressed so far or are new and have not been covered in SIIC.

Demystifying Startup Tax

Over the past couple of days, a lot has been written/discussed about the so called ‘startup tax’ and its perceived ill effects on the startup ecosystem. Under iSPIRT’s new initiative, PolicyHacks, I attempt in this note to demystify the legal/tax jargon around this tax and to clarify the proposed rule for the benefit of ecosystem participants, particularly startups.

What is the law?

Simply put, if a private company issues shares to a resident Indian at a price above the fair market value (FMV) – say the FMV of a share is INR 100 and the company issues it at INR 110 – then the excess consideration (INR 10 in this case) is considered to be the company’s income (since, in a way, it deserved INR 100, but received INR 110). The amount of INR 10 is, therefore, liable to be taxed as the company’s income (which presently is at a rate of 30%). FMV is an important element here, and we will get back to it later. It is popularly called the ‘angel tax’.

Who are exempted from this?

As highlighted above, this provision is applicable only to investments received from resident Indians. Thus, at the first level, it does not affect foreign investments. In addition, the provision does not apply to investments made by SEBI-registered entities. One, therefore, need not worry about money received from angels/VCs/PEs which are either investing from foreign sources or have been registered with SEBI.

Who are hit by this?

Whoever is not covered under the above exemptions or otherwise exempted by the government. Prominently, the Indian angels (which constitute an overwhelming majority of the overall angel investors). Hence, the term ‘angel tax’.

What is ‘startup tax’ then?

As is clear from the above, the law is applicable to all private companies and does not single out startups. However, it has been reported in the media lately that startups which have raised down-rounds will be scrutinised by the tax department, and the valuations of such down-rounds will be considered to be the FMV of all previous (up) rounds.

In other words, if:

  • in the last round:
    • the valuation of the company was INR 1,10,00,000; and
    • the FMV per share was INR 110;
  • in the present (down) round:
    • the valuation of the company is INR 1,00,00,000; and
    • the FMV per share is INR 100,

then the valuation of the down-round, i.e., INR 100 will be considered to be the FMV of the previous round.

Hence, applying the law set out above, anything received by the company in excess of the FMV (in this case INR 10 per share) becomes its income, and is taxable as such.

So what is new in this?

Nothing. There is no change in the law. The issue that the industry has been facing since the introduction of this law is that the income-tax officers (who have wide ranging powers) were found to be using this provision to harass companies.

I have raised money from resident Indians and now I expect a down-round; will the tax department come after me?

Since this is not a new or proposed law, nothing stops the income-tax officer from going after any company even today. In fact, such proceedings have been initiated against quite a few companies in the past.

The key thing here to note is this – No tax can be levied on a company just because it has raised a down-round. The only money that this provision permits to tax is the consideration received by a company in excess of the FMV. It is a settled principle that each funding round can, and quite often, is raised at an FMV different than the previous round. So long as one can justify that in a down-round, the fall in FMV is on account of genuine external factors, and not because the FMV in the previous round was artificially inflated, one should be fine. Thus, even if one receives a notice from an income-tax officer in this respect, all one needs to demonstrate is that the FMV in the last round was calculated in accordance with the valuation mechanism provided under the IT Act, and there was no foul play in that respect. For startups falling in this category, there is nothing (or not much) to worry about, at least prima facie.

iSPIRT view and efforts

At iSPIRT, as part of the Stay-in-India initiative, we have been in continuous discussions with the government to rationalise this provision to ensure that genuine investments using legitimate money (such as angel investments) are not hit by this provision, and there is no unnecessary harassment.

Also, the government has exempted startups (which register on Startup India portal and are approved by the inter-ministerial board) from income-tax. Thus, ideally, such qualified startups should be exempt from this tax as well. We continue to discuss this with the government.

Author note and disclaimer: PolicyHacks, and publications thereunder, are intended to provide a very basic understanding of legal/policy issues that impact Software Product Industry and the startups in the eco-system. PolicyHacks, therefore, do not necessarily set out views of subject matter experts, and should under no circumstances be substituted for legal advice, which, of course, requires a detailed analysis of the relevant fact situation and applicable laws by experts in the subject matter on case to case basis.

iSPIRT’s Stay-in-India Checklist gains further traction: RBI and MCA follow the Startup India Action Plan

Several notable announcements have been made by RBI and MCA pursuant to iSPIRT’s Stay-in-India Checklist (discussed in my earlier post here). In its bi-monthly monetary policy statement released earlier today, RBI has stated that it will take steps to contribute to an ecosystem that is conducive for growth of startups. It is noteworthy that each of the points in the policy framework released by RBI has attempted to address specific issues set out in iSPIRT’s Stay-in-India Checklist. As a member of iSPIRT’s Stay-and-List-in-India Policy Expert Team, it is a proud moment for me to see the result of months of interaction with various authorities on the Stay-in-India Checklist.

IMG_2447The policy changes announced by RBI are as follows:

  • Startups in all sectors will be permitted to receive investments from foreign venture capital investors (FVCI)
  • Transfer of shares from FVCIs to other residents or non-residents will be allowed
  • Permitting receipt of the consideration amount on a deferred basis as also enabling escrow or indemnity arrangements up to a period of 18 months, in case of transfer of ownership of a start-up
  • Enabling online submission of A2 forms for outward remittances on the basis of the form alone or with document(s) upload/submission, depending on the nature of remittance
  • Simplifying the process for dealing with delayed reporting of FDI related transaction by building a penalty structure into the regulations itself
  • Issue of shares without cash payment through sweat equity or against any legitimate payment owed by the company, remittance of which does not require any permission under FEMA
  • Collection of payments by start-ups on behalf of their subsidiaries abroad

In addition to the above, the following Stay-in-India Checklist points have been deferred for consideration with the Central Government.

  • Permitting start-ups to access rupee loans under ECB framework with relaxations in respect of eligible lenders, etc.
  • Issuance of innovative FDI instruments like convertible notes
  • Streamlining of overseas investment operations for start-ups
  • While the above announcements by RBI are encouraging (and extremely fulfilling, given the role iSPIRT’s Stay-in-India Checklist has played), it is important that these relaxations are not limited to the category of startups that are eligible to benefits under the Startup India Action Plan.

In addition to RBI, several key MCA points from iSPIRT’s Stay-in-India Checklist have been discussed in the report of the Companies Law Committee which was submitted to the Government yesterday. These issues are as follows:

  • Reducing private placement process for issuance of securities
  • Excluding convertible notes (convertible into equity or repayable within 5 years from the date of issue, if issued to a person with a minimum investment size of INR 25 lakhs brought in a single tranche) raised by startups from the definition of deposits
  • Allowing startups (which are incorporated as private companies) to raise deposits from members for the first 5 years without any upper limit
  • Simplifying the procedure to convert an LLP into a company
  • Deleting insider trading provisions
  • Allowing startups to issue ESOPs to promoters working as employees or directors
  • Excluding certain private companies under the purview of the definition of ‘listed company’
  • Simplifying the incorporation process

Again, while it is heartening to see this extent of action by the authorities on iSPIRT’s Stay-in-India Checklist, it must be ensured that not everything is linked to the definition of startups announced in the Startup India Action Plan.

photozzLastly, while the RBI has positively stated that it will notify certain changes soon, all of MCA issues and a majority of RBI issues are still at a ‘discussion/recommendation stage’ (and have been merely acknowledged by the authorities as issues that need to be resolved). Hopefully, the authorities will not stop here, and will implement all these changes soon. Needless to add, iSPIRT will keep interacting with, and assisting, the authorities in achieving a quick closure to these items, as well as the remaining issues which have not yet been touched by the authorities.

Startup Action Plan: Glass Half Full

Innovation and entrepreneurship are cornerstones of sustained economic growth. The Government has done well to recognise this by launching the Startup India Action Plan. The event was an unprecedented and resounding success. The energy in entrepreneurs, leaders of unicorns, seasoned investors, Government officials, etc was intense and, for most part, contagious. No doubt the Startup India Action Plan has provided various important exemptions and incentives to startups. However, the key question is this – Whether the Action Plan adequately addresses the irritants that make the Indian startup ecosystem unattractive? In our view, the answer is no.

iSPIRT has been closely associated with the Government in this endeavour, and had put together a list of thirty four key irritants that need to be resolved to arrest the exodus of Indian startups. The list is called the Stay-in-India Checklist. Of the thirty four issues, ten each came under the Revenue Department and the RBI, nine came under the MCA, and the remaining came under multiple departments such as the DEA, DIPP, RBI, MCA, and SEBI. Based on our analysis of the Action Plan and other announcements made, the present status looks like the following:

Startup Action plan

As noted above, only one RBI issue has been resolved so far (that too by way of a clarification during our discussion prior to the Startup India event). There was no announcement on any other RBI issues as part of the Action Plan. For creating a vibrant startup ecosystem, it is imperative that the investments from foreign sources are made easier. While the RBI, MCA, and other authorities had assured us that action will be taken on most of these issues (see the orange category above) once the definition of ‘startup’ is released, so far, there is no clarity as to when such action will be taken.

We will internally continue to interact on the outstanding (orange and red) items with the RBI, MCA, Revenue, and other departments. We hope that these issues will also be resolved by the relevant authorities soon.

Sign Startup Bridge Petition and promote Stay-in-India Checklist

Today’s Economic Times carries an article about “The Dark Secret of India’s Start-up Boom”. This implores the Modi Government to make bold moves regarding the onerous regulations that startups face.

iSPIRT is also part of the new Startup Bridge India campaign, which urges the Indian government to adopt best practices from around the globe to help startups start, flourish and exit.  We’ve been working alongside a consortium of lawyers, think tanks, entrepreneurs and venture capital firms from TiE Silicon Valley to put together detailed legal language and fixes in the current policy. Startup Bridge India is hosting an online petition that demands simpler processes for investing in India’s future, a petition intended to show widespread public support for these important initiatives. Every signature matters and timing is critical to help bring about much needed policy change. You can sign the petition on

iSPIRT has been involved in nitty-gritty work with the Government in the past 75 days around its Stay-in-India Checklist. Here is what’s been happening…

What is Stay-in-India Checklist?

More and more technology startups are being forced to redomicile to Singapore or US due to a host of policy irritants that disparage the Indian startup ecosystem. After careful consideration, iSPIRT’s Stay-and-List-in-India Policy Team identified 34 key issues that need to be resolved immediately to stop this exodus. The list includes issues covering incorporation, fund raising, operations, taxation, exits, closure, payments, and intellectual property.

How was it created?

We looked at submissions from TiE, NASSCOM, IVCA and FICCI and put them into a single spreadsheet. After de-duplication we had about 120 items. These were then classified into hygiene and incentives categories. Based on consultations with startups, the hygiene set was further refined to create the Stay-in-India Checklist.

What are some of the key items on Stay-in-India Checklist?

The Checklist includes requests for favourable IP tax regime, harmony in taxation of listed and unlisted securities, relaxed external commercial borrowing norms, faster incorporation and liquidation processes, and permitting convertible notes, indemnity escrows, and deferred consideration in foreign investment transactions.

Who manages the Checklist?

iSPIRT Stay-and-List-in-India Policy Expert team managed the Checklist. The team has 7 members – two startup CFOs, two VCs and three tax/legal experts. Mohandas Pai as the mentor to the team.

What’s been the progress on the Checklist?

The Checklist received mixed responses from the regulators. While certain items (like permitting share swap as a valid method of share transfer in FDI transactions) were allowed during the discussion process itself (hence removed from the Checklist), the regulators were hesitant in permitting other items (such as tax exemptions). Largely, the regulators were receptive to the suggestions. We had detailed discussions on each item of the Checklist with the relevant regulators. Wherever the regulators were unable to implement our suggestions, they conveyed to us the concerns that restrained them. We hope these concerns are alleviated in due course, and they are able to implement all suggestions.

What are some of the key meetings that have taken place?

We have a good partnership with Mr. Amitabh Kant, Secretary, DIPP on this. His office has setup about two dozen meetings with the relevant regulators. In these meeting, iSPIRT plays the role of being the subject matter expert on items in the Stay-in-India Checklist.

The whole process kicked into high gear after an intense and productive meeting with Mr. Amitabh Kant on Oct 23rd and with Dr. Raghuram Rajan on Oct 24th. This was followed by a meeting with Principal Secretary, Mr. Nripendra Mishra at PMO on Nov 9th. Subsequently, meetings with Revenue Secretary and MCA Secretary took place. These led to numerous follow-up meetings and calls with relevant officers. Nakul Saxena has coordinated all these meetings.

What are some of the learning’s from this effort?

There is very little awareness about the world of technology startups. So education on the realities faced by the startups is critical. Sometimes one runs into situations where the issue can be closed without much effort. At other times, the dichotomy between regulatory agencies is most frustrating. Also, because of the way liberalisation of regulatory framework has been widely misused in India, the authorities exercise great caution before liberalising any regulation. The approach, therefore, is to not permit any ‘risky’ regulation, rather than punishing those who misuse it. Overall, we find the receptivity of the government agencies is good. Our positioning of being a think tank, focussed on the national agenda, rather than being a tradebody is helping a lot as well.

Guest post by Sanjay Khan, Khaitan & Co