Stay-In-India Checklist Index aiming for 5 trillion $ Economy by 2025

What is Stay-in-India Checklist?

The Stay-in-India checklist is a list of regulatory hurdles that makes it attractive for Indian startups to Domicile in foreign jurisdictions like Singapore and USA.

The checklist was prepared by iSPIRT to present the most important issues where respective Government departments or regulators could being in reform to help stop this exodus of start-ups from India.

The checklist is important to achieve the vision and mission objectives of National Policy on Software Products. In turn, it will boost the innovation-driven economy, Ease of Doing Business (EOB) in India, retain and multiply the economic value thereby contributing to the 5 trillion dollar economy goals by 2025.

The issues pertaining to various regulations on making funding of start-ups complex and unattractive, difficult or redundant compliance, ambiguity or unclear notifications etc.

iSPIRT has taken up a list of 36 issues since 2015/16. Until now out of 36 issues, some have been addressed. Some issues were resolved fully, some partially and about 17 or more issues from the original list are still unresolved.

Note: This blog is a progressive blog to maintain the evolution of the Stay-in-India Checklist and its progression as the issues get resolved by the Govt. of India.

Index of issues solved and remaining

The objective of this blog post is to provide readers in the Start-up community to keep track of issues in this checklist.

We covered many of the resolved issues on www.pn.ispirt.in and www.policyhacks.in . Ready links given below.

A list of issues pending to be solved is are given below.

1. Digital Goods and Services Confusion

Authority: MoF and MOC

Status/Explanation:

The digital economy is about “Digital Goods” and “Digital Services”. Even the physical goods are traded through “Digital services” platforms and means. Hence, it is important to get “Digital goods” defined in our legal systems as distinct from “Digital Services”.

National Policy on Software Products (NPSP) was announced in February 2019 promoting Software products with a vision to make India a Software product nation.

Software products possess all properties of “Goods” except that they are intangible. Recognition of Software products as distinct from Software services is paramount to the success of the NPSP and promotion of the Software product industry. In larger shape, this requires a clear treatment and definition of Digital (intangible) “Goods” and “Services”.

Recommendation/Suggestion:

The National Policy on Software Product (NPSP) was announced in Feb 2019 to promote the Software products. The Policy implementation has huge friction owing to the non-acceptance of Software products as separate from Services. To leverage NPSP for the success of the Software product Industry “instituting” this clarity is important.

2. Abrogate Softex forms for SW products

Authority: MoF and MOC

Status/Explanation:

Softex form is required to be filed for export of software. After the GSTN system came into existence, all exporters filed Export invoices and regular exporters filed a letter (LUT) with the Government of India. The GSTN system can be used to track remittances received against each invoice.

Software products are traded based on MRP/list price mechanism in both On-premises and SaaS models and hence does not require any valuation.

Recommendation/Suggestion:

Softex forms is a Redundant process to ascertain Foreign remittances arrivals after the GSTN system is in place. RBI systems should digitally connect EDPMS to GSTN for a homogenous tracking of export proceeds remittances just like Income tax and other systems have done it. This will give way to a homogeneous system across all goods and services.

At the least Softex forms for Software products can be abrogated to ease the business of Software product companies where there is no need of valuation and those listed on the Indian Software Product Registry (ISPR) maintained by MeitY.

3. Remove TDS on sale of Software products

Authority: MoF

Status/Explanation:

A business can buy a hardware product without a TDS but not a Software, as the purchase of a Software product from Software companies are subject to TDS at 10% of all receipts under Section 194J.

The refund of this amount only happens after filing their IT Returns in September of each year, with this delay causing hardship in terms of working capital.

In the case of SMEs and Start-ups, it is hard to receive working capital loans from banks or NBFCs. For SaaS business the transactions are online and it is not possible to map TAN numbers at the time of online transactions and tracking of TDS on all transactions.

Since all profitable businesses with more than 40 lakh turnover are filing GSTN invoices, the tracking can easily be done through the GSTN system of each invoice amount and mapped to the income tax return filed at year-end.

Recommendation/Suggestion:

No product is subject to TDS when sold by producer to channel partners or end consumer. Software Products are subject to this sale. CBDT mixes this TDS with other TDS issues hence is reluctant to remove it. Income from Software products should not be classified as Royalty income and “Software Products” should be treated as “Goods” as defined in constitutions. This again requires recognition of “software products” and a Solution to this problem.

4. Setup HSN Code for Software Products

Authority: MoF

Status/Explanation:

Software products are intangible goods and keeping and treating them with Services in SAC list will not be able to help in creating a “Software product Industry”. They have to be classified as “products”.

Presently Software is classified in HSN code based on the medium on which it is physically supplied. The intangible Software is not defined in HSN and for domestic purposes, the Software product companies use Service Accounting Code Services Accounting Code (SAC) list which is not internationally harmonized. Hence, the trade of Software products can’t be homogeneously measured.

Recommendation/Suggestion:

HSN code mechanism is only used for Physical goods. However, in order to promote “Software products,” some countries are giving treatment to “Software products” and “Digital goods” under chapter 98, 99. India should also create a provision for “software products” HSN code until a harmonious global system is developed for “Digital goods” (including Software Products).

5. Level playing in B2C Sales of SW products

Authority: MoF

Status/Explanation:

Although there are mechanisms laid to report sales in India for foreign companies (non-resident taxable person), yet a lot of business of Software products especially in apps business happen in B2C area from not so popular brands. As a result, the Indian “Software product” companies have a non-level playing field as they have to comply with the GST regime of 18%.

Recommendation/Suggestion:

Provisions should be made to relieve the B2C sales of Indian “Software products” from heavy 18% GST for the advancement of “Digital India” and especially new post-pandemic digital and Gig worker economy.

6. Favourable Tax Regime for IPR

Authority: MoF

Status/Explanation:

In the past several years, India has experienced increased capabilities of innovative, creative and capable young professionals for creation of significant and valuable IPR. At the same time, India has also seen that the ownership of such IPR usually does not reside with Indian companies or in India.

Whilst there are several ‘non-tax’ reasons for this loss of ownership in favour of other jurisdictions, tax remains one of the major reasons. As a result of the huge negative tax impact, Indian companies constantly look to hold their IPRs for worldwide use in a jurisdiction which is more favorable from a tax perspective. Some of such notable jurisdictions are: Ireland, The Netherlands, Switzerland, and Singapore.

Further, governments of certain jurisdictions are aggressively targeting Indian companies to house their IPR there. For instance, a majority of Indian software product companies prefer to set up base in Singapore given the incentives offered by the Singapore government and the aggressive marketing by the Singapore government.

It is noteworthy that in the case of technology companies, IPR is one of the most (if not the most) important assets. Accordingly, technology companies usually follow their IPRs and establish base in jurisdictions that are most favourable for IPR. Lacking this, India has seen most of its technology companies shifting base to jurisdictions such as Singapore.

Creating a favourable tax regime for intellectual property is, therefore, extremely important for retaining technology companies in India.

This is partially covered in the Budget announcement, which provides that income by way of royalty in respect of a patent developed and registered in India will be taxed at 10%.

Recommendation/Suggestion:

Further action also needs to be permitted-

Such companies should not be subject to minimum alternate tax. However, such companies should be subject to dividend distribution tax as may be applicable to all other companies;
Transfer of IPR so developed and owned, or acquired and owned should result only in capital gains and be taxable as capital gains. Such IPR should be characterised as a long term asset if held for more than 3 years as is the case for other assets;
For self-generated IPR, the holding period should start from the date an application is made under the IPR laws for its exclusive ownership, viz, copyright, trademark or patent registration.

7. Informal Guidance Mechanism & appellate authority at RBI

Authority: RBI

Status/Explanation:

This needs to be pursued. The RBI helpline announced recently does not resolve this issue, as it does not contemplate making RBI approvals/rejections public or appeal process for parties aggrieved by an RBI decision.

While public notification of RBI decisions has been announced for compounding orders, it is yet to be done for cases of approvals/rejections of applications under FEMA (on a no-names basis).

Recommendation/Suggestion:

In our discussion with authorities, it was suggested that instead of codifying laws on aspects like round tripping, it is better to have an informal guidance and appeal procedure at RBI, similar to SEBI. This needs to be pursued.

8. Filing of Form FC-TRS – post-transfer requirement

Authority: RBI

Status/Explanation:

In terms of the FDI policy, a transfer of shares of an Indian company between non-residents and residents can be taken on record by the company subject to it receiving endorsed form FC-TRS. While the filing of this form has been made online, it still takes a few days’ time for the AD banks to review and approve the form.

Thus, the transfer of shares cannot be recorded by the company (despite the purchaser remitting monies to the seller and completing all other formalities) until form FC-TRS is endorsed/approved by the AD bank. At times, this process takes months (there are substantial delays even after the filing process has been made online).

Recommendation/Suggestion:

Since FC-TRS filing is online now, there should not be an issue in making it a post-transfer requirement.

9. Collection of monies by a resident on behalf of a non-resident to be permitted

Authority: RBI

Status/Explanation:

The Foreign Exchange Management Act, 1999 (FEMA) prohibits any person to make any payment to or for the credit of any person resident outside India in any manner. As the nature of commerce has undergone major change and many services and goods are being delivered through aggregators using online or mobile media, there is a need to re-look at this provision. Essentially, in all aggregator arrangements, the aggregator acts ‘on behalf of’ the seller to collect payments and provide selling and/or ancillary services.

Recommendation/Suggestion:

Presently, only start-ups have been permitted to collect monies in India on behalf of their foreign subsidiaries. This needs to be permitted for all companies, and also on behalf of any other entity (regardless of such entity being a subsidiary).

10. Acquisition by residents of overseas companies with an existing subsidiary(ies) in India to be permitted

Authority: RBI

Status/Explanation:

Presently, there is uncertainty on the meaning of “round-tripping” in relation to such transactions.

Recommendation/Suggestion:

“Round tripping” is usually invoked when an Indian company acquires a foreign company, with an existing subsidiary in India.

It needs to be clarified whether the transfer of shares between an overseas subsidiary of an Indian company and a third party falls under any compliance/approval process under FEMA.

Also, there is a limitation on foreign investment by resident individuals in association with the ‘Indian Party’ in only operating entities. This may be done away with.

The RBI policy announcements contain only the following generic statement: “Streamlining of overseas investment operations for the start-up enterprises”. The aforesaid specific actions need to be performed.

11. ODI JVs/WOS investing back into India to be permitted where it is a genuine business requirement and bona-fide investment

Authority: RBI

Status/Explanation:

There is uncertainty with regard to “round-tripping” in such transactions.

Recommendation/Suggestion:

Such investments should be permitted (under the approval route, if need be) on commercial justification.

The following transaction may be specifically permitted:

Bona-fide acquisition of existing structures having a leg in India; or
Where the Indian investment is made for bonafide commercial reasons out of funds earned/raised overseas without Indian guarantee and is in 100% FDI automatic route sector (e.g. infrastructure).

Further, setting up an overseas structure under the ODI route to raise equity capital for investing back into India should be specified/clarified to be a bonafide and permitted overseas investment.

Since there is no bar under the extant regulations, entities which have overseas JVs / WOS which have downstream investments in India should not be subject to punitive action.

Individuals should be allowed to hold shares in foreign entities with step-down subsidiaries, subject to the investment in the foreign entity being a specific fraction (and not the whole of) of foreign funding received by step-down subsidiaries.

To permit Investments up to a specified limit (eg USD 10 million) by companies (regardless of their net worth) in overseas entities.

Again, the RBI policy announcements contain only the following generic statement: “Streamlining of overseas investment operations for the start-up enterprises”. The aforesaid specific actions need to be performed.

12. Late filing to be allowed for subsidiary formations by start-up founders

Authority: RBI

Status/Explanation:

Currently, this is not permissible.

Recommendation/Suggestion:

Lot of founders who set-up subsidiaries abroad and have not compiled with RBI, should be allowed an automatic route through late fees.

13. Restriction on FVCIs to invest in all sectors to be removed and brought in line with FDI policy

Authority: RBI

Status/Explanation:

Presently, FVCIs are permitted to invest in only certain sectors.

Recommendation/Suggestion:

In terms of RBI/2016-17/89/ A.P. (DIR Series) Circular No. 7 of 20 October 2016, FVCIs are permitted to invest only on ten sectors (viz., Biotechnology, IT related to hardware and software development, Nanotechnology, Seed research and development, Research and development of new chemical entities in pharmaceutical sector, Dairy industry, Poultry industry, Production of biofuels, Hotel-cum-convention centres with seating capacity of more than three thousand, and Infrastructure sector).

While RBI (under the above circular) has exempted start-ups from this restriction, other companies also need to be exempted from this.

14. Limit on acceptance of deposits from shareholders to be removed for private companies

Authority: MCA

Status/Explanation:

Under Section 73 of the Companies Act, private companies are allowed to accept deposits from their shareholders up to 100% of their share capital and free reserves. However, since most start-ups require constant funding during initial years, and do not have free reserves, such limits may be removed for them.

Recommendation/Suggestion:

The Companies Law Committee Report recommends removal of this limit for all start-ups. However, fine print is awaited.

15. Grant of ESOPs to promoters and independent directors for all private companies

Authority: MCA

Status/Explanation:

The provisions of the Companies Act do not permit companies to grant ESOPs to promoters or members of the promoter group or independent directors. There is no rationale for this restriction as the promoters essentially function as employees of the company. Further, through multiple rounds of fundraising, the stake held by the Promoters would have significantly diluted. Also, to get good professionals to join as independent directors, it is important to issue them ESOPs as payment in cash for compensating them is a burden on the company’s resources.

Recommendation/Suggestion:

Provisions of the Companies Act need to be amended to permit issuing of ESOPs to promoters and members of the promoter group and independent directors. Management ESOP should be permitted for unlisted companies to keep the Promoters incentivized and motivated. Likewise, the role of advisors is critical for the success of the ventures. Equity seems to be the only logical form of incentive, given the lack of liquidity.

While the MCA has permitted the issuance of ESOPs to promoters for start-ups, this needs to be permitted for other companies as well. Also, the issuance of ESOPs to independent directors needs to be permitted as well.

16. Taxation of gains from sale of ESOPs as salary or prerequisite (leading to very high tax at present)

Authority: MCA

Status/Explanation:

The ESOP regime in India is geared more towards listed entities, which have a liquid market, as opposed to start-ups. Section 17, IT Act 1961 and Rule 3, IT Rules 1962 deal with the taxation of ESOPs. First, the employee is subject to tax at the time of exercise of option – i.e. this tax is payable immediately even if the employee has not sold the share in that tax period. The magnitude of the tax is calculated on the notional gain between the acquisition price of the share (option strike price) and the fair market value (FMV) at the time of exercise. Secondly, the nature of such gains is considered as salary or perquisite. This means that the employee may be payable for ordinary income tax – 30% (excluding surcharge and education cess), calculated as per the marginal income tax rate) for the notional gains calculated above. This causes an economic outflow in the hands of the employee upon exercise, which is funded by debt or is at times even declined due to this reason. This is especially acute since the shares they hold don’t have the same rights as those offered to Investors.

Recommendation/Suggestion:

Amend Rule 3(8)(iii) of the Income Tax Rules, 1962 and as follows (insertion in bold) “In a case where, on the date of exercising of the option, the share in the company is not listed on a recognised stock exchange, the fair market value shall be such value of the share in the company as determined by a merchant banker or accountant on the specified date as per Rule 11UA(1)(c)(b), provided such fair market value shall not be less than the exercise price ”

Tax incidence should arise in the year of the sale of shares (not the year of exercise of the option). Profit made on sale of shares should be treated as capital gains (vs. the treatment as a portion of the gains as salary or perquisite).

17. Dividends from overseas subsidiaries taxed again in India

Authority: MoF

Status/Explanation:

Dividend received from overseas subsidiaries is taxed once again in India as income in the hands of the company. Also, while the rate of tax on such dividends for certain companies is 15% (as against 30%), the same exemption is not provided to limited-liability partnerships and individuals.

Recommendation/Suggestion:

Thus, tax levied on dividends from overseas subsidiaries should be discontinued, for parent companies incorporated by resident Indians in India.

18. Fair market value tax

Authority: MoF

Status/Explanation:

Any investment above the ‘fair market value’ (as may be determined by the Income Tax Authority at a future date) is treated as income for the company and is subject to income tax. This impacts angel investments at high valuation, as there is a risk of the Income Tax Authority determining such investment as above fair market value and requiring the company to pay tax on the differential.

Recommendation/Suggestion:

Start-ups have been exempted from this tax. However, the certification process to be recognized as a start-up is cumbersome and needs to be relaxed.

19. Harmonisation of tax policy for listed and unlisted equity instruments

Authority: MoF

Status/Explanation:

Listed Securities have a holding Period of 12 months for LTCG whereas for Unlisted it is 24 months Unlisted securities have a tax rate that is twice the rate of their listed counterparts, and the surcharge applies on the sale of unlisted securities while it is exempt for listed securities.

Recommendation/Suggestion:

Globally, the differentiation in tax treatment on listed and unlisted securities is not prevalent. Unlisted securities are more illiquid and riskier as compared to listed securities. They should have the same tenure of holding and the same tax rate on the same. There is a disparity in the tax rates applicable for capital gains on the sale of listed securities (12 months) vis-à-vis sale of unlisted securities (24 months). Dematted Unlisted securities of start-ups or companies that were registered as start-ups can also be subject to STT (or the new Stamp Duty regime announced in February 2019) in order to harmonise the tax treatment of both listed and unlisted securities.

Disclaimer: The discussion and ideas expressed here should not be construed as legal advice. The discussion is conducted with Industry practitioners and experts for purpose of benefiting the Industry members in the Software product, Start-up ecosystem and other related industry sectors

19/02/201919/02/2019

Clipping The Wings Of Angel Tax

2000 startups. 100 meetings. 25 articles. 7 years. 3 WhatsApp groups. 2 whitepapers.

1 unwavering ask:

No More Angel Tax.

This evening, when we first got to see the circular from DPIIT/CBDT that formalized key recommendations suggested with respect to Angel Tax or section 56(2)(viib), we admit our minds went blank for a moment. After all, this one document represents the tireless, collaborative efforts of iSPIRT, the entrepreneurial community of India and ecosystem partners like IVCA, Local Circles, IAN, TiE, 3one4 Capital, Blume Ventures etc., and the proactive support from the government. It has been one relentless outreach initiative that has seen us become a permanent fixture at Udyog Bhavan and North Block (I even checked with the guards regarding the possibility of a season pass). My colleagues Sharad Sharma, TV Mohandas Pai, and partners such as Siddharth Pai, Nikunj Bubna, Sreejith Moolayil, Monika, Ashish Chaturvedi and Sachin Taporia deserve a big shout out for their diligent efforts at connecting with various ecosystem partners and initiating a regular cadence of dialogue with the government.

The key takeaways from the circular are as below –

Blanket exemption for up to INR 25Cr of capital raised by DIPP registered startups from any sources
Amendment in the definition of startups in terms of tenure from 7 to 10 years
Increase in the revenue threshold for the definition of startups from INR 25Cr to INR 100 Cr
Breaking the barrier for listed company investments by excluding high-traded listed companies and their subsidiaries, with a net-worth above INR 100Cr or a Turnover of 250 cr, from section 56(2)(viib)’s ambit

Each of these points is a major win for the startup community. If one looks at the data from the LocalCircles startup survey in January 2019, nearly 96% of startups that had received notices regarding angel tax, had raised below the permissible limit of INR 10cr. Expansion of this limit to INR 25cr is a huge boost and instantaneously removes thousands of startups from the reach of angel tax. There is an effort here to critically analyse, define and differentiate genuine startups from shell corporations. It includes measures such as increase in the revenue and tenure threshold that will not only help startups with respect to the challenges posed by angel tax but also open up eligibility for benefits under Startup India schemes and policies. We have been talking about the need to encourage and protect domestic investments and the government has paid heed to our concerns by introducing accredited investor norms and by breaking the barrier for listed company investments.

Initiated in 2012 by the UPA government, Section 56(2)(viib) or the “angel tax” section has been a relentless shadow on the entrepreneurial ecosystem. It taxed as income any investment received at a premium by an Indian startup. This provision saw many entrepreneurs clash with the tax officials about the true value of their business and pitted unstoppable entrepreneurial zeal against the immovable tax department.

All of us from the policy team at iSPIRT have been at the forefront of this issue since 2015 when we began petitioning the government to exclude startups from section 56(2)(viib) as taxing investments from Indian sources would cripple the startup ecosystem. We laud the government for appreciating the urgency of the situation and prioritizing this issue.

We first had an inkling of things to come at the February 4th, 2019 meeting held by DPIIT. It was unprecedented as it saw a direct dialogue between government and entrepreneurs wherein both sides could better understand the issues facing each other – how section 56(2)(viib) was hampering founder confidence and how it is a needed tool in the government’s arsenal for combatting the circulation of unaccounted funds.

After this, a smaller working group was constituted on February 9th, to review the proposals made by DPIIT to address this issue, in consultation with the CBDT and the startup ecosystem. iSPIRT were part of both meetings and contributed actively to the discussion.

We can now heave a sigh of relief as we have finally achieved to a large extent what we had set out to do. We finally have a solution that ensures genuine startups will have no reason to fear this income tax provision and the CBDT can continue to use it against those attempting to subvert the law.

This could not have been possible without the help of well-wishers in government departments like Mr Nrpendra Misra, Mr Sanjeev Sanyal, Mr Suresh Prabhu, Mr Ramesh Abhishek, Mr Anil Chaturvedi, Mr Rajesh Kumar Bhoot, Mr Anil Agarwal, who patiently met the iSPIRT policy team and helped develop a feasible solution.

At long last, domestic pools of capital will no longer be disadvantaged as compared to foreign sources. At long last, Indian entrepreneurs will no longer have to fear the questioning of the valuations of their businesses and taxation of capital raised.

Who knows, someday we might have a movie on this. On a more serious note, it is a step that will go down in the chronicles of India’s startup story. This puts the startup engine back on track. More importantly, it shows what can be achieved when citizens and the government get together.

By Nakul Saxena and Siddharth Pai, Policy Experts – iSPIRT

23/01/201923/01/2019

Angel Tax Notification: A Step In The Right Direction, But More Needs To Be Done

There have been some notifications which have come out last week, it is heartening to see that the government is trying to solve the matter. However, this is a partial solution to a much larger problem, the CBDT needs to solve for the basic reason behind the cause of Angel Tax (Section 56(2)(viib)) to be able to give a complete long-term solution to Indian Startups.

While the share capital and share premium limit after the proposed issue of share is till 10 crores and helps startups for their initial fundraising, which is usually in the range of Rs 5-10 Cr. Around 80-85% of the money raised on LetsVenture, AngelList and other platforms by startups is within this range, but the government needs to solve for the remaining 15-20% as startups who are raising further rounds of capital, which is the sign of a growing business, are still exposed to this “angel tax”. Instead, the circular should be amended to state that Section 56(2)(viib) will not apply to capital raises up to Rs 10 Cr every financial year provided that the startups submit the PAN of the investors.

The income criteria of INR 50 lakhs and net worth requirement of INR 2 crores is again a move by the government that requires further consideration for the investing community. Therefore, to further encourage investments by Angels or to introduce new Angels to the ecosystem, there is a need to look towards a reduced income criterion of INR 20 Lakhs or a net worth of INR 1 crore, enabling more investors for a healthier funding environment. We also, need to build a mechanism to facilitate investments by corporates and trusts into the startups.

Most importantly, any startup who has received an assessment order under this section should also be able to for the prescribed remedies and submit this during their appeal. They should not be excluded from this circular since its stated scope is both past and future investments. The CBDT should also state that the tax officers should accept these submissions during the appeals process and take it into consideration during their deliberation.

Angel Tax Presentation To DIPP [Section 56(2)(viib)] from ProductNation/iSPIRT

So, to summarise:

Section 56(2)(viib) should not apply to any investment below Rs 10 crore received by a startup per year or increase the share premium limit to Rs 25 Crores, from Indian investors provided that the startup has the PAN of the investors
Section 56(2)(viib) should not apply to investors who have registered themselves with DIPP as accredited investors, regardless of the quantum of investment
The threshold stated should be either a minimum income of Rs 25 lakhs or a net worth of at least Rs 1 crore
Any startup who has received an assessment order should be able to seek recourse under this circular during their appeal

Through this circular, the government has reaffirmed its commitment to promoting entrepreneurship and startups in India. With these suggestions, the spectre of the “angel tax” will end up as a footnote in the history of the Indian startup ecosystem.

We look forward to the early resolution of these pending matters. For any suggestions, Do write to us [email protected]

The article is co-authored with Siddarth Pai, Policy Expert – iSPIRT Foundation and Founding Partner – 3one4 Capital.

17/01/201917/01/2019

Disciplining The Not So Angelic, Angel Tax

If you are an entrepreneur, investor, or simply interested in the start-up sector, then you already know that Angel Tax is the buzzword right now.

Based on a law that was introduced in the 2012 budget by Mr Pranab Mukherjee, the rule aimed to target money laundering through high share premium. But unfortunately, the same provision is today attacking startups for their “high” share premiums and treating the difference between book value and DCF (Discounted Cash Flow) projections as income taxable at 30%. (For those interested in a more in-depth study of the provision and associated rulings can check out this article.

Thus, a law to penalize shell corporations and sham transactions are now being used against startups employing tens of people and generating value for the community. Valuations are usually based on a startup’s future potential for growth and revenue and using book value, a method that’s better suited to asset-heavy manufacturing industries, is like measuring time in light years – it sounds right but is blatantly inappropriate

Hence the problem. This section hasn’t kept pace with the other anti-laundering and anti-abuse measures instituted by law and has become a blanket provision with little opportunity for a Startup to distinguish itself from a fake business. It also specifically discriminates against domestic investments thereby discouraging both investors and startups from accepting investments from Indian residents.

Latest changes, notified just yesterday, provide some way out for certain startups. However, this is a partial solution to a much larger problem, the CBDT needs to solve for the basic reason behind the cause of Angel Tax to be able to give a complete long-term solution to Indian Startups.

While the share capital and share premium limit after the proposed issue of share is till 10 crores and helps startups for their initial fundraising, which is usually in the range of Rs 5-10 Cr. Around 80-85% of the money raised on LetsVenture, AngelList and other platforms by startups is within this range, but the government needs to solve for the remaining 15-20% as startups who are raising further rounds of capital, which is the sign of a growing business, are still exposed to this “angel tax”. Instead, the circular should be amended to state that section 56(2)(viib) will not apply to capital raises up to Rs 10 Cr every financial year provided that the startups submit the PAN of the investors.

The notification also introduces the concept of an “accredited investor” into the startup ecosystem, which is an acknowledgement of the role that domestic investors play. Globally, an accredited investor tag is given to sophisticated investors investing in risky asset classes to denote that they acknowledge the risks associated with such investments and that they have the financial ability to do so. But instead of fulfilling both criteria of income and net worth, they should follow the global model of fulfilling either criteria and lowering the threshold to 25 lakhs of income or a net worth of Rs 1 crore. Their investment into startups should be excluded from the scope of section 56(2)(viiib). As a process mechanism if the CBDT could put in place a simple once a year mechanism for the Investor to submit his returns and giving him a reference number valid for the financial year, this will enable him to invest in more startups in the year without the need to get permissions every time the investor invests his funds.

So, to summarise:

The angel tax should not apply to any investment below Rs 10 crore received by a startup per year, from Indian investors provided that the startup has the PAN of the investors
The angel tax should not apply to investors who have registered themselves with DIPP as accredited investors, regardless of the quantum of investment
The threshold stated should be either a minimum income of Rs 25 lakhs or a net worth of at least Rs 1 crore
Any startup who has received an assessment order should be able to seek recourse under this circular during their appeal

Through this circular, DIPP has reaffirmed its commitment to promoting entrepreneurship and startups in India. With these suggestions, the spectre of the “angel tax” will end up as a footnote in the history of the Indian startup ecosystem. We look forward to these pending matters

Start up India, Stand up India.

The post is authored by our policy experts, Nakul Saxena and Siddarth Pai.

27/12/2018

White Paper On The Analysis Of High Share Premium Amongst Startups In India

“High share premium is not the basis of a high valuation but the outcome of valid business decisions. This new whitepaper by our iSPIRT policy experts highlights how share premia is a consequence of valid business decisions, why 56(2)(viib) is only for unaccounted funds and measures to prevent valid companies from being aggrieved by it”

White paper on the analysis of High share premium amongst Startups in India from ProductNation/iSPIRT

14/07/201618/07/2016

Investment above Fair Market Value – no more Angel tax for Startups

In this session we take up a long pending issue of “Angel Tax”. It has been given partial reprieve recently, under StartupIndia plan. We also discuss how startups can raise money from Angels, without getting trapped in fair market value rule of finance act 2012.

Sanjay Khan speaks on the problem, the latest announcement and the way out for startups to raise equity without DIPP route, in the below given google hangout video.

What is this issue of Angel Tax? And what changes after new announcement?

Startups receive equity infusions from various sources. One of the most lucrative and internationally prevalent source is the Individual investor (Angels).

In India income tax department is skeptical about angel investment. This is because, at times angel investment was misused to channelize black money. Artificial valuations is mostly the doubt in mind of income tax authorities.

As per, Finance Act 2012, capital raised by an unlisted company from any individual against an issue of shares in excess of fair market value would be taxable as ‘income from other sources’ under Sec 56 (2) of the I-T Act. This came to be popularly called as angel tax.

So, if fair market value is say e.g. Rs. 10 per share and a startup receives Rs. 15 investment from an Angel investor. Income tax treats this difference i.e. Rs. 5 per share, as income.

As per the above provisions, the angel investments are subject to assessing officer’s approval. The jurisdictional assessing officers of income tax enjoy the discretionary powers. Instances of misuse of these discretionary powers by assessing officers created problems for startups.

Many startups are not serious about the documentation. Mostly, such startups get into problems due to lack of documentary evidence about their valuations.

Govt. of India recently announced a change under StartupIndia policy of DIPP. A Central Board of Direct Taxes notification, dated June 14, made the required changes to Section 56(2)(viib) of the Income-Tax Act, exempting startups raising funds from angel investors. This is limited to the startups approved by DIPP.

Is it available to all DIPP registered startups?

No, not to all startups approved or recognised by DIPP.

There are three kinds of startups now.

(a) General Startups, that have not applied to DIPP or are not even eligible to apply to DIPP.

(b) those who applied and got recognised by DIPP but did not apply for Income tax exemption.

Only the third (c) category of startups are eligible. These startups need not worry about the assessing officer discretion now. The benefit is available so long as they enjoy the income tax exemption under startup policy.

So, if this is not applicable to all startups, does it mean other startups cannot raise equity from Angel investors at all?

The Finance act 2012 provision does not bar angel investments. Startups not under (c) above can raise the investment from Angels (individual investors). The limitation is that the valuations in such cases will be subject to examination by assessing officer approval. They have to extra careful about the valuation at each round of funding.

Such startups should get a professional third party valuation reports. Get a valuation reports for all rounds of valuations with proper documentary proofs. You can face the assessing officers with proper documents without any fear.

The recent hype created in media was mainly arising from down rounds. That is when the new round of investment was done at a lower rate than the previous round. This led to income tax doubting the misuse.

In such challenging valuation situations like down round valuations, the startup can get a professional third party valuation from 2 or 3 sources. This way they can deter the assessing officer’s misuse of discretionary power as well as stand any litigation test, if put through.

In essence, a startup can raise honest angel investment at right fair market value. A professional valuation exercise with all objectivity can help you cover the risk.

iSPIRT’ stand

Startups ecosystems in developed countries enjoy a favourable investment climate that proactively promote and protect the angel’s investments.

Government of India should show give clear signal of favourable investment climate in the country.

Government of India should think of measures that can deter black money getting invested in the Startups, instead of doubting each and every investment. For this Govt. should repeal the the provision introduced by finance bill 2012 should. Discretion to assessing officer is not serving the cause of building investment climate.

India seriously needs a policy that promotes angel investments in general, with responsibility of money invested taken by investors rather than Startups.

04/07/201615/03/2017

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 29^th 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.