We are so proud of our start-up economy, aren’t we?
Well, here is some sobering data to bring down that euphoria.
Of the 26 start-ups valued at over $1 billion (unicorns) and 30 potential unicorns, over 33% or one third of them have their headquarters abroad.
Only 10% of all investment into the start-ups comes from domestic capital
Angel investing declined from 653 investors in 2016 to 343 in 2018, a fall of 48.5%.
Just as the Indian start-up economy has run into a storm named “Angel Tax” we read the news yesterday that food delivery startup Swiggy raised a jaw dropping $1 billion - the single largest fund raise by a foodtech company in India. And here too, all the money comes from abroad capital. Ditto for Byjus which raised $540 million from South Africa's Naspers Ventures and others.
It is not as though there are no investors in India; it is just that they are little put off currently as most are wondering about the notice they have received from the Income Tax (IT) department. It is not the start-ups but those who invest in it are getting notices, where the IT wants to establish the creditworthiness of the investor. So they are asking these investors to furnish them with bank statements, IT returns filed, financial statements. And this is discriminatory – only domestic investors are getting this notice and if the money comes from abroad, naturally, they do not have the jurisdiction to demand these papers. This discrimination is the reason why domestic investors are shying away from directly investing in start-ups, in turn drying up the capital pool available in India.
Here, the main bone of contention is the Angel Tax, where ‘valuation’ is at the crux of it. Known as Section 56(2)(viib) of the Indian Income Tax Act, 1961 or Angel Tax, it is levied on private company that raises capital above its fair market value, as determined by the IT department. Thus when the ‘fair value’ is more than the price at which these shares are issued, the earnings on this difference is taxed at 30%. Investments from SEBI - registered VCs and alternate investment funds are exempted from the rule. This clause exists only in India and was introduced in 2012 to stop money laundering where shell companies are created to evade tax.
The intention was good but sadly, it is not being implemented right. When a start-up seeks investment, naturally, the price which gets quoted to the investors is what is perceived as the fair market value or valuation based on estimated future earnings and prospects. Isn’t that how even our IPOs are priced? These start-ups engage services of merchant bankers and CAs to arrive at the best valuation.
But once this valuation goes to the IT, the officers reject saying that it is overinflated. The assessing officer has only one valuation criteria – book value or net worth. How can valuations be done on book value when even listed entities are today valued at such a premium to the book value. This difference between what the company perceives as its value and what the IT officer sees as value is causing all the friction.
And this has led to many start-ups opting to have the holding company abroad in Singapore, Netherlands or Mauritius; this way though the income earned will get taxed at least when it comes to valuation, there would be no questioning, not even from RBI.
Even many start-ups, already established, are shutting shop in India and relocating to better locations out of India, preferring to open only a subsidiary in India. Thus India is losing out on a very significant portion in the value creation cycle, giving it all instead to other countries.
Currently, the practice of sending notices to legitimate investors is not right as while investing, they have already submitted all the required papers, used the proper legitimate channels; when there is a proper paper trail of all the money, how is this known as tracking the money laundering?