Budget 2019: Start-ups, investors seek tax sops, easier compliance regime

While 'recognised' start-ups don't have to pay corporate tax for 5-7 years, they still have to pay MAT on book-profits at 18.5%, which is seen as a major cash out-go in early stage enterprises

With the Narendra Modi-led NDA government going into its second term, albeit with a stronger majority, the start-up community expects it follow through on entrepreneurial policies introduced over the last five years and remove a dozen or so bottlenecks to position the country as a start-up powerhouse.

The interim budget presented on February 1 this year, which is only meant to support activities for two-three months in an election year, was understandably missing on big-bang announcements for start-ups. All eyes are on the Union Budget that will be presented by finance minister Nirmala Sitharaman on Friday.

According to half a dozen experts Business Standard spoke to, the industry is looking ahead for more tax sops for start-ups, a simpler and toned-down compliance regime and a uniform policy framework that courts foreign business and investors in India as well as supports local entrepreneurship.  

Having made start-up a key theme for its first terms, the Modi government put in place building blocks for an enabling ecosystem, attracting foreign capital and spurting innovation through policies like Start-up India, Make in India and Digital India. According to official figures, the commerce department has recognised over 18,000 start-ups; the Rs 10,000 crore Funds of Funds has allocated a fourth of the earmarked capital to 45 domestic investors; and over Rs 100 crore has been disbursed for setting up incubators, accelerators and research parks, besides several policies for start-ups to enjoy corporate tax rebates and subsidies in things such as patent filing and research and development.  

Among the main points that require resolution, according to experts, is tax. While corporate tax is exempted for ‘recognised’ start-ups for a period of five-seven years, companies still have to pay Minimum Alternate Tax (MAT) on book-profits which is levied at 18.5 per cent, and is seen as a major cash out-go in early stage start-ups.  

“The revenue should focus on enabling these companies to grow and once they do, their contribution to the economy would more than compensate for loss due to taxes forgone,” according to Nasscom, an industry body for software and IT industry. In its recommendations to the government, it has suggested doing away with MAT for start-ups and small businesses with turnover of less than Rs 50 crore.  

Experts also pointed to double-taxation on employee stock options (ESPOs) as a major deterrent to wealth creation. Esops are instruments given to employees as part of their compensation that can be converted to shares in the company at a later stage. According to prevailing rules, Espos are taxed (as income) when they are converted to shares (typically after 2-4 years) and again when the employee sells the shares for actual cash.    

According to Siddarth Pai, founding partner at early-stage venture capital firm 3one4 Capital, not only is the employee is taxed twice but gets taxed on notional gains when options are exercised. “The tax regime makes sense only for listed companies where employees can immediately sell their shares in the market.”    

Paytm and Flipkart are only two big start-ups that have had major Esop buy-back programmes in India. “The reason why they did that because employees couldn’t sell those shares… Change in regime is needed for Espos to become more viable for employees and start-ups,” said Pai.

Another type of tax that is stifling corporate M&A and forcing start-ups to incorporate outside India, is the high capital gains tax. Capital gains tax is levied at 30 per cent (for short-term) and 20 per cent (long-term) on profit from the sale of shares in unlisted companies which has prompted investors and start-ups to look for loopholes. To avoid paying this tax, many start-up are seen getting incorporated or shifting their headquarters to other countries, especially Singapore where capital gains tax is nil. Indian exchequer lost millions of dollars in taxes that in the Flipkart’s sale to Walmart in May last year, which would have come to India had the e-commerce firm been registered in India and not in Singapore.

According to Ankur Pahwa, partner and national leader for e-commerce and consumer internet at consultancy EY, India’s Internet sector is poised for consolidation and capital gains may become a bigger pain point in the years to come. “There will be good amount of M&As and consolidation in the near and medium term, not just in e-commerce but in areas like AI and ML. Why I say this is because a lot of established Indian players and conglomerates do a build versus buy scenario. Digital is not in their DNA and ultimately they may be acquiring assets in digital. There will be a lot of small niche companies that will be absorbed by larger corporates resulting in faster M&As, especially in tech businesses,” said Pahwa.  

Pahwa is of the view that corporate gains tax should be reduced, if not scrapped, for companies under a certain age or turnover. Nasscom, on its part, has recommended scrapping of long-term corporate gains tax and lowering short-term corporate gains tax to 15 per cent.

“Funding is the lifeline of start-ups, and listing of a start-up is lot more riskier. So in order to attract private investment in start-ups, long-term capital gains tax must be exempted,” said Ashish Aggarwal, Sr Director & Head, Policy Advocacy at Nasscom.

While capital gains is a concern for people involved in large M&As, seed-stage investors are pitching for scrapping of the contentious angel tax. Section 56 of the Income Tax Act, which is also called angel tax, mandates start-ups to pay tax on angel investment at 30 per cent. Over 2017-18, the income tax department used the clause to go after start-ups, most of which had legitimately raised funding from authentic sources. As many as 80 start-ups have received demand notices from the Central Bureau of Direct Taxes. While the clause does not apply to start-ups receiving funds from registered venture capital investors, the industry wants the scope of the exemption to be expanded.  

“Currently only a few sub-categories of AIF -I are exempt from Sec 56, for historical reasons. With the evolution of the industry to largely use Category II, we strongly recommend that all CAT I and CAT II AIFs should be exempt from Sec 56( 2)(viib),” said Rajat Tandon, president, Indian Private Equity and Venture Capital Association (IVCA).  

Besides taxes, onerous compliance burden is the second the biggest pain point for start-ups in the country. In 2018, World Bank ranked India at 77 in terms of ease of doing business in the country, way behind the US (6th) and Singapore (2th).  

According to Pai of 3one4 Capital, a typical start-up in India spends anywhere from 16 to 20 hours every month, besides costs, to fill out multiple forms for various regulators including the Income tax department, RBI (relating to fund raise) and corporate affairs ministry. Compliance has almost doubled with the introduction of GST and KYC norms, among other new policies introduced recently.  

“The govt. should reduce this 20-hour burden to one-hour a month, let them have a very simple form they have to fill up, and make sure there is cross pollination amongst all the government departments so the start-ups don’t have to give the same information in multiple formats,” Pai said.

In the Modi regime, there has been a few solid policy hits like introduction of shares with differential voting rights, a coherent policy for flying unmanned aerial vehicle, creating of a robust digital payments infrastructure through on India Stack, Aadhaar and Unified Payments Interface, and defining start-ups, among other things.    

“Say, in the case of payments where the government provided the public infrastructure (UPI) and private parties were able to build on top of it. It’s was a jugalbandi (fusion) between digital public infrastructure and private innovation. This model needs to be extended across several other areas, including easier credit for small businesses and healthcare services,” said Sharad Sharma, a co-founder at iSpirit, a think for product and tech companies. 

Policies appreciated by industry	What the industry wants now
Fund of Funds supporting growth of domestic VCs. Rs 2,570 cr committed	Reduce slabs for capital gains tax and minimum alternate tax
Framework to issue shares with differential voting rights	Remove double-taxation on Esops, angel tax
Defining start-ups; introducing subsidies, tax rebates	Easier compliance; merge similar regulatory submissions
Dedicated start-up policies in 24 states	Boost credit to small businesses, MSMEs
Make in India attracting foreign capital	Digital infrastructure for healthcare, other sectors
FDI in several sectors converted to automatic route	Consistent policies for foreign and domestic companies