Anomalies to be corrected in Indian regulations on startups
- The government taxes capital gains of unlisted companies at 20%, while the same is taxed at 10% for listed companies.
- Even though the Indian government introduced the angel tax exemption nearly three years ago, the conditions surrounding it continue to be harsh.
- Meanwhile, an angel investor needs a net worth of at least ₹2 crore before they can start investing officially.
Investors like Tiger Global, Accel and SoftBank have turned a startup into a billion-dollar company at an average of one every eight days in 2021. Industry insiders say the new year could see much more money than the $42 billion raised by Indian startups last year, if the government fixes some of the tax, process and regulatory anomalies.
A unicorn, in startup parlance, is a veiled, billion-dollar business. And there were 44 in 2021, bringing the total to 81.
Regulatory crackdowns on similar segments in China helped Indian startup valuations last year. However, India still has a long way to go before its ecosystem of startups and venture capital can reach the level of China. And that’s where changing rules and regulations can help.
Prime Minister Narendra Modi would interact with 150 startups from several fields — agriculture, health, business, space and more — today (January 15) at 10:30 a.m.
Ahead of the upcoming 2022 Budget on February 1, Business Insider spoke with a group of industry participants to understand which fixes they’d like to see sooner rather than later. These are the best takeaways.
“Investors cannot be taxed more for taking on a higher risk”
The government taxes capital gains of unlisted companies at 20%, while the same is taxed at 10% for listed companies. That’s too high, says Devender Agrawal of Dexter Capital.
The capital gains tax disparity between investments in listed and unlisted companies has pushed more angel investors and early-stage investors into the shell.
Unfortunately, Indian startups – or rather the investment community – have been calling it back for two years, but no action has been taken so far. TV Mohandas Pai, along with a few start-up entrepreneurs, raised the issue with Finance Minister Niramala Sitharaman two years ago.
“Equity investments in unlisted companies carry higher risk due to lack of liquidity and lack of appropriate price discovery. Investors cannot be taxed more for taking on higher risk,” Pai said. cited as the Economic Times said in 2019.
Despite Sitharaman’s assurance, there have been no updates in this regard so far.
To get away with Angel Tax, you have to give up a lot
Angel tax is an income tax levied on funds collected by a company from wealthy individuals known as “angels”. The 30% tax is imposed on the premium paid for shares of the unlisted company above fair market value (FMV).
In 2019, the Indian government decided to offer angel tax exemption to companies provided they meet certain criteria. But it’s not an easy set of requirements. They define everything from how the startup is valued to how funds are used, and founders and investors hope some of them will be relaxed.
Condition set for requesting exemption from Angel Tax
|Startups cannot invest in land or buildings, shares and securities, capital of other entities, mode of transportation above ₹10 lakh.||Seven years from the last financial year||No restricted end use for assets|
|No loans or advances should be given unless the loan is in the normal course of business (includes salary advances to employees)||Seven years from the last financial year||The loan could be an option.|
|Paid-up capital must not exceed ₹25 crore||Up to 10 years from the year of incorporation.||Currency limit could be extended to ₹50 crore or ₹75 crore|
|The start-up valuation is determined by the net asset value (NAV) method, which is the next value of an entity.||N / A||The valuation should be determined by future earnings using the discounted cash flow (DCF) method.|
More than 3,600 startups were considered eligible for the exemption between August 27, 2019 and February 3, 2021. This would represent only a small fraction of the estimated 60,000 startups in the country.
The restriction on the deployment of funds is not just for funds raised from angel investors, but capital subsequently raised from venture capitalists or venture capital funds. Failure to comply with these restrictions would result in a 200% penalty on such amount.
“While the government’s intention to prevent misuse and abuse of the provisions is understandable, relaxing some conditions and reducing the time limit would go a long way to ensuring that genuine start-ups are not affected by the regulations. “, Divakar Vijayasarathy of DVS Advisors LLP said.
Some indulgence can produce more “angels”
If there is one thing that is common in the issues raised above, it is the involvement of angel investors. Until a year ago, very few individuals were willing to risk their personal assets to be part of a startup that could “make or break”.
The number of angel investors in India has grown 10X thanks to 2021 and the startup boom.
But there are others who would be ready to join the bandwagon and ignoring them would not be a good idea, believes Gaurav VK Singhvi of We Founder Circles.
However, SEBI may be getting a bit too demanding with its angel investors. An angel investor must have net tangible assets of at least ₹2 crore, excluding the value of their principal residence. Early-stage investment experience, serial entrepreneurship, and 10 years of work experience as a senior executive can also come in handy.
The said investor, in case of investing through an angel fund, must pledge ₹25 lakh rupees over a period of three years.
“No Wi-Fi [angel investor] wants to invest in four startups from four different funds [Angel Funds], I have to pledge ₹25 lakh for each of these funds. I have to commit ₹1 crore to four startups while I will only invest ₹3-5 lakh in each startup. This interchangeability is necessary,” Singhvi added.
|Requirement||Request||Why change is needed|
|Minimum net worth of ₹2 crore||Network Reduction||A young working professional will not be able to fulfill this requirement|
|Need to commit ₹25 lakh to angel fund||Commitment should be reduced to ₹10 lakh and one should be able to commit this amount to angel funds, instead of focusing on just one||Investing ₹25 lakh is capital intensive and it becomes a problem if one has to commit at least ₹25 lakh to multiple funds to grab the deals they prefer.|
“India has become the third largest ecosystem for startups and will be a key segment in making India a $3 trillion economy. With a huge amount of capital flowing into Indian startups, the government needs to focus on greater ease of doing business, both for investors and startups,” says Ankur Bansal of Blacksoil.
India’s startup ecosystem has finally come of age and it will get no more passing mention in the Indian union budget, Anil Joshi of startup investment firm Unicorn India Ventures told Business Insider.
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