S.tart up in india, as elsewhere, is in trouble. venture capital(VCs) January investment fell 80% year-on-year, according to online publication Inc42. Many of the reasons are also well known. Money is no longer free. Local banks pay more for deposits. Once-popular business models like food delivery and online learning haven’t lived up to expectations. And crashing valuations are eroding market confidence. Indian companies now face another unique hurdle.
New tax rules buried in the latest annual budget being debated in Congress expand rules from 2013 that deal with most investments from unregistered VCs Backers such as wealthy individuals, family offices, and other “angel” investors may receive as income for the recipient if the accompanying valuation “exceeds fair value.” This tax currently applies to money from sources in India. The new version will extend to generosity from any foreign investor, including: VCs Companies and pension funds that are not registered with the securities regulators of India.
Like many Indian rules, the ‘angel tax’ was born out of a scandal. Details are unclear, but officials in southern Indian states are alleged to have evaded tax laws by channeling funds through shell companies and declaring the earnings to be investments rather than taxable income. Tax collection was an attempt to curb such excesses. For startups with poor revenues today and high valuations based on expected future profits — most young tech companies — that’s a pretty heavy burden. Businesses are required to present sales forecasts to tax authorities along with costly approval of funding assessments from accountants and bankers. The angels get an intrusive call from the tax office about where their money came from. Many simply give up.
The experience of Nikunj Bubna, an entrepreneur from Mumbai, is instructive. His software company, Whats Extra India, in 2011 he raised his $100,000 at a valuation of $1.5 million, and in 2014 he raised $3 million and he raised $200,000. bottom. By 2017, we had a product and customers, but we needed new capital. The $500,000 funding round, this time valuing his Whats Extra at $5 million, has attracted existing investors and some new investors. He was then notified by the tax authorities that in the previous round he was subject to 33% income tax and a fine equal to his 200% of the total funds raised. An appeal against the decision required a security deposit equal to 20% of the full outstanding amount and several years in court.
The process choked Bubna’s company to death and is now out of business. Not all startups met the same fate.But extending the rule to foreigners, who are believed to make up the majority of these early supporters, could put many more at risk. P.wC., the firm of accountants and consultants says it has been inundated with inquiries from foreign investors. Indian founder says money promised by foreigners has evaporated.
Indian tax authorities are notoriously squeamish. They have been chasing large multinational corporations with retroactive tax bills. A lawsuit involving British telecoms giant Vodafone lasted eight years until a settlement was reached in 2021. This time, India’s business elite are sounding the alarm about the devastating consequences of the new rules for ambitious Indian companies.
The 250-member WhatsApp group Bubna created to draw attention to the issue includes some big names from India. VCs, casts the new rule as an existential threat to Indian innovation. Venture capitalist Sidarth Pai called it a “tax shame” that drives entrepreneurs out of the country. He and others are calling for a budget amendment that normally goes into effect on April 1st. Prime Minister Narendra Modi has hailed India as a ‘startup nation’. He should pass it on to the budget drafters. ■
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https://www.economist.com/business/2023/03/02/foreign-investors-are-being-snagged-by-indias-tax-net Foreign investors are plagued by Indian tax revenue