Heavy Taxes And Red Tape: RBI’s MSME Committee Takes A Hard Look At Why Indian Startups Migrate

An expert committee on Micro, Small and Medium Enterprises (MSMEs) set up by the Reserve Bank Of India, has shared ways to promote entrepreneurship and enable startup environment in India. The central bank will form an Expert Committee on MSMEs under the chairmanship of former SEBI chairman, U K Sinha. The MSME committee, which had eight other specialist members, the report on June 19.

The MSME committee also deliberated on all the aspects relating to startups in India. It was noted that in recent years many Indian startups, which were well-funded and primarily operated in India, have chosen to relocate. The major reason for the migration of startups to other countries is because of the better environment and enablers such as tax concessions, well-developed infrastructure, ease of doing business, exit policy, etc.

“Hence, the committee is of the view that financial incentives and excellent infrastructure facilities must be deployed to retain successful Indian startups and to lure the best talent from across the world to start businesses in India,” the report said.

Key Reasons For Startup Migration

India is today home to more than 49K startups (Datalabs by Inc42 estimates). However, the ecosystem is still facing challenges due to physical infrastructure bottlenecks, absence of formalisation, technology adoption, capacity building, backward and forward linkages, lack of access to credit, risk capital, the perennial problem of delayed payments, etc.

Although India has pushed its ease of doing business ranking to 77 from 100, it still lags behind in comparison to countries like China, Vietnam, Singapore among others.

Further, the MSME committee noted that one of the biggest concern for investors wanting to invest in Indian companies has been the tax liability. For instance, Singapore have 0% capital gains taxes which incentivises flow of capital. Also, these investors are likely to plough back the profits from startup entities into new startups thereby, creating a virtuous cycle of investment. Higher tax rate for investors in India is hindering investment in startups.

Not only this, the maturing startups that have achieved or are on the precipice of achieving profitability are eyeing lower corporate taxes. Countries such as Singapore are offering a simplified tax regime which charges 17% from corporates, compared to the global average of approximately 22% (in 2015). India charges a corporate tax of 30% on domestic companies if taxable income exceeds INR 1 Cr.

Startups which have not yet reached this level are still liable to pay the Minimum Alternate Tax (MAT) at 18.5%. Though the MAT credit has been extended to 15 years it has not been eliminated completely.

“Therefore, the successful companies not only move their headquarters away from India but also take with them the Intellectual Property (IPs), and the proceeds from any possible Initial Public Offerings. Furthermore, it’s a double whammy for India because most retail Indian investors would not be able to participate in such companies’ IPOs if they list on foreign exchanges such as NASDAQ,” the report added.

The MSME committee also noted that capacity building of the entrepreneurs is an essential pre-requisite for the development of the sector as it equips the entrepreneurs with the necessary knowledge and wherewithal to function.

Key Suggestions For Developing The Startup Environment

• Proposed to establish Enterprise Development Centres (EDCs) within District Industries Centres (DICs) in each district
• Equip EDCs and DICs to assist rural enterprises in respect of GST, IT, UAM registration, PAN application, loan document preparation, etc.
• Financial incentives and excellent infrastructure facilities must be deployed to retain successful Indian startups and invite foreign talent
• Reforms on the supply side need to augment the delivery capacity of Government agencies and be more responsive and tailored to the demands of MSMEs
• SEBI must relax the norms defining the Accredited Investors (AIs) who could participate, as part of the proposed  Innovators Growth Platform (IGP)
• To create enough liquidity, the participation of HNIs, Mutual Funds, FIIs, etc. must be encouraged.
• Most technology startups or high-growth startups are often loss-making hence there should be no profitability requirement to list.
• SEBI should facilitate dual-class share structure which is very popular with tech startups across the world.
• Standards for the internal governance of MSMEs may be developed that can help MSMEs identify current gaps and areas of improvement.

Video KYC Should Be The New Norm

The MSME Committee report further suggested a nine step process to adopt video KYC as a part of digital financial architecture as a suitable alternative to performing a digital Aadhaar-based KYC process towards enabling non – physical customer onboarding.

Here,

• Valid documentation as per extant requirements is identified and verified by an employee of the entity;
• PAN number from document is validated against the NSDL database
• Face match is done between OVD (Official Valid Document) provided and the customer image taken as a part of the process, hence validating the document holder is indeed the applicant.
• Face match is validated by the employee
• Customer, through the mobile app/website, provides confirmation on proceeding with the transaction after verification through an OTP based verification process.

The MSME committee further suggested that PAN system should serve as the Universal Enterprise ID and there must be introduction of e-PAN, PAN authentication and e-KYC APIs, institutional structure, law, etc.