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Will India’s SaaS Startups With Flipped Structure Fall Under Tax Net Soon?

Will India’s SaaS Startups With Flipped Structure Fall Under Tax Net Soon?

The tax department could delve deeper into the shareholding patterns, the corporate structures of Indian startups with holding companies overseas

Several SaaS and other enterprise tech startups have flipped their structure to set up holding companies in the US primarily

While the flipping is said to save time on paperwork and regulatory procedures, experts believe the primary factor is attracting funds from global investors

India’s SaaS giants and enterprise tech startups setting up shop in the US could soon find themselves tangled in a regulatory web as the Indian government is looking to widen its taxation net to target flipped-structure companies.

While no official comment has come in this regard, an ET report quotes two unnamed revenue department officials who believe that India is losing out on the intellectual property (IP) value as well as tax revenue. The tax department would likely delve deeper into the shareholding patterns, the corporate structures as well as the merit of the foreign holding companies for the Indian startup.

Essentially, many SaaS and other enterprise tech startups have flipped their structure to set up holding companies in the US primarily and in some cases, other countries such as Singapore or Mauritius. The flipping in this case refers to setting up a company in the US with the same shareholding pattern as in India, which then raises funding and owns most of the IP, essentially making the Indian business a subsidiary of the US-registered company. The flipping is typically done at an early stage of the startup, since mirroring the shareholding pattern is easier in these cases.

The central issue here is that global private equity (PE) and venture capital investors prefer to invest in companies that have an Indian subsidiary and a holding company in Singapore, Mauritius, US and other favourable geographies. This not only is beneficial for the investor from a taxation point of view, given India’s tightly-regulated regime, but is often tied into the company’s goal of expanding to the US as well, as is the case with many SaaS startups that consider the US their primary market.

The Y Combinator And Flipped Structure Saga

In late 2020, some controversy did erupt on social media about Y Combinator required the Indian startups selected in its 2019 and 2020 batches to shift their headquarters to the US, but the famed accelerator-incubator clarified that this was not a mandate as some companies in these batches could not be registered in the US.

Sanjeev Bikhchandani, executive vice chairman of the digital behemoth Info Edge, which owns and operates Naukri, Jeevansaathi, Shiksha and 99acres (the holding company is currently listed on the New York Stock Exchange), told Inc42 in December 2020 that investors are swaying Indian startups with their promises of large investments and big valuations. He also pointed to the exploitation of Indian intellectual property (IP), where investors gain from the IPs developed by Indian founders and engineers.

“So you have a bunch of foreign investors who tell our best young startups that they will invest in their companies provided they shift their company domicile overseas. The reason being that they do not want to be subject to Indian laws, taxes and government rules except to the minimum extent required (because) they say they do not trust the Indian government and the legal system. So the ownership of the startup, the intellectual property (IP) and data all shift overseas. However, other operations continue as before; they build their products in India as before using Indian manpower; they sell to customers in India as before,” Bikhchandani told us in an emailed response.

Others believe India’s incorporation and taxation laws have not been exactly friendly to startup investors and founders, especially to those in the early-stage ecosystem. When the coronavirus pandemic hit India in March this year, the “angel tax, which is levied on non-listed companies (such as startups), was brought back.

Other experts believe that the track record of India’s IT and BPO companies has also proven that registering in the US might deliver large gains — from a revenue and customer standpoint. Shantanu Surpure, a partner at California-based law firm Inventus Law, who has over two decades of experience in cross-border deals, told us that more than 100 technology startups and companies from India ‘chose’ to register in the US, Singapore and other foreign geographies, just in the last decade. The primary factor is attracting funds from global investors.

“Even if you go way back to the early 2000s during the early software era in India, one of the biggest exits at that time was Genpact, which was a BPO company which was listed on NYSE in 2007 and that company was incorporated in Bermuda. India tech and software companies have been doing this global restructuring for a long time, especially in the last 15-20 years,” Surpure told us in an earlier interaction.