Repeal Angel Tax & Set Up INR 50K Cr Startup Fund: Mohandas Pai Urges Modi 3.0 Govt

With the BJP-led National Democratic Alliance securing 290 out of 543 seats in the general election, Prime Minister Narendra Modi is poised to be sworn in for his third term. 

However, this time, the PM won’t command the same majority as before, with the ruling BJP winning 240 seats and its alliance partners securing 50 seats, unlike the previous election where they surpassed 350 seats.

The BJP’s victory for the third consecutive term has raised optimism among certain Indian startups and VCs. And there are reasons for that. Over the past decade, the number of startups has surged from a few hundred in 2014 to 1.38 lakh currently, plus the previous two Modi-led governments were seen as being bullish on Indian startups through policy as well. 

The introduction of the Startup India initiative in 2015 was a significant stride towards promoting entrepreneurship, offering policy support and encouragement. Measures like self-certification for startups under labour and environmental laws aimed to reduce compliance burdens. 

The establishment of the Fund of Funds for Startups scheme, managed by SIDBI, has facilitated funding, complemented by regulatory reforms that have simplified business processes, with over 50 implemented since 2016.

Notably, concerted efforts have been made to promote female entrepreneurship, including earmarking funds for women-led startups. Additionally, the government’s establishment of over 10,000 Atal Tinkering Labs in schools fosters innovation among students, underscoring its commitment to nurturing a dynamic startup ecosystem in India.

However, expectations are higher this time. Speaking to Inc42, T.V. Mohandas Pai, the former CFO of Infosys and partner at Aarin Capital, emphasised the need for funding support. He stated, “We must establish a INR 50,000 Cr fund through various entities in the next five years. With the economy at $3.6 Tn this year, we’re lagging behind in AI and other frontier technologies due to inadequate investment.”

Repeal Angel Tax

Angel tax continues to harass startups, and stakeholders across the ecosystem and Pai stressed that angel tax must be abolished. “The opposition included its removal in their manifesto, despite being the ones to introduce it. The Modi government should repeal the law to eliminate angel tax.”

Angel tax pertains to the taxation of capital raised by unlisted companies through the issuance of shares, where the share price surpasses the fair market value of the shares. The excess amount is considered as income and taxed at the startup’s hands, as per Section 56(2)(viib) of the Income Tax Act, 1961.

Initially introduced to combat money laundering via the issuance of shares at a premium substantially higher than their fair market value, angel tax has often impacted genuine startups, raising concerns within the entrepreneurial ecosystem.

In response, the Indian government has taken measures to alleviate the burden of angel tax on startups, including providing exemptions for eligible startups meeting specific criteria. However, this has resulted in creating numerous restrictions for startups, as evidenced by the fact that out of 1,14,902 startups registered with the Department for Promotion of Industry and Internal Trade, only 10,939 have applied for exemption from angel tax thus far.

“And they must, once again, resolve all disputes promptly and refrain from harassing people with unnecessary complications. Furthermore, suppose income tax officers lose a case in the high court. In that case, they should be penalised because only a certain group of people are deliberately causing such issues for reasons known to them,” Pai added.

Create INR 50K Cr Fund To Address The Capital Issue

During its first term in 2016, the Modi government launched the Fund of Funds for Startups (FFS). Through this scheme, the government has facilitated investments worth INR 17,354 crore in 928 Indian startups as of December 18, 2023.

Pai believes that since the startup fund is either exhausted or nearing exhaustion, the government should initiate another fund because startup funding remains insufficient. 

“For instance, deeptech and startups that have high gestation models don’t receive adequate funding. Once you establish a foundation, attention must be directed towards areas like deeptech and frontier technologies, which have not been adequately supported.”

Highlighting that over INR 8 Lakh Cr worth of subsidies are provided to farmers and others, Pai questioned, “Why not allocate additional funds to startups, which represent the next generation and create significant employment opportunities?

Additionally, he bemoaned the lack of participation by insurance companies in the investment pool for the startup ecosystem. “Globally, insurance companies are the largest investors, but in India, despite having a balance sheet of 65 lakh crores, they have invested minimally in startups. They should have invested, as it makes sense in the long term through funds of funds. However, this significant source of capital remains untapped,” the Aarin Capital partner remarked.

He believes that one of the priorities for the new government in the next five years should be to establish an INR 50,000 Cr fund through various entities. Despite the measurable progress in GDP, sectors such as AI and new emerging technologies are lagging behind in India due to inadequate investments.

Ease Of Doing Business: Address The Regulatory Cracks

While the Modi government deserves credit for introducing a fast-track tax dispute resolution mechanism, self-certification for startups under labour and environmental laws to reduce compliance burden, and tax incentives for startups, including a three-year income tax exemption, there is much more to be done, and some steps have even been taken in the reverse, believes Pai.

Pai criticised the government for making taxation laws complex. “I believe in the last 10 years, more controls have been implemented to grant more power to the taxman than in the previous 10 years. Although refunds and assessments have been expedited for the vast majority of people in the last three years, which is commendable, disputes have not decreased.” 

He pointed out that despite more refunds being issued last year, disputes have not decreased and that in fact, the amount involved in disputes has increased. This indicates that the dispute resolution process has been unsuccessful, which eventually hurts the ease of doing business, just as angel tax.

Additionally, Pai highlighted some RBI restrictions for startups that could have an adverse effect on investments in fintech startups. “Despite having $650 Bn in FDI equity inflow, there are too many restrictions and excessive documentation, which has resulted in a decline in FDI. Even though many big startups are returning to India today, they had previously left to establish domiciles outside. 

Now they are returning because they believe listing in India will provide them with better value. This decision is purely driven by self-interest, which is positive because India is an attractive market. However, the government could have done more for startups to foster a more positive environment, which they have not done.”

Pointing out the unnecessary requirements of three separate valuation reports, Pai said. “When two parties engage in a transaction, they determine the premium and provide a valuation report. However, remitting money takes longer because banks often misplace documents. The process should mirror that of the public market. It’s commendable that shares have been dematerialised, which allows for better tracking of investments in startups and funds. Therefore, it is essential to implement these measures. The IBC has prepared a document that I believe the government should follow.”

Reflecting on the achievements of the past 10 years, Pai asserted that the Modi government has made significant strides for startups by envisioning initiatives like Startup India and Stand-up India.

Moreover, the government has successfully propelled a digital revolution by establishing digital public infrastructure (DPI), which has been highly beneficial for startups.