Successful entrepreneurial ecosystems need a balance of two qualities: individual variables, primarily talent and attitude, and contextual variables, such as the role of government and access to capital. If India has to become the startup capital of the world, it has to stop being its own worst enemy. The government has to clear the way rather than getting in the way. Angel Tax has been a thorn in the flesh for startups in India since its introduction in 2012. While the government has been making modifications in the coverage of this tax over the years, the criteria with regard to exemptions became more complex and confusing.
Many founders have said they have been asked to pay up as much as 30% of their funding as tax. Angels have also received multiple notices asking them to furnish details on their source of income and other financial data. Procuring valuations from merchant bankers is far more expensive for startups than going through chartered accountants.
At long last, the voice of the startup ecosystem was heard by the Finance Minister on 23rd August 2019, when she announced that Angel Tax would not be applicable for startups registered with the DPIIT (Department for Promotion of Industry and Internal Trade).
India has a flourishing startup ecosystem and out of the estimated 50,000 startups, 21,651 are currently registered with DPIIT. The process of registering with DPIIT is online and seamless. With the government already taking measures against angel tax abolishment, this piece looks at the impact of this announcement and suggests further measures towards ease of business.
One fact that has come through over the past seven years is that the harassment by “one or two overzealous officials”, as noted by Minister of Commerce and Industry, Piyush Goyal, has given this tax an unsavoury reputation. The government has also announced that a dedicated cell will be set up at the Central Board of Direct Taxes (CBDT) for startups – this will go a long way in bringing the clarity that investors and startups are seeking. The government is also working on a definition of eligible investors to reduce the scope of further enquiries.
Angel investors are attracted to new innovative ideas with potential, however, they are also looking for ease of exit, as they typically move on after a few years. Here, there are two possible measures that can make it easier for investors to exit when they want.
Under current rules of long term capital gains tax, any gains from unlisted startup investments are taxed at the rate of 20%, while gains from listed equity investments are taxed at 10.0%. Creating a level playing field here, by reducing the tax on gains when exiting a startup investment, will encourage investors to take on the risk in the initial years of the startup.
Another measure that the government can put in place is to set up an investor matching portal on the StartupIndia Hub, that will connect an investor that seeks to exit with an investor who is looking for an attractive project to invest in. Often, an entrepreneur has to spend time and effort in finding a new investor when one wants to leave, and if this is facilitated through the portal, the entrepreneur can concentrate on the core business.
Even as government policy is to encourage startups, the tendency to get bogged down in fine details in compliance hurts the ecosystem. For a startup working from a home office or shared space, within its first year, it needs to obtain registrations under at least seven regulators and file a minimum of 18 returns to a maximum of 69 returns. It is not enough to get an idea that has the potential to scale – a young entrepreneur has to then convince investors and then work hard towards achieving the dream.
While framing policy and compliance in India, the government should keep in mind that this segment is particularly sensitive to regulatory uncertainty, lack of clarity and frequent changes. More moves towards ease of doing business will unleash innovation from young entrepreneurs.
At last, “A young entrepreneur has an idea to change the world. An angel funds the idea. The idea becomes real. Investors fuel the growth further. Growth leads to big exits. Exits invite more entrepreneurs to the party”. This is the story of Silicon Valley. When passion is fueled by capital, innovation happens.