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Rajat Tandon

Rajat Tandon is the President of IVCA.

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Are Taxes Being Fair Enough for the Indian Startups & Investors?

The tax authorities must consider that calculation of a book value and cash flow statements are just misleading “versions of the truth” that are available at all times.

The startup ecosystem needs greater liquidity to pay taxes and fair valuation benefits. The Indian government desires to address various tax and legislative issues which the start-ups are facing at the current moment. The startup community is hoping that the tax authorities will adhere to their concerns and offer relevant concessions and incentives in the budget 2017. The Indian startups find the tax regime standardization and cumbersome. They long for legitimate concessions so as to remove big deterrent to investments.

Moving forward to Section 52(2) (vii)(b) which was initially introduced to prevent startup tax abuse. It is perceived that the money was routed into companies at an exaggerated valuation as the means to compensate the existing investors for benefits that they had extended to the investors. In many cases, the valuation of start-ups exceeds the market value on the basis of the idea and not that of its immediate worth. In such instances the startup face immense loses which further makes them loose chunks of capital inflows, to some extent hampering their profitability and expansion goal plans. The startup community is at a standstill in dealing with such complex tax reforms. These rigid tax impositions raise challenge in the optimum functioning of the professional investors. Investing is a willing buyer – willing seller process, where the investor will entrust what he considers to be the fair value along with being provided with justifiable future value assessments and ROI.

The tax authorities must consider that calculation of a book value and cash flow statements are just misleading “versions of the truth” that are available at all times. Their judgment must go beyond this rational specifically while referring to startups which are at their nascent stages of development and start-up with zero or low-revenues. Startup that have received the tax demand will have to pay up to 33% tax on premium under the Section 56(2)(vii)(b) of the Income-tax Act . This is the never ending problematic issue associated with the fair market value system introduced by the government. The SEBI’s AIPAC has come forth with suitable recommendations expressed at DIPP (Department of Industrial Policy and Promotion) that should exempt all AIF’s and their investee companies from the tenacity of Section 56(2)(vii)(a) and 56(2)(vii)(b). AIFs, being institutional investors, hold a fiduciary responsibility to invest in transactions on an arm’s length basis and face investor reporting obligations and are subjected to supervision of SEBI. It is justifiable to assume that the price of acquisition is determined on a reasonable basis taking in account all the factors of Investee Company, sectors past performance and future potential. In this way the transactions undergone by the AIF’s can be assumed to be in conformity with FMV principles. There must be ease of doing business for the start-up with initiatives such as Bharat Navodya.

The intervention of the tax authority in assessing and passing judgments whether this can be stated as a fair value or not is a complete irresoluteness, and this only acts as a constraint to the accredited and forthcoming investments, principally start-ups which are widely recognized to be “star-value” promoters where the anticipated value and actual current values are dramatically distinct. For instance this trend can be seen in investments in companies like, Flipkart, Snapdeal, Ola, Paytm who talk about hurdles and regulatory adversities for Indian companies to raise capital and unfair playing field for Indian start-up. Although the government has recently introduced start-up exemptions and regulations giving protection against 56(2b) f registered start-ups and certain SEBI recognized Category 1 AIFs, start-up complain that this move has not appropriately triggered the entrepreneurship spirit and has a counter effect on start-up ecosystem.

Start-ups at this point facing tax issues is either opting for registration with DIPP process which is simple and easy. The start-up getting tax exemptions are the ones which fall under the limited revenue framework along with the condition of being in the first five years of their inception or convinced of funds from Category 1 AIFs (Venture Capital funds) of their potential worth. The start-up not falling under these categories and their valuation in excess of the mechanicals MPVs / Book value calculation (is more likely in this case) are facing the threats to pay comply with set tax rates on the excess value. Setting off of the accumulated tax losses could lead to tax demand on perceived overvaluation in many cases and there is a danger of being punished for undisclosed income.

These stringent laws need to be waived off the books ideally. The government should scrutinize the current data information of the tax department, compelling tax authorities to select cases based upon views, facts, identifying the motives of the potential investors who have cleared egregious excess valuation and investigate their sources of income, and any unlawful motives for such valuation. Due to detection of fraudulent transactions in the past the tax authorities are harming the licit start-up which is facing severe unintended consequences on legally approved investments and start-up investing community. The investors are sceptical to invest, in this way entrepreneurs will not boom in the Indian economy and these small enterprises will never get the opportunity to become large enterprises.

There must be relaxations in tax policies and exemption of start-up from rigorous provisions. They should be able to issue shares to investors at prices higher than fair value without the burden of taxes. The tax department should annul the taxes on start-up whose valuations have collapsed due to exceeding firm’s fair value and simplify the value rules and regulations. The government must realize that start-up need a healthy atmosphere to flourish with stability and certainty in tax policy and must stop wrongly aiming at genuinely launched start-up . It is expected that start-up are likely to get tax benefits in Union Budget 2017, start-up are hoping that the budget will address major issues and offer tax concessions to improve the ease of doing business, encourage start-up participation in government purchases.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house

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