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Startups meet the taxman

Startups are the new epicenter of economic activity in the country, but the tax-man is far from friendly towards them. For a 100 of them have registered in Hong Kong, Singapore and the US to raise capital. Top sources in North Block, which houses the finance ministry, say consultations have begun over incentives to startups in the form of tax sops to angel investors. The Revenue Department is working towards these making such incentives real. At the Center of this is the capital gains tax, levied on investors; and the tax on employee stock options (ESOPs), where a tax is levied on the income of the employee even before the company – that’s allotted those shares – has generated any revenue or has raised capital.

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Startups are the new epicenter of economic activity in the country, but the tax-man is far from friendly towards them. For a 100 of them have registered in Hong Kong, Singapore and the US to raise capital.

Top sources in North Block, which houses the finance ministry, say consultations have begun over incentives to startups in the form of tax sops to angel investors. The Revenue Department is working towards these making such incentives real. At the Center of this is the capital gains tax, levied on investors; and the tax on employee stock options (ESOPs), where a tax is levied on the income of the employee even before the company – that’s allotted those shares – has generated any revenue or has raised capital.

The capital gains tax, in startup-friendly countries, is less than 10 per cent. Compare this with India — it is as high as 23 percent, making it a most unfavorable investment destination for startups. But with over $6 billion expected to be pumped in to Indian startups in 2015, the central government is serious in promoting this industry because will be the primary job creators for the next decade.

The government has already mooted new listing norms and a concrete plan is to be released by December on the fundamentals for a startup course. The white paper on listing, which is with the SEBI, will allow startups to list even if they are not making profits. It has capped the minimum investment for retail investors at Rs 10 lakh. Here a steady tax or a minimum tax on capital gains – upon exiting the listing startup – is what investors are expecting to make this a viable investment class. Remember startups do not make net profits because the investment goes in the building a viable product which will be accepted over five years.

It might be recalled here that the BSE has formed an Advisory Group for Development of BSE Hi-Tech (Institutional Trading Platform) for start-ups. This group comprises of experts from the start-up ecosystem, investors, merchant bankers and legal professionals who will advise the exchange on the newly proposed framework on BSE Hi-Tech, which will be based on the new Institutional Trading Platform regulations announced by SEBI in August 2015.

The other problem is the tax on ESOPs. “This sector is already showing potential to create jobs. And that is why we are looking at ways to provide an enabling environment to them” says a top official in the Finance Ministry.

Just two months away from Arun Jaitley’s next budget, various departments within Finance Ministry have already begun the spade work for it. Sources in the Revenue Department say that they are well aware of the demands from startups and are looking at ways to address them. “We are already weighing option of tax breaks on ESOPs,” says a top source in North Block. ESOPs are often offered by startup founders, to their employees, because they cannot afford high salaries to retain talent. But when the shares are allotted they are taxed as salary, which becomes a big disincentive for an employee with ESOPs.

“Presently, an employee pays a flat 30 percent tax on allotment of ESOPs,” explains the official and he says that consultations were on to reduce the tax rate.

The other big concern of investors, putting their money in startups, is the 3-year lock-in period on capital gains tax. Withdrawing the investment before the end of the lock-in period attracts capital gains tax. “We know that there are concerns about this lock-in period,” says the source in the revenue department. The source adds that they realize the frustrations of investors because of this lock-in period. “We are evaluating the concern and looking for solutions,” he says. Modi Government’s big promise to usher in “ache din” or good days hinges upon job creation; a recent Nasscom report shows that the startup community in India has created 80,000 jobs.

“Startups are going to generate at least 5 million jobs. The listing norms will also allow high net worth individuals, in India, to take to investing in startups seriously,” says Mohandas Pai, founder of Aarin Capital. He adds that the problem however is that either it has to set a new benchmark for global investments in India. “It cannot be an half hearted attempt to create a platform,” says Pai. He adds that the government should address tax implications, protect investors – both retail and venture capital funds – and also help these startup ideas grow with capital.



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