Anomalies that need to be resolved in the start-up regulations of India

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  • The government taxes the capital gains of unlisted companies at 20%, while the same is taxed at 10% for listed companies.
  • Even though the Indian government introduced the Angel Tax exemption nearly three years ago, conditions continue to be tough.
  • Meanwhile, an angel investor needs a net worth of at least ₹ 2 crore before they can start investing formally.

Investors like Tiger Global, Accel, and SoftBank have turned a startup into a billion dollar business with an average of one every eight days in 2021. Insiders say the new year could see far more money than the $ 42 billion. collected by Indian startups last year, if the government resolved some of the anomalies in taxation, processes and regulations.

A unicorn, in startup parlance, is a more than one billion dollar veiled company. And there were 44 in 2021, bringing the total to 81.

Anomalies that need to be resolved in the start-up regulations of India
BI India

Tight regulation on similar segments in China helped Indian startup valuations last year. However, India still has a long way to go before its startups and venture capital ecosystem can scale to China’s level. And this is where changing rules and regulations can help.

Prime Minister Narendra Modi will interact with 150 startups across multiple domains – agriculture, health, business, space and more – today (Jan.15) at 10:30 am.

Ahead of the upcoming 2022 budget on February 1, Business Insider spoke with a group of industry participants to understand what solutions they would like to see sooner or later. These are the best takeaways.

“Investors cannot be taxed more if they take greater risks”

The government taxes the capital gains of unlisted companies at 20%, while the same is taxed at 10% for listed companies. This is too high, says Dexter Capital’s Devender Agrawal.

The disparity in capital gains tax between listed and unlisted investments has pushed more angelic investors and early stage investors into the shell.

Sadly, Indian startups, or rather the investing community, have remembered this for the past couple of years, but no action has been taken so far. TV Mohandas Pai, along with some startup entrepreneurs, raised the issue before Finance Minister Niramala Sitharaman two years ago.

“Investments in unlisted companies involve greater risk due to a lack of liquidity and a lack of adequate price discovery. Investors can’t be taxed more for taking higher risk, ”Pai said of The Economic Times in 2019.

Despite Sitharaman’s assurance, there have been no updates on this so far.

To get away with Angel Tax, you have to give up a lot

Angel tax is an income tax levied on funds raised by a company from wealthy people called “Angels”. The 30% tax is imposed on the premium paid for the shares of the unlisted company beyond the fair market value (FMV).

In 2019, the Indian government decided to offer Angel Tax exemption to companies provided they meet certain criteria. But that’s not an easy set of requirements. They define everything from how the startup is valued to how the funds are used, and both founders and investors hope some of them are relaxed.

Condition for requesting exemption from the Angel tax

Restrictions / Conditions Timeline Request
Startups cannot invest in land or buildings, stocks and shares, capital of other entities, modes of transport exceeding ₹ 10 lakh. Seven years from the last fiscal year No limited end use for resources
No loans or advances should be granted, unless the loan is in the normal course of business (includes salary advances to employees) Seven years from the last fiscal year The loan could be an option.
The paid-up capital must not exceed ₹ 25 crore Up to 10 years from the year of incorporation. The monetary limit could be extended to ₹ 50 crore or ₹ 75 crore
Initial valuation is determined by the net asset value (NAV) method, which is the subsequent value of an entity. N / A The valuation should be determined from future profits using the Discounted Cash Flow (DCF) method.

Over 3,600 startups were considered eligible for the exemption between August 27, 2019 and February 3, 2021. This would be a small fraction of the estimated 60,000 startups in the country.

The restriction on the distribution of funds is not intended only for funds raised by Angel investors, but for capital subsequently raised by venture capitalists or venture capital funds. Failure to comply with these restrictions would result in a 200% penalty on this amount.

“While the government’s intent to prevent misuse and abuse of the provisions is understandable, loosening certain conditions and shortening the timeline would go a long way in ensuring that real start-ups are not affected by the regulations.” , Divakar Vijayasarathy of DVS Advisors LLP states.

A little leniency can produce more “angels”

If there is one thing that is common in the issues raised above, it is the involvement of angelic investors. Until a year ago, very limited people were willing to risk their personal assets to be part of a startup that could “hide it or break it”.

The number of angel investors in India has grown tenfold thanks to 2021 and the boom in startups.
But there are others who would be willing to join the bandwagon and ignoring them wouldn’t be a great idea, believes We Founder Circles’ Gaurav VK Singhvi.

However, SEBI may get a little too picky with its angelic investors. An Angel investor must have a net tangible asset of at least ₹ 2 crore, not including the value of their primary residence. Early stage investment experience, serial entrepreneurship, and 10 years of work experience as a senior executive can also come in handy.

The aforementioned investor, in the event that he invests through an angel fund, must pledge ₹ 25 lakh rupees over a period of three years.

“Now if I [angel investor] wants to invest in four startups from four different funds [Angel Funds], I have to pledge ₹ 25 lakh for each of these funds. I have to commit ₹ 1 crore to four startups, while I will only invest ₹ 3-5 lakh in each startup. This interchangeability is necessary, “Singhvi added.

Requirements Request Why change is needed
Minimum net worth of ₹ 2 crore Net equity reduction The young professional who works will not be able to meet this requirement
It is necessary to pledge ₹ 25 lakh in an angel fund The pledge should be reduced to ₹ 10 lakh and you should be able to pledge this amount through angel funds instead of focusing on one Investing ₹ 25 lakh is capital intensive and becomes a problem if you have to commit at least ₹ 25 lakh more funds to get the deals of your choice.

“India has become the third largest ecosystem for startups and will be a key segment in making India a $ 3 trillion economy. With a huge amount of capital flowing into Indian startups, the government needs to focus. on greater ease of business, for both investors and startups, “says Blacksoil’s Ankur Bansal.

The Indian startup ecosystem has finally come of age and will no longer have a passing mention in India’s union budget, Anil Joshi of early stage investment firm Unicorn India Ventures told Business Insider.

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