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Foreign investors suffer from the Indian tax net

sTartop in India, as elsewhere, in trouble. venture capital (VCInvestments in January were down 80%, year over year, according to Inc42, an online publication. Many of the reasons are also familiar: the money is no longer free; local banks pay more on deposits; Once popular business models such as food delivery or online learning have not lived up to expectations; Deteriorating valuations undermine market credibility. Indian companies now face another hurdle of their own.

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A new tax provision buried in the most recent annual budget, which is being debated in parliament, expands a rule from 2013 that treats most investments from unregistered VC Backers, such as wealthy individuals, family offices, and other “angel” investors, like the recipient’s income if the accompanying valuation “exceeds fair value.” The tax currently applies to funds received from Indian sources. The new version will extend to the generosity of any foreign investor incl VC Corporations and Pension Funds, not registered with the Securities Regulator of India.

As with many Indian rules, the “owner tax” was born out of scandal. Details are sketchy, but a South Indian government official allegedly circumvented tax rules by funneling money through a shell company and declaring the proceeds to be investments rather than taxable income. The levy was an attempt to curb such excesses. For startups with scant revenue today and high valuations built on hopeful future earnings — that is, most young tech companies — that’s a huge burden. Companies must show tax authorities sales projections, along with confirmations charged with fund-raising assessments from accountants and bankers. The Angels, for their part, are getting intrusive calls from the tax officer about where their money comes from. Many simply give up.

The experience of Nikong Bupna, an entrepreneur from Mumbai, is instructive. His software company, Whats Extra India, collected $100,000 in 2011 at a valuation of $1.5 million, and then $200,000 in 2014 at a valuation of $3 million. By 2017, it had products and customers but needed new capital. A $500,000 fundraising round, this time Whats Extra at $5 million, attracted existing investors and some new ones. Then a notice arrived from the IRS subjecting the previous rounds to an income tax of 33% and penalties equal to 200% of the total money collected. An appeal against the decision required a deposit of up to 20% of the full amount owed, plus years in court.

This operation strangled Mr. Bubna’s company, which is now defunct. Not all startups shared the fate: until recently, few had problems securing early support. But expanding the rules to foreigners, who are thought to make up the lion’s share of those early backers, could put many at risk. Tushar Sachadi swcHe was inundated with inquiries from foreign investors, says the firm of accountants and consultants. Indian founders say the money pledged by foreigners has evaporated.

India’s tax men are known to stick around. They chased the big multinational corporations with retroactive tax bills. A case involving Vodafone, the British telecoms giant, dragged on for eight years before it was settled in 2021. This time India’s business elite are alarmed by the potentially devastating consequences of the new rules for ambitious Indian companies.

A WhatsApp group set up by Mr Bubna to draw attention to the problem, which has 250 senior Indian members as members. VC, casts the New Rules as an existential threat to Indian innovation. It was described by Siddarth Pai, a venture capitalist, as a “shame on the taxes” that would drive entrepreneurs abroad. He and others are calling for an amendment to the budget, which usually goes into effect on April 1. The Prime Minister, Narendra Modi, speaks fondly of India as an “emerging country”. That should say that to budget makers.

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