It is true that Indian startups have come a long way with the help of widespread government initiatives. However, 2016 was a rough year for the startup ecosystem. After so much exuberance, many companies had a tough time getting access to funding and witnessed financial difficulties that threatened their growth, if not survival. Uncertainty in the global environment, such as Brexit and the US elections, put further pressure on the global financial markets, resulting in a decline in the ticket size of the funding amount. Moreover, there was a radical shift in measurement parameters to evaluate the health of startups. It was more towards profitability than growth in size or increase in transactions.
A startup can easily lose track of what it has been set up to achieve in its pursuit to ensure that it is meeting the requisite compliances.
In the current year, we hope that the government will provide a competitive advantage to startups to encourage them to grow further and expand their horizons. The startup culture is quite different in India from the rest of the world; the people here are divided by geographies, religion, language and cultural prejudice. A greater government push is a definite need to build a successful start up ecosystem. Here are a few of my expectations from the coming union budget 2017.
Relax compliance for early stage startups
Compliance means that businesses are run in line with applicable laws and regulations. However, there is a cost and time aspect that comes with compliances. A startup can easily lose track of what it has been set up to achieve in its pursuit to ensure that it is meeting the requisite compliances. Compliances such as the Internal Finance Control (IFC) that requires significant allocation of time and resources should be relaxed for a startup until it reaches a certain size or a certain stage in its life journey.
Last year, the government had announced three-year tax holiday for startups set up between April 2016 and March 2019. We expect the government to provide a real tax incentive to startups by increasing the tax exemption limit from three years to a minimum of seven years in the coming budget. Most startups begin to grow only after the completion of a major milestone in 1000 days, if the tax burden is deferred by four more years, it will be a more effective incentive and create room for further growth.
Also, it would be an apt move on the part of the government if it considers the money received in the earlier rounds (at higher valuation) as profit and tax the startups in case of a down round. This would be uniform with its income tax guidelines that impose an angel tax on issuance of shares in excess of fair market value.
Let ESOP be a perk, not a headache
In most startups, companies give ESOPs (Employee Stock Ownership Plan) to their employees over and above the salary. This comes with a time period in which the given options get converted into shares. These ESOPs are usually given as perks other than salaries, which at the time of selling are taxable.
In line with the government support for the Startup India initiative, it would be a prudent move to make ESOPs tax-free in the hands of employees.
Typically in the initial years of a startup, the first joiners are either drawing less salary and more stocks or are on a complete stock option plan. If the company grows and the employees exercise the option of liquidating their ESOPs, a significant amount goes out of their pocket as taxes. This effectively dampens their watershed moment. An initial joiner in a startup takes a far greater risk and forgoes the kind of salary that they could draw in a matured company. In line with the government support for the Startup India initiative, it would be a prudent move to make ESOPs tax-free in the hands of employees.
Minimum alternative tax exemption (MAT) for startups
Currently, a company, irrespective of its size and turnover, is required to pay MAT based on their registered book profit. Though companies set up between April 2016 and March 2019 can avail tax exemption for three years, they will be liable to pay MAT. Levy of MAT instead of corporate tax for startups is a good move by the government but this can be further incentivised by relaxing the MAT limit. As of now, any startup comes under the MAT regime, which is nearly 20%, as soon as it starts registering book profit. However, book profit does not take into consideration certain deductions and exemptions and it may be different from the net profit of the company. Therefore, we think the government should exempt startups from the MAT minimum for five years.
We think the government should exempt startups from the MAT minimum for five years.
Apart from the above, profit earned by selling the shares of a listed company after a time span of one year is tax-free but this isn't the case with unlisted companies. A similar provision should be there for young entrepreneurial setups and unlisted companies as the risk factor is comparatively high. Moreover, there is tax impact in the first year for bonus share issuance and there exists limitation of minimum par value at ₹1 in the Indian capital market. Many private companies have huge share reserve and will appreciate flexibility around these. Going to the US capital market for listing helps, as it doesn't have any such restrictions. However, there is also ambiguity on whether Indian companies would be able to access foreign capital for the first capital market listing. Industry views are divided on this, and clarity from the government on the same would be welcome.