Indian government has asked S. Ramadorai, ex-CEO of TCS to advise the government on startup tax bill. S Ramadorai currently serves as an advisor to the Prime Minister of India in the National Council on Skill Development, Government of India. He holds a rank equivalent to an Indian Cabinet Minister.
More from ET: FinMin says New Safeguards For Angel Investors
The finance ministry has said it could bring in more safeguards in the income-tax law to ensure that genuine angel investors are not impacted by a budget proposal to tax exorbitant profits by venture capital funds, but effectively ruled out a rollback.
The use-case that the government is looking to plug is where a large sum of money comes in from an Indian resident into a company, which classifies it as “share premium”. This money has no service tax, and the company pays no income tax on it. The “investor” may get a few shares at a very high rate (say Rs. 1 crore per share). The company gets to use that money for regular expenses, and never pays any tax.
How would the government differentiate that situation from, say, a situation where an angel or seed level investor buys into a startup, and pays a premium because the founders bring in knowledge or experience or connections or passion?
It’s going to be tricky but I imagine what will eventually happen : The tax department will only demand an explanation for investment above, say, Rs. 3 crores per year.
What do you think?
The current workarounds for angel investors are:
a) Go abroad. The tax rule applies only to investments from Indian residents.
b) Use convertible debt, where the investor doesn’t buy equity shares but uses some sort of convertible instrument issued at par, where the convertible ratio may be either deferred (decided later) or pre-decided.
c) Invest in your stake at par, provide the rest of the money as a loan. This has structural issues with new investors coming in, for legit startups.
d) Create the startup as an LLP instead. This has no concept of “shares”.
The tax-evaders can use these routes as well, remember. It’s going to be very difficult to design a system that keeps out only wrong-doers but allows the large majority of valid investments.