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Foreign investors are being lured by India’s tax net

smallStart S in IndiaAs elsewhere, there are troubles. venture capital (The venture capital company) Investments fell 80% in January from a year earlier, according to online publication Inc42. Many of the reasons are also familiar: money is no longer free; local banks are paying more on deposits; once-hot business models like food delivery or online learning are not living up to expectations; and plunging valuations are undermining credibility in markets. Now, Indian companies face another particular hurdle.

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A new tax provision in the latest annual budget being debated in parliament expands on a 2013 rule that dealt with most unregistered investments The venture capital company Backers such as wealthy individuals, family offices and other such “angel” investors, receive income as recipients if the attached valuation is “in excess of fair value”. The tax currently applies to funds originating in India.The new version will expand the generosity of any foreign investor, including The venture capital company Companies and pension funds, not registered with Indian securities regulators.

Like many Indian rules, the “angel tax” stems from a scandal. Details are unclear, but a state official in southern India is said to have circumvented tax rules by channeling funds through a shell company and declaring the proceeds as investments rather than taxable income. Taxes are intended to curb such excesses. That’s quite a burden for today’s thin-revenue, high-valuation startups (which is to say most young tech companies). Companies must present sales forecasts to tax authorities, along with costly endorsements from accountants and bankers to raise valuations. In the case of angels, they get harassing calls from the taxman asking where their money came from. Many simply give up.

The experience of entrepreneur Nikunj Bubna from Mumbai is instructive. His software company, Whats Extra India, raised $100,000 in 2011 at a $1.5 million valuation and then $200,000 in 2014 at a $3 million valuation. By 2017, it had a product and customers, but needed new funding. A $500,000 funding round, this time at a valuation of $5 million for Whats Extra, attracted existing investors and some new ones. Afterwards, the tax authority issued a circular calling for a 33% income tax on previous rounds of financing and a penalty equal to 200% of the total funds raised. Appealing the decision requires a deposit equal to 20% of the entire amount owed, plus the number of years in court.

The process killed Mr. Bubner’s company, which is now defunct. Not all startups suffer the same fate: Until recently, very few startups had problems getting early backing. But expanding the rules to foreigners, who are believed to make up the lion’s share of those early supporters, could put many more people at risk. Tushar Sachade’s PwC, a firm of accountants and consultants, said it had received a flood of inquiries from foreign investors. Funds pledged by foreigners have been wiped out, says Indian founder.

Indian tax collectors are notoriously greedy. They go after big multinational corporations with backdated tax bills. A case involving British telecommunications giant Vodafone dragged on for eight years before being settled in 2021. This time, India’s business elite is alarmed by the potentially devastating consequences of ambitious new rules for corporate India.

A WhatsApp group created by Mr Bubna to draw attention to the issue has 250 members, including noblemen from India The venture capital company, seeing the new rules as an existential threat to Indian innovation. Venture capitalist Siddarth Pai called it “a tax of shame” that would drive entrepreneurs abroad. He and others called for revisions to the budget, which usually takes effect April 1. Prime Minister Narendra Modi has fondly referred to India as “startup nation”. He should tell his budget drafters.

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