[Budget 2017] Save us from taxes – Indian venture capital investors tell Union Finance Minister Arun Jaitley

It’s that time of the year again when all eyes, at least in the world of business, are on the Union Finance Minister as the Budget presentation is just a day away. Everyone has their laundry list of demands and so do Indian venture capital investors.

With Indian startups dominating the news cycle all of last year, it is quite understandable that everyone in the community is hoping for some major announcements that will make the lives of startup entrepreneurs and investors a little bit easier. Indian tech startups have absorbed about $22 billion in risk capital since 2010, according to YourStory Research. This capital has been critical in making India an innovation hub and one of the leading startup ecosystems globally. However, the governments over the years cannot really take credit for this. In fact, many would argue that Indian startups have thrived despite the government.

There is, however, a consensus that with the right government support entrepreneurs can achieve much more.

Put taxing times behind

The biggest issue that investors are highlighting is ‘tax’. Angel tax has been a major issue for investors and entrepreneurs. The Income Tax department has ordered about 100 startups to pay tax on their lowered valuations.

“The tax was introduced by the previous government to tax investment above fair market value. This was to discourage illicit transactions. Startups were collateral damage. In early stage companies, it is the entrepreneur and investor who decide fair value. Sometimes angel investors invest in an idea that is just on a piece of paper. So every investment could be above fair market value. The entrepreneur will pay the price. He will have to dilute more, to get more investment so he can pay the tax,” says Saurabh Srivastava, Co-founder of Indian Angel Network (IAN).

This issue has come to the fore now as the IT department has now begun to take action. Until now, most investors and entrepreneurs thought action will not be taken. Saurabh says:

Say 40 angels have come together to make the investment with each investing a few lakhs of rupees. Now the tax department is asking for details of all these investors. The angels are saying why go to all this trouble, we will not invest. If this issue is not solved, angel investing could just disappear."

Now angel investor networks and others have asked the government to create an exemption for angel networks.

Another major issue is capital gains tax. “Tax on long-term gains from private investments and public market should be brought at par. Today, the tax is 20 percent on private side but zero percent on public market investments. This will help divert local capital towards startups,” says Rahul Chowdhri, Partner at Stellaris Venture Partners.

Saurabh says taxing Esops also creates problems. He says Esops should not be taxed when they are vested; the tax should be applied only at the time of exit. “If I exercise it (stock options) only when the company is being sold, then I pay 33 percent capital gains tax. It is a catch-22 situation. If a Flipkart employee had exercised stock at $15 billion valuation and, say, the company gets sold at $ 5 billion, then the employee is being taxed for value that he has not seen,” he says.

Encourage Indian investors

Sudhir Sethi, Founder Chairman and Managing Director of early-stage fund IDG Ventures India, says that Rupee funds registered as Alternative Investment Funds (AIF) should be given a boost. Over 95 percent of VC and PE investments in India, says Sudhir, is done by international funds. Indian funds, he adds, should account for 30 percent of investments in the next five years. “Indian Institutions like banks, insurance companies, and family offices must be encouraged as investors in Indian Rupee AIF Funds. For banks who invest in VC Funds, the excessive provisioning clause must be removed,” says Sudhir. He says globally family offices invest up to 15 percent of their wealth into alternate assets, while in India this figure is around one percent or lower. “We need to provide tax breaks to get family offices to invest.”

Rahul of Stellaris says VC funds that raise money from the government should be allowed to invest in companies based on fund mandate versus restricting it to startups as defined by the government. “Further, there is restriction on how much capital can be budgeted for follow-on and time period by which this investment needs to be committed. This should rather be left at investment manager's discretion as long as it is within fund time boundaries,” he adds.

India does not have a sovereign wealth fund manager and Sudhir says this can be remedied easily. “SIDBI has played a pivotal role in funding startups in India as a Fund of Fund, as direct investor, and as a provider of debt to startups. We should scale this up to position SIDBI as a Sovereign Wealth Fund Manager with a mandate to commit at least $3 billion in Fund of Funds in next five years,” says Sudhir, adding that SIDBI should anchor funds, which have experience and track record, with a minimum of $50 million to $100 million each. This, he says, will lead to India having at least 20 Rupee funds of over $250 million to $500 million at least with investment focus in manufacturing, healthcare, technology, internet, mobile, software, fintech, and defence, among other sectors. Says Sudhir:

In the past 10 years, India has absorbed approximately $100 billion in VC/PE investments. In the next five years, India needs over $200 billion of investments and has the capacity to absorb this capital in startup funding. The budget must facilitate this to ensure over 5,000 startups are funded from early to late stage in next five years.”