Entrepreneurs In India Are Very Upset – And For A Good Reason!
Many barriers that don’t exist today in India cannot even be imagined by entrepreneurs who expect business conditions here to be competitive with the global best practices
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Just last week, I came across through iSPIRIT a survey conducted by Local Circles among start ups. Response to one question caught my attention:Has your business benefited in any way as a result of Start Up India scheme?82% of more than 3700 respondents answered in the negative. It is a shocking statistic in terms of perceptions. It is clearly unfair to the government as startups have benefited a lot from the reforms introduced since Feb 2016 particularly from improvements in ease of doing business.
Many barriers that don’t exist today in India cannot even be imagined by entrepreneurs who expect business conditions here to be competitive with the global best practices. In fact the business conditions were horrendous. For those driving on a resurfaced road, the potholes of the past are rarely visible. The accumulated baggage of regulations imposed by previous governments that were tone deaf to the needs of startups had created an environment hostile to start ups.They did so not by design but by neglect and because of their ignorance of special needs of the start ups. This government was the first government since Independence to realize the potential of startups to transform India. Unique among politicians of all hues since independence, PM Modi had the foresight and the conviction to stake his reputation on Start Up India initiative.He promised to break the chains holding back the tsunami of entrepreneurship in India.
Raised expectations are a double edged sword. And perceptions matter.
Modi’s bet on startups has been prescient. Per a survey by Inc 42, 39000 start ups in India have raised over $38 billion in the last four years and have created a value of more than $130 billion. If, by my estimate,each start up generated 5 jobs on average, then the start up movement has created close to two lakh new jobs. Meanwhile, big companies are shedding jobs as they get more efficient and public sector is not hiring any more.
So, why is the start up community so downbeat on Start Up India initiative? For one, no start up has seen any procurement from the government under the relaxed norms for procurement from them – the provisions have proven to be paper tigers. But there is a much bigger issue and the Inc 42 survey gives a clue. Angel investment at seed stage has gone down by over 21% since last year and number of angel investors has declined by 48% since 2016.
No wonder that the entire ecosystem of entrepreneurship in India got riled up enough to send an urgent letter to Arun Jaitley in early January. A letter jointly written by TiE, Nasscom, India Angel Network, India Venture Capital Association and a whole bunch of angel groups points out that the Start Up India initiative has “unfortunately run into severe implementation problems”.
Here is the problem. In US, if a start up wants to raise money, it finds someone willing to give it money and negotiates a valuation mutually acceptable to both. The money changes hands and the start up goes about building the product and the company right away. If the start up is successful and the angel investor makes money, he pays tax at a reduced rate or pays no tax at all if he recycles his gains as investment in another start up. Other countries offer even more aggressive incentives to angel investors.
Not so in India. You have to deal with bureaucrats with discretionary powers at every step of the way.
If you raise money from domestic angels, a portion of it will be taxed as income. Why? The tax people have a reason no matter how bizzare it sounds to normal people. The tax officer decides what a reasonable valuation is ostensibly to avoid kickbacks disguised as high valuations to friendly companies. The well intentioned objective of preventing corruption in a few companies has resulted in regulations that strangulate the growth of all companies. So kill an entire crop to prevent a few weeds from growing. Sounds reasonable to the tax department even if everyone else considers it bizarre. Don’t like the valuation assessed by the tax department? Go in appeal but first deposit 20% of the assessed tax.Spend a few months or years fighting this.What you took money for can wait.
Well, of course there is a way out thanks to Start Up India initiative. First, you get registered with DIPP. Then you apply to get “approved” where a committee of career bureaucrats with zero experience in entrepreneurship will decide if you are worthy of being an approved start up. The bureaucrats do not take this responsibility lightly – out of 40,000 or so start ups in India, only 92 or so have been found worthy in the last four years! Let us say, you get lucky and you get their stamp of approval. Now can you raise money? Sort of. Onlytime will tell whether Income Tax Department exercises any more discretion under Section 56(2)(viib). It has probably taken at least six months to a year since the time you started this process – a lifetime for a start up. The idea you were chasing has become stale or some other company in China or Singapore has stolen a march over you or the key employees you intended to hire have gone elsewhere.
All this jumping through the hoops does not get you any tax exemption or tax rebate. But it does spare you from the harassment of the tax department - on this issue of taxation of angel investment.
I guess that is why 82% of startups do not believe they have benefited from Start Up India initiative.
And I do not believe that this is what PM Modi had in mind when he launched Start Up India initiative.
TiE and all these other groups want the Finance Minister to intervene to end tax harassment but what they really want is an environment conducive to entrepreneurship - an environment where the toughest challenge for the entrepreneur is to find some investor willing to risk his money. They want a government that does not get in the way by demanding needless approvals and a tax code that encourages investments in startups and not slow it down or tax it.
Will Mr Jaitley deliver? Only he can deliver.All the other stakeholders - DIPP, Niti Aayog, the Commerce Minister -have come out in support of these demands but the Income Tax Department is the holdout. It is a political decision now. The buck stops at Mr Jaitley’s table. This is a signature initiative of PM Modi.The Finance Minister should ensure its success and abolish this retrograde angel tax in the budget session of the parliament.
Do I believe it will happen? Not really. This step requires some degree of conviction to fight the entrenched mindset. If he had the conviction, this problem would have been solved long time ago.
What is likely to happen is some dilution of the offending provision and a decision to go slow on its enforcement for the time being. Straight from the standard bureaucratic playbook when faced with pressure for significant change. I would be thrilled if I were proven wrong and the country will be thankful that the entrepreneurs are being set free.
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