The tax and regulatory environment around the start-up ecosystem is still evolving and the considerations which an accelerator will have to consider are two-foldthat of its own and that of the investee companies. These considerations span across the life-cycle of the accelerators from start to finish.
Setting up an accelerator involves traversing through multiple decisions points such as:
*Whether the accelerator should be set up in India or abroad
*If abroad, then in which jurisdiction
*Whether the accelerator should be registered in India with Sebi or not
Each of these decisions could have a bearing on the regulatory and tax status of the accelerators. Where accelerators are backed by large corporations or where they pool money from investors abroad, the decision points would revolve around the jurisdiction where the accelerator should be set up. Setting up in jurisdictions like Mauritius or Singapore, which have historically been the jurisdictions that funds have chosen, is no longer the obvious choice with the increasing chorus against treaty-shopping and need for business purpose.
On the other side, domestic accelerators set up in India which pool money from various investors will have to consider the need for registration as an Alternative Investment Fund under the Sebi regulations. Sebi has prescribed high thresholds in terms of corpus and investment size for funds to qualify as Alternative Investment Fund. Given that accelerators typically pick up a 2% to 10% equity stake in start-ups for contributions ranging from $25,000-100,000, most accelerators may not fall within the requirements laid out by Sebi. Failure to satisfy the investment conditions laid down by Sebi could result in prohibition from pooling money and operating as a fund.
Another important aspect to consider while setting up an accelerator is the form of entity. An accelerator could be set up as a company, a limited liability partnership (LLP) or a trust. Tax efficiency and commercial considerations would drive the decision on the nature of entity to be set up. LLPs and trusts are tax efficient as compared to a company due to the single-level taxation applicable. However, commercial considerations and the mix of investors would also play an important role in determining the nature of entity.
Once the entrepreneurs are on board, accelerators typically hand-hold them for 4-6 months during which they provide infrastructure and mentoring support. During this period they incur significant expenditure on providing these facilities including payments to mentors, trainers, infrastructure, etc. Whether such expenditure would be available as a deduction in computing the income chargeable to tax of the accelerator is not free from doubt and adding the costs of service tax can bring in several tax inefficiencies.
The taxability of the payments made to the promoters and mentors of the accelerators is another aspect which needs to be taken into consideration in structuring the payouts. The payouts could be structured in one or multiple ways depending upon the commercial considerations.
Once the entrepreneurs have completed the mentoring programme, the expectation is that they would land up with Series-A Funding. However, considering the infancy of the start-up ecosystem in India, the period until the entrepreneurs get their first round of funding could get stretched. This would mean longer mentoring periods and increased tax inefficiencies, which only means some changes in business models may become necessary.
Accelerators typically achieve exits when they sell their stake to venture capitalists/private equity funds or exit in an initial public offer. Gains arising from exits should typically be characterised as capital gains, although considering the relatively larger number of investments an accelerator may make compared to a fund, and considering the related mentoring and support, there could be questions on whether the activity is in the nature of a business. Additionally, with the increasing rigour of the revenue authorities and the proposed amendments to the treaties for inserting anti-abuse provisions, the accelerators will have to make sure that they satisfy the necessary conditions and have implemented adequate steps to ensure availability of treaty benefits.
As the start-up ecosystem matures in India, it is to be seen how the tax and regulatory environment evolves alongside. Over the years, while a favourable tax and regulatory regime has been carved out for venture capital/angel funds, considering that accelerators are actually playing a role beyond just funding in catalysing ideas, it is time that note is taken of this concept of a fund with benefits!
With inputs from Raghunath Rao, associate director, BMR Advisors
The author is partner, BMR Advisors. Views are personal