Less taxing solutions for startups

An IIT/IIM panel to resolve the issue of tax-treatment for startups a good idea; indeed, do this for others as well.

. Indian startups are deploying unique business models, converging market acumen with technological expertise.
. Indian startups are deploying unique business models, converging market acumen with technological expertise.

Given the attention prime minister Narendra Modi has given to startups and the adoption of technology – the government even has a startup fund and Modi is the only Indian prime minister to travel to Silicon Valley to meet tech giants – the angry protests from both startups as well as angel investors was a rude shock. Over the past few weeks, both have been protesting the taxman asking startups to pay taxes on the premium received in various funding rounds; the taxman has argued that this premium is unjustified and so has to be treated as normal business income for the year.

When the matter was first highlighted, the government tried to calm investors by saying genuine investors had nothing to fear and that this was only an attempt to catch those who were trying to launder their money by using the startup route. While that may have seemed a good strategy to the political class, it worried investors more for there was no clarity on who was going to decide whether a startup was genuine or not.

It is to the government’s credit that is has now decided to form a committee of experts to sort out the matter. The taxman’s need to ensure there is no money laundering is a genuine one, as is the need for startups to not be harassed. The panel will comprise experts drawn up from institutions like the IIMs and the IITs. And in the meanwhile, it has been decided that the taxman will take no coercive action/measures to recover the demands.

Indeed, in the past, this newspaper has advocated precisely this kind of approach to other cases as well. So, whenever there is a tax ruling/demand that has larger implications for the industry, the tax department must – at the level of the Board – examine the issue and give immediate clarifications to all revenue officials; if setting up a committee of experts is required, this should be done at the earliest.

In April 2015, while the budget had said that the minimum alternate tax (MAT) would not be levied on FIIs, the Authority on Advance Rulings (AAR) gave an adverse ruling in the case of one FII on whether MAT could be levied on entities that did not have a ‘permanent establishment’ in India; while there were other AAR rulings that said MAT could not be charged if there was no ‘permanent establishment’, in this case, the ruling was that it could be taxed.

Given the potential impact, as well as the contradictory AAR rulings, this was the perfect case for the Board to issue clarifications, but it did not for a long time; and when it did, it did so in favour of the taxman and even briefed the finance minister incorrectly. It is only when it looked as if FIIs may pull out their investments due to this that the matter was referred to the Justice AP Shah panel which recommended the tax be dropped. Similarly, the taxman levying all manner of taxes on MNC back offices or subsidiaries became a sore point with investors; at one point, the US government also got into the discussion but said it refused to deal with the Indian official in charge of international taxation.

When this happened, one of the steps taken, apart from replacing the official concerned, was to set up various committees whose job was to fix profit margins for various types of industries that were acceptable to both the taxman and the industry; once these ‘safe harbour’ levels were finalized, taxation of MNC arms has become much easier. Given there are many such instances of large differences in opinion, the Board needs to be far more proactive in coming up with solutions that include setting up expert panels comprising both taxmen and industry experts to tease out solutions.

In the case of startups, if the taxman does suspect money laundering, a simpler solution would be to track payments made by these startups after their funding rounds; if there is any money laundering, the money has to flow back from the startups sooner rather than later.

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First published on: 24-12-2018 at 11:48 IST