Tax experts say the ‘flip company’ structure will become more popular for early-stage start-ups following the imposition of angel tax on overseas investments. More start-ups may be compelled to register their parent companies in investor-friendly jurisdictions.
The process of flipping the holding structure involves transferring ownership of the company from an Indian entity to a foreign one. The amendments to Section 56 of the I-T Act, which require non-resident Indians (NRI) and foreign investors in private companies to pay tax on any or all shares, that are issued at a premium pricing, could mean smaller foreign flows into start-ups.
Rehan Yar Khan, managing partner, Orios Venture Partners, says the angel tax on overseas investors has the potential to put the brakes on foreign investments into Indian startups. “It’s in a way more worrisome than earlier domestic angel tax because that at least had exempted AIFs but this has no such exemption. This will again encourage a flight of companies to offshore jurisdictions and overseas investors will be shy of investing in domestic companies,” Khan added.
Vaibhav Gupta, partner, Dhruva Advisors, further pointed out that such onerous provisions could impact genuine FDI transactions in the country. “One can also expect heightened scrutiny of valuations at which the funds are raised,” added Gupta.
Since its introduction in 2012, the angel tax is levied on the differential amount between the fair market value of the shares and the consideration received by the company; startups pay a tax on the premium received from angel investors. The tax had earlier resulted in many startups being penalised, even when they had not made any profits, making it a significant challenge for early-stage startups to raise capital.
Neeraj Tyagi, founder of the angel network We Founder Circle (WFC), observed that typically NRI investors avoid investing directly in the equity an Indian startup to stay out of the tax ambit. So, they invest via angel funds or syndicates.“This is one reason why the Indian government is now amending the income tax act to bringNRIs under the purview of angel tax,” Tyagi said.
“Earlier, even while registering an AIF, the foreign cross-border remittance or cross-border investments could not happen directly to India via the fund. The only workaround for this was to create a feeder fund outside India in Singapore, Mauritius, Dubai or another country, and syndicate money into India,” said Tyagi.