By Siddarth Pai
Indian innovation powers the digital world. India has shipped more software than Saudi Arabia exports oil — worth over $200 billion in a year. Over 1 million engineers in the US are of Indian origin. Over 10% of the Fortune 500 companies have Indian-origin chief executive officers (CEOs). Eric Garcetti, the US envoy to India, joked that one cannot become a CEO in America unless they are from India. A study of US unicorn founders by Ilya Strebulaev of Stanford Graduate School of Business showed how Indians are the largest proportion of non-US-born founders.
This innovative heft has propelled India to become the third-largest start-up ecosystem in the world in terms of capital raised, unicorns, and number of start-ups. Yet, a dirty secret exists in the Indian start-up ecosystem — over half of India’s unicorns are not Indian companies, but foreign companies run by Indians. The Flipkart sale to Walmart, which is the largest start-up exit from India, was not of an Indian company. Flipkart was and is still headquartered in Singapore, though the team and management sit in India. India is at risk of becoming a land of subsidiaries, not start-ups.
The reasons for founders to choose to enter the Indian market though a foreign country are manifold, beginning with incorporating a company where founders run the risk of their company names being rejected for frivolous reasons. Our compliance demands for raising capital are onerous and require multiple forms to be filed and approved, with the choices of securities severely restricted. India is also unique in taxing capital investments as income, a tax colloquially known as angel tax.
Though laundering unaccounted funds is a global issue, no other country has sought this innovation of taxing investments as income. The Foreign Exchange Management Act regulations and enforcement make it impossible to launch global software as a service companies from India, where every credit from a foreign source requires invoices in triplicate before the bank processes the transaction. Even exits as share swaps, the most common exit avenue for start-ups, is taxed in India, despite no cash exchanging hands. India also taxes domestic capital at twice the rate of foreign capital, and investments in start-ups at twice the rate of investments in listed companies. The Economic Survey 2022-23 covers the reasons for flipping in great detail and urges the government to look at remedying these issues.
Despite these frictions, India is still the third-largest start-up ecosystem in the world. The ability of Indian entrepreneurs to build world-class products despite such odds is commendable.
The situation has improved in the last 10 years, with further reforms in tow. India crossing $2,000 in terms of per capita GDP in 2019 marks an inflection point where spending shifts from sustenance to consumption. This happened in the US in the 1950s, Germany in the 1960s, Japan in the 1970s, and China in the early 2000s. Regulators such as the Securities and Exchange Board of India and International Financial Services Centres Authority (IFSCA) have created regulated vehicles for pooling capital into private assets such as start-ups, creating an over $100 billion investing industry through alternative investments funds. This has allowed rupee capital to finally invest in start-ups, though the legislated subordination of private market investing to listed market investing in terms of tax rates and holding periods should be removed. Various committees have been formed to reevaluate our existing laws and rationalise them further. Indian retail investors are pumping close to Rs 19,000 crore monthly as systematic investment plans into the stock market and are lapping up initial public offerings through double-digit oversubscriptions.
Many start-ups that shifted out of India over the last 15 years now wish to come back to the country, but lack a mechanism to do so. PhonePe was unique in paying over $1 billion in taxes for moving back to India from Singapore, but no other start-ups have the balance sheet to support this.
This is why the scheme mentioned in the “Onshoring Indian innovation to GIFT IFSC” report released in August 2023 is crucial. It lays out a framework based on the scheme to redomicile funds investing in India but based in other countries to shift to GIFT International Financial Services Centre (IFSC) in a tax-free manner. GIFT IFSC has a unified regulator in the form of the IFSCA, allows start-ups to maintain accounts in US dollars, and has a host of tax benefits to attract and retain companies. It forms the perfect landing spot for such flipped start-ups to come back to India and remain Indian companies.
Digital businesses have blurred geographic boundaries and the extent of the sovereign over digital businesses arises from having these companies domicile in the said country. This is best understood by the US and China, who allow their companies to operate overseas while remaining domiciled in the motherland. Europe is a digital colony as it lacks major tech companies headquartered in its borders. India too runs the risk of this unless it allows for Indian entrepreneurs to redomicile in India and reforms legislation that prompted them to move out in the first place.
Indian entrepreneurs look up to the Start-up Prime Minister to allow them to return to the country and create immense value for India and Indians.
The author is Partner, CFO and ESG officer, 3one4 Capital
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