Start-ups learn the hard way, that parts of government still don’t get it

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Published: November 29, 2018 3:13:51 AM

Given India has added around 1,200 start-ups so far this year, and around 7,500 in the last five, you would think every arm of the government would be engaged in trying to nurture the start-ups as much as is possible.

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Given India has added around 1,200 start-ups so far this year, and around 7,500 in the last five, you would think every arm of the government would be engaged in trying to nurture the start-ups as much as is possible. Apart from the fact that India has the third-largest number of unicorns in the world—and this is a powerful magnet to attract foreign investors—most of the start-ups are looking for solutions that, if they deliver, can change the economic/social landscape of the country. A fifth or so are working on healthcare solutions that can be critical in a country that has a poor healthcare system and an even poorer record of delivery based on this. An equally large number of start-ups are in the education space, again another area that needs all the help it can in terms of increasing learning outcomes. There are a large number of start-ups focused on clean energy, agriculture technology and, if you please, even in trying to prevent crime. It is probably because of this potential that the government, under prime minister Narendra Modi, even has a start-up fund—the government funding start-ups may not be a great idea, but the fact that it is doing this makes it clear how much the government values what start-ups bring to the table.

Given this, it came as a surprise when, a couple of years ago, the taxman started sending notices to start-ups that had got funding, and asked them to pay tax on the premium they got from investors. Apart from the fact that capital receipts cannot be subject to a tax, the move never made sense since it left that much less for the start-ups to invest. It was also premature, given the high fatality rates of start-ups. If, say, a third of start-ups fail, this meant a third of them were paying the tax for no apparent reason. After all, if capital gains have to be paid, they should be paid at the time the investor exits at a premium.

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If this wasn’t bad enough, according to a story in The Economic Times, even the ministry of corporate affairs has now got into the act and it has sent several start-ups notices asking them to justify the premiums that they have got and also to indicate if they are registered under various government schemes including the one run by the department of industrial policy and promotion. Presumably, the corporate affairs ministry wants to ensure start-ups are not being used to launder money, but this need to crack down on black money has to be balanced by what damage this does for the start-up eco-system. The premium paid is essentially what the investor thinks of the plan the start-up has, its ability to deliver on it, and the wealth this can create if it works. At a rational level, few start-ups, or even investors, can really justify this since it is really a punt, albeit a better informed one. How can a WhatsApp, for instance, justify what Facebook paid for it, given its lack of revenue model? The government would do well to tread lightly, lest it kill start-ups before they really get going.

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