Startup India: Policies Abound But Limited Impact on Ground

Propelled by the perceived success of the Digital India and Skill India initiatives, the Narendra Modi government had announced its ambitious Startup India programme in January last year. Mooted with the objective of creating a conducive ecosystem for emerging businesses in India, an assessment of its impact a year on puts a spotlight on the challenges that such an undertaking brings in practice.

Taxing policies

One of the key declarations made in the Action Plan was the three-year tax exemption for a startup deemed eligible by the government. This clause, however, was revisited in Budget 2017 with many industry leaders echoing the common sentiment that it ran counter-intuitive to the drive to encourage entrepreneurship in India.

The prevailing argument in the circle was that most startups typically take a lot more time to just break-even. It was tweaked to extend the three-year tax exemption for startups to the first seven years from five years previously. But this minor adjustment notwithstanding, there is little less to celebrate in a programme that was hailed as a liberator for India’s fledgling but promising startup ecosystem.

Although many startups that were set up in or after 2016 would undoubtedly rush in to leverage this provision, startups and industry experts strongly felt that there was never a more pressing need for Minimum Alternate Tax (MAT) to be included as part of this tax break and for angel taxes to be struck down completely. However, no such radical exception was made to the original policies in the programme – neither on the imposition of MAT nor on angel taxes, both of which would continue to haunt StartUp.

“Since very few companies churn out profits in the first few years, it is debatable how positive present tax reforms could be, even though the extension of the period from five to seven years is welcome,” says President of Indian Angel Network (IAN), Padmaja Ruparel. “We were, however, expecting announcements anchored around tax breaks on MAT. That would have been a better approach since it essentially taxes daily cash flow and not profits generated through daily operations,” she adds.

Under MAT, all companies having book profits under Companies Act are required to pay taxes at the rate of 18.5%. The government’s rationale behind keeping MAT out of the tax holiday period for startups was to ensure that companies making substantial profits are unable to find loopholes to avoid paying taxes. But, without exempting MAT for startups or reducing its rate, the unanimous opinion is that it could negate any likely benefit that other tax reforms enlisted in the programme can bring about.

Another problem with the plan is that the benefit is only applicable to startups incorporated after April 1, 2016. This means a vast majority of the startups formed before that date are not eligible for the scheme. DIPP, Secretary, Ramesh Abhishek in an interview with EconomicTimes Digital said the criterion has been fixed by the Ministry of Finance and that DIPP is looking to get that changed.

Devil in the detail

Furthermore, Section 56 of the I-T Act states that companies are liable to pay taxes on money invested at capital. This draconian tax – paradoxically named Angel Tax – is notorious for its reputation of driving away interested investors and initial backers and bringing down the pool of early-stage startups that are angel-backed.

“A lot of startups raise money from angels or non-listed entities. So for most of these companies, although the government may be giving them a sop through tax breaks on profits – which may or may not be relevant to them – it is at the same time treating part of the money that comes in from angel investors as taxable income,” says Ruparel. “This certainly needs to be looked into since it eats into the funds of a startup even before it has started making money,” she adds.

“Startups, especially those that deal with hardware, have no source of income in the initial years of operation and hence tax reforms, as it exists today, is of little help since we are not making any money anyway,” chips in co-founder of sound technology startup Soundrex, Shrey Goyal.

As it stands now, fund from angels are subjected to 33% tax if it is more than the fair market value (FMV). To protest against this, a coalition made up of startup organizations including Nasscom, IAN, Indian Venture Capital Association (IVCA) and TiE had pulled up the government for introducing this policy and had appealed to the concerned body to exclude it in the Union Budget, which clearly fell on deaf ears.

Bottlenecks in business

The country’s stringent tax regime has been one of the key reasons why businesses prefer to keep their distance from starting operations in India. For instance, as reported earlier this year, about 100 startups with marked-down valuations are facing tax demands without any consideration of the actual profit they are making. So despite the stentorian call to create a flexible environment for startups to thrive and survive, it still remains mired in convoluted legislations that make little or no sense

Startups also face the challenge of systematic inefficiencies and corruption-related complications, which more often than not, manifests itself in the form of convoluted dealings with state and district administration for land allotment licenses and certifications. While a proactive approach to building a mindset that recognises the true potential of these new businesses can go a long way, these bottlenecks can take time to disappear completely.

“In addition to this, it all ultimately comes down to the overall negative mood in the marketplace which has been slowing down big-ticket investments,” says VP – Industry Initiatives at Nasscom, K S Viswanathan. “The total inflow of investment last year was approximately $4 billion, which is expected to come down to roughly $3.2 billion this year,” he adds. But, is exemption from tax and faster issuance of permits enough to provide a significant boost to startups? Perhaps not.

Startup? Prove it

To make matters worse, companies that want to avail of the benefits in the programme have to follow a stringent set of criteria to even register as a startup, with only a third qualifying as one. According to the status report of the programme, DIPP has stated that out of 1,425 applications received, only 522 have been recognised as startups.

“There is heavy scrutiny in registering as a startup because of which most do not even try and waste time only to be rejected later,” feels co-founder of Nimble, Harshit Shrivastava. Even those who have taken the pains of getting registered with DIPP have found it to not be of much use.
A recent survey done by EconomicTimes Digital across 145 startups in the country shows that 93.8% of the respondents have not availed of any benefits under the Startup India Action plan. About 70% say the action plan does not have anything to make a material difference to their business, while 59% have never felt the need to be certified under the Action plan. If we take plus or minus 10 % to the above results given the number of respondents is low, the numbers are not flattering.

“The sample size needs to be much larger to give an accurate result, but in most cases startups do not know what is on offer. There has been such a trust deficit between people and government that no one looks at the website where much of the details is available. Take for example, patent for startups, facilitators and mentors are some of the concrete steps that have been taken. People come to know gradually and the idea is to increase our reach to people. It is a large country and we have to work harder and make efforts to improve our outreach,” says DIPP, Secretary, Ramesh Abhishek.

According to rules, startups have been qualified as “individual persons” instead of companies and are eligible for 80% rebate in patent fees as per the startup action plan. The Secretary says 108 applications have been filed by startups of which 104 have received the benefit of 80% rebate. “This number cannot become one million because total number of patents filed in India is 45000 and only 20% of that is filed by Indians,” says Abhishek.

Small start to something big

However, despite the narrow scope of the programme, most agree that it will still give entrepreneurship a much-needed boost in India. According to Viswanathan, an average of 1,200 to 1,400 technology startups is jumping into the fray every year.

“There is a definite impetus given to entrepreneurship today and I see that reflected in the number of applications we get for the Nasscom 10k Startup programme,” he says. “About 14,800 startups had applied for the sixth phase of our programme. It is a different matter that we can accommodate only about 20% of that number, but the important thing to note here is that the startup momentum is moving upwards at an aggressive pace. Whether that can be attributed to the government’s Startup India programme is debatable, but there is a definite push to keep this momentum going,” he signs off.

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