The Taxman and Innovation – How UK and India compare

UK and India have consistently managed a top 5 ranking when startup ecosystems are compared. India VC investments were at $7.3 Billion in 2017, and UK received $8 Billion investments with $40 Billion worth of exits in 2018. However, their approach to tax policies supporting startup funding have been very different.

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The startup ecosystem in India received a new shock wave in the form of Tax policies. The taxman sent a bunch of notices to several startups to pay up what is called “Angel Tax” on funds received from Angel investors. The tax would be on the premium in valuation that the firm received from its investors.

This has caused a lot of noise in the local press, with big names like Anand Mahindra (who is also an Angel investor) asking the government to intervene. However, several factors come to mind around this issue.

  • The valuations of startups in India have been generally on the higher side. Startups who receive premium valuations in their early stages of funding, often find it hard to justify the valuations at a later stage. This is one of the factors that creates the funding gap.
  • Startup valuations aside, if the tax man decides to calculate a tax on the premium valuation – there should be a clear valuation methodology published for startups to understand their tax liability when they go for funding.
  • In a fast paced innovation ecosystem where at times abstracts such as quality of team, potential market, intellectual property (not so abstract), first mover advantage etc., decide valuation premiums – the government cannot come up with a comprehensive baseline valuation framework.

 “It needs immediate attention or else all chances of building a rival to Silicon Valley in India will be lost,”

– Anand Mahindra

Without the level of clarity described in the above points, it will be hard for startups to know where they stand. Any tax slapped on them without a comprehensive framework will see an uproar from both startups and investors.

At the Singapore Fintech Festival, when Narendra Modi gave a keynote speech, he referred to the Fintech ecosystem in India and its achievements. However, there seems to be a disconnect between his vision and policy execution.

On the other hand, UK have implemented the Enterprise Investment Scheme and the Seed Enterprise Investment Scheme as tax benefits for investors investing into early stage firms. The HMRC website should give details. But these are the key aspects of the schemes.

  • Investors get a refund (from previously paid tax) of upto 50% of their investment into startups.
  • If the investment is held for more than 3 years, there is no capital gains tax when profits are realised
  • If the investment goes bad, investors can claim refunds (from previously paid taxes) for upto 70% of their investment.

Thanks to these schemes, the early stage investment space in the UK is in pretty good shape. Often times these schemes are carried into Series A rounds by investors. Many funds use special structures to operate in compliance with these schemes.

Tax schemes supporting the innovation ecosystem often provide the much needed traction for startups looking for finance. But they have to be executed through well thought through operational steps to be effective. UK has certainly got it right for early stage backers. India has some work to do.

Arunkumar Krishnakumar is a Venture Capital investor at Green Shores Capital focusing on Inclusion and a podcast host.

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