A government panel recommended that long term capital gains from investment in startups should be abolished, at least for the next two years, in the wake of the COVID-19 pandemic.
The government’s Standing Committee on Finance released a report on September 15 outlining its views on the startup ecosystem, opportunities and challenges.
The report suggested a number of measures to boost the domestic startup investment scene, including fixing the difference in tax rates between domestic and foreign funds, benefits between investing in listed and unlisted securities, exempting domestic fund managers from GST, and mobilising domestic funds to pool into funds of funds, more common in foreign countries.
These are some of the recommendations:
-Need for tax parity between listed and unlisted securities. Currently, investing in listed securities provides more benefits for investors from a tax point of view. This also ties in somewhat with the angel tax issue, where many investors have complained about high rates of taxes on their angel investments in startups, and being taxed years later, with retrospective effect.
-Currently, when foreign investors earn money via Long Term Capital Gains from startups, they are taxed at a lower 10 percent, while domestic investors are taxed at 20 percent with a surcharge adding up to 37 percent. This should be fixed.
-Alternative Investment Funds (AIFs) such as venture capital and private equity funds pay GST, and the management fee which fund managers earn is treated as cost of service. The report said since AIFs are a pooling vehicle and provides no other service, the GST paid on fund management is a sunk cost, and challenging for the industry.
-Pension funds, provident funds and charitable organisations can be pooled to create a fund of funds and invest in startups, a common practice in western countries and the Middle East. India has recently tried this with National Investment and Infrastructure Fund (NIIF) and will make the investing ecosystem more diverse.
-Category 1 AIFs- mainly VC - funds should be allowed to invest in non-banking finance companies (NBFCS) as India is still a developing country.
-LTCG on unlisted shares should be exempted for a limited period. They are currently taxed between 28 percent and 43 percent. “In contrast, various developed jurisdictions, such as the US, the UK and other EU countries do not tax capital gains earned by foreign investors. Even closer to home, countries such as Singapore do not have any capital gains tax, which attracts investors to pool/ invest in Singapore,” the report said.
The government was also cautious about the large amount of foreign capital, including Chinese money in Indian startups. “Industry data indicates that more than 80 percent of startup financing is coming through foreign capital, largely channelled through the venture capital and private equity industry. India’s financial system must be strengthened so that much more domestic equity capital is available to scale up our startups,” it said.
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