A self reliant budget for Indian investors in the offing

In a prelude to the upcoming Union Bodget, the Prime Minister Narendra Modi, had a few days ago, announced a seed fund of Rs 1,000 crore for startups to set up and grow their businesses at Startup India’s international summit ‘Prarambh’.

He said that the government is taking important steps to ensure that India’s startups don’t face a shortage of capital. He indicated that startups are already receiving assistance to raise equity capital through the Fund of Funds. To supplement this, the government has decided to also enable startups to raise debt capital by providing a guarantee. India’s goal for the next five years will be to enable startups to become unicorns.This is a laudable initiative by the Centre.

India currently has the third-largest startup ecosystem in the world with around 50,000 startups and 42 unicorns creating a value of $170 billion and 800,000 jobs. Over 20 unicorns are domiciled overseas and almost all of them have very high foreign holding due to onerous Indian regulations.

Consequent to the good policies of the government in the last couple of years, about 721 AIFs have been set up in India with a capital commitment of $55 billion. It is a bad thing though that only 10 per cent of the capital invested in startups between 2014 and 2020 ($70 billion) is from India. India targets 100,000 startups, 100 unicorns, 32,50,000 jobs by 2025, but due to lack of adequate Indian investments, India is well on its way to become a Digital colony.

To encourage high-income earners in India to invest in startups, the Centre should remove the discrimination in taxation faced by investors in startups in India and the MSMEs. The Finance (No.2) Act 2019 imposed a higher surcharge on individuals with taxable income beyond Rs 2 crore.

The effective income tax (I-T) rate for individuals with taxable income between Rs 2-5 crore increased to 39 per cent and for those above Rs 5 crore to 42.7 per cent. This enhanced surcharge was later withdrawn on short-and long-term capital gains from listed equity shares on which securities transaction tax (STT) is paid and on short-and long-term capital gains generated by FIIs on the transfer of securities.

As a result, resident individuals are required to pay an enhanced surcharge on short-and long-term capital gains generated from the transfer of unlisted shares, which is not applicable to FIIs. This creates discrimination against high-income earners in India who invest in startups. To encourage the growth of Indian capital and to prevent India from becoming a digital colony, the enhanced surcharge on capital gains from unlisted shares should be abolished, as has been done for FIIs!

There is blatant discrimination on the taxation of listed and unlisted equity shares. Investments in unlisted equity shares carry higher risks and lower liquidity compared to listed equity shares. However, to qualify as a long-term capital asset, the holding period is 24 months for unlisted shares compared to 12 months for listed shares.

LTCG tax on the sale of listed shares is 10 per cent while it is 20 per cent for unlisted shares. Even non-residents pay LTCG tax at 10 per cent on unlisted shares. Considering that angel investors having high income generally invest in startup companies, the LTCG tax for them after surcharge and cess would be over 28 per cent.

There is no rationale for this difference. To provide an incentive to domestic investors to set aside a portion of their investment corpus for unlisted companies, the holding period for unlisted equity shares should be reduced to 12 months to qualify as a long-term capital asset and the LTCG tax on the sale of unlisted shares should be reduced to 10 per cent.

To come out of the discrimination between foreign and domestic investors who remain invested in India at all times, dividend and interest income should be taxed at the slab rates or 20 per cent (ex surcharge and cess), whichever is lower. Consequently, the maximum tax rate applicable to dividend and interest income should be 20 per cent (excluding surcharge and cess) to all tax resident in India. A large number of MSMEs in India are registered as partnership firms and Limited Liability Partnerships (LLP).

However, the rates were not reduced for partnership firms/LLPs. By reducing the base I-T rate for them without being eligible to specified exemptions or deductions, all enterprises in India will have a common base tax rate of 22 per cent. Remuneration paid by a partnership firm or an LLP to its partners, according to the terms of the partnership deed exceeding certain defined limits isn’t allowed as a deduction to the partnership firm or the LLP.