This article of mine was published on Economic Times, Asia’s largest business newspaper and on e27, one of Asia’s biggest startup news sources on 19th January, 2016 over here and here.
Starting in the early part of this decade, we have seen a large number of startups move out of India, to places like Singapore. Examples of such startups are Grofers, Flipkart, InMobi and MobiKon. The difficulty in doing business in is often cited as the key reasons for this. In this article, we will analyze the impact that Prime Minister Narendra Modi’s Startup India Action Plan is likely to have on this mass exodus of India’s best startups to Singapore.
Startup India: The intent is visible but will it translate to action on the ground?
Prime Minister Narendra Modi has taken up the cause of startups via the Startup India initiative and put it on mission mode. The Startup India Action Plan has a series of policy initiatives and schemes that are aimed at easing the hurdles that startups face. The intention is laudable, especially given that earlier governments did precious little to further the cause of startups and MSMEs. However, the key question is – “Is this enough and will this help stem the exodus of startups to places like Singapore?”
Of the proposals put forth in the Startup Action Plan, I found the most interesting ones to be:
- 1-day incorporation via a mobile app: This is by far the most important proposal outlined in the plan though I would be pleasantly surprised if the system can pull off a 1 day incorporation and thus remain skeptical about its execution. As of now, it takes anywhere between 15 and 30 days for a company to get incorporated. It would also be interesting would be to see if all steps ranging from Digital Signatures, Director Identification Numbers (DINs), Name approvals and Certificates of Incorporation are covered by this app.
- The exemption of startups from labour inspections for the first 3 years: This proposal, if implemented, would save startups from harassment by labour inspectors.
- 3 year tax holiday for startups: This is a welcome step, though I would think that most startups would not benefit since they tend not to make profits in the initial years anyway.
- Faster exits for startups: The winding down of defunct startups is a cumbersome process currently. If the stated 90-day winding-down scheme is indeed implemented, it would be a major step towards making it easier to do business in India. However, I am skeptical about the execution of this step given that the bill is stuck in gridlocked Parliament.
- Capital gains exemption on startups: Another welcome step in line with best practices globally.
- Credit Guarantee Fund for loans to startups: This proposal, if executed (big IF), would be a game changer for startups in line with the schemes of the US Small Business Administration. Unfortunately, India’ experience with the CGTS scheme for MSMEs has been rather tepid with less than 1% of the total credit demand being covered by the scheme.
- Fund of Funds that invests in startups: If this is executed, unlike the unspent budget allocations of the past, it would be a big boost to startups.
What remains unaddressed?
While these are all good steps in the right direction, a lot has been left unaddressed. Two such examples are:
- “Angel tax”-This is the cause of much harassment by tax-authorities and allows the Assessing Office to judge the “Fair Market Value” (FMV) of a startup and tax all investment at a valuation above this FMV as income.
- Ongoing compliance – This has not been made any easier by this Action Plan. For example, even a startup with no revenue has to file audited accounts every year and submit returns- thus incurring significant costs. In contrast, Singapore exempts all startups from these cumbersome requirements under the “Exempt Pte Ltd” category.
Further, the definition of a “startup” under this action plan leaves room for more red-tape with the requirement for certification by an “Inter-Ministerial Board”.
Will this Action Plan prevent India’s best startups from moving to Singapore?
Getting back to the original discussion on startups leaving India en-masse- while people talk about India’s “best startups” moving to Singapore, they tend to overlook the fact that most of these startups that move to Singapore are hardly startups when they move. Most of them are 2-5 years old and have annual revenues in order of millions or tens of millions of dollars. While we think of them as “startups” because they started small, they are certainly not small organizations when they actually move out.
Of course, these companies continue to access the Indian market (high growth) and keep almost 100% of their operations in India (cost reasons), but move their headquarters to Singapore, wrapping the Indian operations as a wholly-owned-subsidiary of the Singaporean entity.
I am of the opinion that this exodus has almost nothing to do with the stifling red-tape that chokes entrepreneurs in India. After all, even if a startup moves its holding company to Singapore, its Indian entity still has to deal with the very same red-tape, get harassed by the very same “babus” and jump through the same hoops that the holding company would have escaped by moving to Singapore. There is also the additional headache of transfer-pricing and the tax-man breathing down your neck on this front.
Therefore, it is not logical to think of red-tape as being the reason for the move to Singapore. This phenomenon of companies moving their holding companies to Singapore is due to the following reasons, which I believe cannot possibly be addressed by Startup India in 1 year or even 5 years:
- Lower Capital Gains Tax rates– Singapore has a 0% Capital Gains Tax, compared to India’s 20% (with inflation benefits). Therefore, founders and investors can save millions of dollars on capital gains tax if they sell their Singapore listed company’s shares rather than their Indian listed company’s shares, while simultaneously structuring the deal smartly and remaining out of the country for 183 days in that Financial Year.
Startup India effect -The Startup India Action plan abolishes capital gains tax on startups, but because of the definition of “Startups”, most of these companies re-incorporating in Singapore do not qualify for these benefits.
- Lower Corporate Tax rates – Singapore has a Corporate tax rate of 17% p.a. while India has a rate of 30% p.a. Therefore, even after accounting for “transfer pricing” and the associated harassment involving the Indian subsidiary, the company saves tax by incorporating in Singapore.
The Startup India effect -The tax-holiday for 3 years will not help these companies as they are usually older than 3 years and would usually have revenue higher than the Rs 25cr limit.
- Access to well-developed capital markets – Indian capital markets, especially the equity markets are simply not deep enough for companies like SnapDeal or Flipkart to get the kind of valuation on an IPO that they would get in Singapore or USA. Therefore, it makes sense for them to list their holding company in Singapore, which would work to their advantage while listing on an SGX or a Nasdaq.
The Startup India effect -Startup India cannot reasonably be expected to address this aspect and I would reckon that it would take a minimum of 10 years of fast-tracked reforms for our markets to come close that of a developed economy’s.
- Reputation of being a “Singapore company” – When it comes to doing business with American, European or even South East Asian clients or investors, there is nothing like being a “Singapore company” or an “American company”. Singapore has an excellent reputation for investor protection, ease of doing business and intellectual property protection. Therefore, investors and clients are much more likely to be comfortable doing business with a company registered in Singapore rather than one registered in India.
The Startup India effect – This too is an aspect that we cannot expect Startup India to address. It will take decades of brand-building, effective enforcement of laws and hard reforms to address this issue.
The bottom line
The Startup India initiative is praise-worthy as it has some very important steps around the ease of doing business, taxation and intellectual property protection. However, the definition of a “startup” for the purpose of these schemes means that a company with over Rs 25 cr in revenue or older than 5 years or without “certification from the Inter-Ministerial Board” (more red tape?) cannot get any of these tax or policy incentives. This would automatically disqualify the Snapdeals, Flipkarts and Grofers of the world from any of these benefits.
In summary, while Startup India is a great first step in the right direction and will probably help startups to some extent, it will probably not make a dent on the exodus of India’s Flipkarts or InMobis to Singapore in any meaningful way. Will it help small startups become the next Flipkart or InMobi? That really depends on the execution and we will come to know only after the next few years.
Ashwini Anand, CFA is a 2nd time FinTech Entrepreneur who had startups in India as well as Singapore. He is currently a Co-Founder and Director at Monsoon FinTech– a startup that uses machine learning to help lenders make profitable loans.
Ashwini Anand, CFA : Investing, Politics, Economics 