A parliamentary panel has ‘strongly recommended’ the abolition of long term capital gains tax (LTCG) for investment in startups, apart from other tax incentives in order to drive a sharp post-pandemic revival. This should apply to investments made through collective investment vehicles such as angel funds, alternate investment funds and investment LLPs, it said.
The Parliamentary Standing Committee on Finance, headed by former Minister of State for Finance Jayant Sinha, said that a strong startup ecosystem can propel investment, jobs, and demand creation, and for that substantial growth capital is required. It also pitched for self-reliance in capital funding of unicorns to cut dependence on funding from China and the US.
The committee also suggested that companies and LLPs be allowed to invest in startups without being classified as NBFCs by the Reserve Bank of India, in order to expand capital sources for startup financing.
“The Committee would like to strongly recommend that tax on LTCG be abolished for all investments in startup companies (as designated by DPIIT) which are made through collective investment vehicles (CIVs) such as angel funds, AIFs, and investment LLPs,” said the report titled ‘Financing the startup ecosystem’. The report was submitted to the Lok Sabha Speaker last week.
At a minimum, this should be done for at least the next two years to encourage investments during the pandemic period. After this two year period, the Securities Transaction Tax (STT) may be applied to CIVs in order to maintain revenue neutrality.
Since, investments by CIVs are transparent and at fair market value, it is easy to calculate the STT associated with these investments. Thus, it can be done in lieu of imposing LTCG on these CIVs and to make the taxation system fairer, less cumbersome, and transparent, it noted.
The panel also recommended that the exemption for income on investments be made before March 31, 2024, subject to the investments being held for a period of at least 36 months as incentivised in the Finance Act, 2020, and be provided to long-term and patient capital invested across all sectors.
“With adequate risk capital backing them, startups can provide innovative new services which can have a multiplier effect on the economy,” said the panel.
It pressed for adopting a more pragmatic approach on applying fair market value principles in transactions between independent parties as businesses are stressed for liquidity in the current environment and valuations of businesses have softened. The pricing guidelines are prescribed under the various laws and regulations by SEBI.
The Income Tax Act, Companies Act, Foreign Exchange Management Act (FEMA) should be made more consistent to provide a certain, coherent and simple framework for facilitating large-scale investments in India, the panel said.
The panel also batted for self-reliance in capital funding for unicorns, which now mainly comes from US and China. It said that the Small Industries Development Bank of India (SIDBI) Fund-of-Funds vehicle should be expanded and fully operationalised or utilised to play an anchor investment role. The term unicorn is used to describe a privately held startup company with a value of over $1 billion.
“Unicorns initially require seed capital of hundreds of crores, and then as they grow they need thousands of crores to build global scale businesses. The Committee notes in this regard that capital going into India’s unicorns comes mainly from foreign sources such as the US and China. The Committee believes that this dependence be reduced so that India becomes self-reliant by having several large domestic growth Funds powered by domestic capital to support India’s unicorns,” it said.