Building businesses in Bharat’s regressive legal framework
I know of an early-stage company that made a minor copy-paste error in a few offer letters that nearly cost it Rs1.5 crore in legal and compliance costs. Put yourself in the shoes of the founder of this start-up that has limited resources, and 200 employees. Can you imagine anything more demotivating?
“Should I build my business or should I just keep running after consultants and lawyers?” This is a question that each of the several young entrepreneurs I work with have asked me more than once.
These are professional, first-generation entrepreneurs—law-abiding citizens trying to do their bit in the nation building process by building businesses and generating value and employment. They have invested most of their life savings, borrowed money from friends and family, and signed onerous terms with investors. And often, the regulatory system just piles on the pain.
The incumbents, namely large corporations and multi-generation family-owned business, have learnt to tackle India’s regressive legal framework in their own ways. Large corporations by deploying the might of their resources and family-owned business, well let’s just say, by “managing” it.
The first-generation professional entrepreneur is, however, caught unawares in the trap of legal mishmash. In the madness of getting the last detail of the product right, finding the first customers, spending sleepless nights in making the first deliveries, she misses out on a meeting compliance requirement. For the inspectors, she is an easy target—someone who is willing to accept her mistake and do what is required to do as per law, but is not willing to resort to unlawful appeasement. Penalties are imposed on her without a shred of empathy—the residuary penal provisions in almost all laws are enforced to the fullest extent, resulting in a hefty fine or even the threat of imprisonment for the most trivial issue. This is the reality of officer raj.
The entrepreneur, who has not taken home a decent salary for months, is now spending what little she has on lawyers and consultants. To make matters worse, her most precious resource—time—is frittered away in appearing before authorities.
The irony here is that while she is being punished for her failure to comply with the irrelevant fine print of law, there are others who blatantly flout its spirit. They pay hefty fees to lawyers and “structure experts”, finding ways around the legal verbiage to avoid taxes and execute “grey area” transactions. One example is how textile and gutkha companies exploited a loophole, which tied taxes to installed machine capacity by importing the parts of machines as spares and having them assembled on premises.
The creativity of these legal and structuring experts has not just resulted in losses to the exchequer—more importantly they have propagated a vicious tailspin in legal drafting, where increasingly banal and complicated laws are drafted with the sole purpose of plugging these loopholes. What we end up with is a legal framework which can charitably be described as an incomprehensible patchwork. One that not only has failed to check the actions of the “wrongdoers”, but has ensured that the honest entrepreneur always ends up with the short end of the stick.
The Indian Income Tax Act, 1961 holds the distinction of being the most amended piece of law in the world. Is it a surprise then that India lies somewhere at the bottom of the ease of doing business index?
The gazillion laws of our country require all businesses irrespective of size to obtain licences, maintain multiple registers and records (including a register for recording the frequency of whitewashing washrooms), pay numerous taxes and levies, and file periodic returns. It is nearly impossible for small businesses to be compliant with every requirement or every law applicable to them. In fact, it is a challenge just to make a list of all the statutes applicable. The ones who are willing to compromise on ethics find a way out. But those who are not, bear the costs, including being subjected to penal provisions.
The way out is not difficult—all it needs is the courage to ruthlessly scrap the overheads—clearly distinguish small and medium enterprises (SMEs) from the large ones and substantially reduce compliance points for them. Every law has its own list of records that need to be maintained, most of which are common across other laws/statues with minor variations. Small and medium enterprises should be deemed compliant if they have maintained a defined set of basic minimum records.
The frequency of filing of various returns should be reduced from monthly (or thrice a month in case of the goods and services tax), to semi-annual or annual. Registrations under all the statutes should be online, self-administered and automatic. Labour-related payments and levies (provident fund, employees’ state insurance, professional tax, contribution to labour welfare funds, etc.) should be consolidated under a single programme. Most importantly, the Companies Act needs to be modified from SMEs’ perspective and penal provisions for non-compliances should be linked to potential losses/costs to stakeholders resulting from the non-compliance.
Our entrepreneurs do not need any tax breaks or subsidies. They are capable of building successful businesses independent of these incentives. All they need is an objective and progressive regulatory ecosystem that allows them to grow their businesses without the fear of someone imposing steep penalties or putting them behind bars for an inadvertent violation of an insignificant section of an outdated law. The true potential of our country’s entrepreneurial talent shall be realized only when our legal framework facilitates an environment where “the mind is without fear”.
Kushal Agrawal is a partner and CFO at Aspada Investment Advisors. The Bharat Rough Book is a weekly column on building businesses for the middle of India’s income pyramid.