4 min read.Updated: 30 Jan 2020, 12:02 AM ISTSalman S.H.
Investors and founders also seek active participation of government for incubation, and easing of valuation norms for new startups
Double taxation on ESOPs held by employees has also been deterring what ESOPs are set out to do
Post the landmark Flipkart-Walmart deal in 2018, several existing and former employees of the e-commerce firm, including those across holding firms such as Myntra and PhonePe, turned multimillionaires overnight. Just days after the deal was made public, Flipkart and Walmart announced a $500 million ( ₹3,363.88 crore) employee stock ownership plan (ESOP) buyback from its employees. Some employees reportedly took home up to ₹7 crore in ESOP redemptions.
In 2020, startup founders and investors want the government to do away with dual taxation applicable to ESOPs, which serve as an important compensation tool for employees and for startups in helping reduce attrition rates. At present, startup employees are required to pay tax whenever they sign up for ESOPs with a vesting schedule and also pay a tax on capital gains whenever they redeem their ESOPs.
“ESOPs are meant to reward the team that helps build a successful enterprise. Current laws tax the ESOPs prematurely when options are exercised. ESOPs should be taxed only when an employee has realized a benefit with regard to the same. Taxation should follow actual gains and not notional gains. Moreover, founders/promoters should be permitted to receive ESOPs. This is currently not allowed," Kunal Bahl, chief executive of Snapdeal, said in an emailed response.
Double taxation on ESOPs held by employees has also been deterring what ESOPs are set out to do—attract the best talent pool available and retain the top performers.
“Employees can’t afford to pay income tax at the point of purchase of ESOPs because the stock is not public or liquid. This is why most employees leave their vested ESOPs behind when they change jobs," said Sameer Nigam, chief executive of PhonePe.
Startups also want active participation from the government for incubation and relaxation of public listing norms for companies eyeing IPOs.
“Angel tax continues to be a problem for many of the early-stage founders. This kind of capital (early stage) must be nurtured the most, because these are private individuals who are risking their own money and penalizing them on scenarios outside their control isn’t going to work," said Archit Gupta, CEO, ClearTax.
Early-stage deal volume increased to $1.15 billion in 2019, from $1.13 billion in 2018, but the number of deals came down to 387 from 416 in the same period, according to investment tracking platform Venture Intelligence. The steady drop in the number of early-stage deals from 540 in 2015, means that seed and angel investors are now cautious about the ideas they want to incubate.
Government agencies could provide tax holidays to startup incubators based on certain criteria, said Rameesh Kailasam, CEO of tech lobby group IndiaTech.org, formed by firms such as Ola, Hike Messenger, MakeMyTrip, and Quikr and investors SoftBank, Matrix Partners, Kalaari Capital and IDG Ventures.
“Incubators are important engines for nurturing and promoting startups. If an incubator depending on classification and size is able to reach certain specified thresholds in terms of startups incubated and employment generated etc., then these could be encouraged through tax breaks and other incentives," Kailasam said.
Early-stage investors and founders also demand that the government authorities do away with certification of valuations for new startups raising seed and angel funding. “The need for a valuation report should be mandated only beyond a particular threshold such as ₹25 crore of investment," said Yagnesh Sanghrajka, chief financial officer of early-stage fund 100X.VC.
Angel and individual investors need to show the value of shares to the I-T department, according to income-tax norms, and to determine this regulation dictates preparation of a valuation report by a government certified valuer. However, a certified valuer usually sticks to a valuation methodology determined by the I-T department. Startups and investors said that the conventional methods of valuation should be done away with. “Today’s startup valuations are based entirely on the customer base, whether the startup is an app or website, projection of the user base, and market opportunity online. But this may not be acceptable to the income-tax officer," said Preeti Khurana, chief editor, ClearTax.
“When the government looks at startups from a valuation standpoint for consumer internet-based startups to avail benefits from government, the methodology for valuations cannot be similar to the ones used for conventional businesses. These businesses being disruptive in nature are different in their initial years as metrics for growth are not profits as they are in a constant customer acquisition mode or building acceptability with the new age customers," Kailasam said.
Unicorns and bigger startup brands such as Oyo, Ola, MobiKwik, and Byju’s have been aiming go public to provide a favourable exit to its investors. Many late and growth-stage investors in these firms also expect large exits via IPOs rather than just secondary exits.
However, India’s public listing guidelines specify that a company needs to show profits for at least three years, along with a minimum promoter holding of 20% of the total paid-up capital. Kailasam said that India Inc. should start with doing away with minimum promoter holding requirement, which will allow tech startups to instead list on the Securities and Exchange Board of India (Sebi)-regulated Innovator’s Growth Platform (IGP) meant for SMEs.
“Indian startups are starved of exit options because of the listing norms that are antiquated and do not help the new age tech ecosystem at all. Several American companies over the past 10-15 years have listed on Nasdaq while they were loss-making and are now hugely profitable. Facebook, Square to name a few," said Upasana Taku, CEO, MobiKwik.