Budget Expectations: What are start-ups expecting this year?

25 Jan 2024 , 08:07 AM

 A TOUGH YEAR FOR START-UP ECOSYSTEM

It has not been the greatest year for the start-up ecosystem in India. The year hardly saw 2 unicorns being created. Start-up funding was at a multi-year low. To add to the woes, the extent of lay-offs by start-ups during the year stood at an all-time high. But, the most nerve-wracking of all was to see valuations of the start-ups erode. Just to give an example, Byju’s saw its indicative valuation erode from $22 billion to $2 billion and the company was desperate to raise equity even at these valuations. 

PE funds and VCs are wary about early stage seed funding, but are a lot more sceptical about late stage funding. However, all was not lost. The year did see many of the start-ups seeing their valuations written up again by global investors. Remember December 2023 alone saw $1 billion raised in start-up funding. It is in this context, that the finance minister will present the Union Budget 2024-25.

PAST BUDGETS HAVE BEEN RESPONSIVE TO START-UPS

It is not that past budgets have not been responsive to the start-up story. No less a person, than the prime minister himself, had called start-ups the fulcrum of India’s future growth. Even Nirmal Sitharaman referred to them as the engines of growth of the Indian economy. The adulation has not just been in words, but in action too. Here are some of the key announcements that have favoured start-ups in the past.

• The tax holiday for startups has been extended and the time period for which start-ups can carry over losses from changes in shareholding were enhanced from 7 years to 10 years. In addition, around 3400 law requirements were made less punishable, while around 39,000 compliances were sharply lowered. This has been complemented by a Rs9,000 crore credit-guarantee financial infusion. 

   

• An agricultural accelerator fund was initiated to support agri-tech startups to empower the entrepreneurs to introduce contemporary technologies and innovative solutions to farmers problems. The government also plans a digital public infrastructure for agri sector, which will be open source, open standard and inter-operable. 

   

• There has been a major accent on green energy with a budgetary allocation of Rs19,700 crore for the National Green Hydrogen Mission. In addition, a budgetary allocation of Rs35,000 crore for energy transition was also announced. Tax sops for regional last-mile connectivity were raised.

   

• With 5G taking off in a big way in India, the government has offered to set up 100 labs to develop apps based on 5G. These apps will cover use cases such as smart classrooms, precision farming, healthcare, and intelligent transportation systems to explore options. 

   

• The government wants to extend the make in India push to AI (artificial intelligence) also. Government of India will set up 3 centres of excellence for AI to explore areas where AI can be fruitfully applied. In fact, it will partner with top industry players to conduct research and develop applications and scalable problem solutions in areas like agriculture, health, and sustainable cities.

   

• The government has announced a National Data Governance policy with a Digilocker prep to it. Under the data governance policy, the government will share anonymized data with researchers and academia. It will also extend the scope of the Digilocker, a digital document wallet for citizens to assist in fintech sector innovation. 

   

• Let us turn to the progress on electronics. The government of India announced relief in customs duty on the import of certain parts such as camera lenses, and extended the concessional duty on lithium-ion cells for one more year. Like in the case of mobile phones, government also reduced basic customs duty on parts of open cells of TV panels. 

   

• Finally, we shift focus to electrical vehicles (EV) and drones. The government has also extended customs duty exemption on importing capital goods and machinery used to manufacture lithium-ion cells for EV (electrical vehicles) batteries.​​ Lower costs will help the domestic EV industry to grow at a rapid pace and also reduce the costs. Government has also encouraged Drone start-ups through the “Drone Shakti” program. This includes building various applications and leveraging Drone-As-A-Services (DAAS).  Specialized skilling courses will also be launched through the ITI on a pan-India basis.

To sum up the government push story, recent budgets have provided a major fillip to the growth of the start-up ecosystem in India. It is a long haul investment, so the real impact may only be visible over the next few years. However, that is not to detract from the wish-list that the start-ups have for the upcoming Union Budget 2024-25.

WHAT START-UPS EXPECT FROM UNION BUDGET 2024-25?

The good thing is that the government can afford to be pro-startups even in the interim budget. It is unlikely to invoke the model code of conduct and people are generally of the view that anything for the start-up ecosystem is good for the economy as a whole. Here are some of the key expectations from Budget 2024-25.

1. There continues to be a dichotomy between the way listed and unlisted equities are treated in India with respect to the imposition of long term capital gains. For instance, the LTCG on investments in private shares continue to be taxed at 20%, compared to 10% for publicly traded shares (on top of a base exemption). The contention of the start-up players is that they cannot be penalized at a time when they are actually taking the higher level of business risk. 

    

2. The levy of capital gains tax on investors also has a cascading effect on the start-ups. In most cases, start-ups are where the promoter and the business are almost attached to each other from the conception stage. Here, the business gets taxed, the dividends get taxed and the capital gains get taxed at a higher rte. Start-ups believe that such a high level of taxation can be a disincentive for risk-taking by companies. More so, considering that many of the start-ups are generating intellectual property for India, which will have long term implications as it moves towards its $5 trillion GDP target.

    

3. Start-ups have also been concerned about the inequity of taxing ESOPs (employee stock option plans) on the current model. Normally, the ESOPs are given by start-ups to retain and reward key employees at a time when the cash flows are still struggling. The issue is that, in the case of ESOPs, taxes are based on the difference between the Fair Market Value (FMV) and the actual exercise price and are paid as perquisites (salary) at the time of share allocation. However, there is no resale market for these unlisted shares. That means employees end up paying taxes even in the absence of any direct cash flows. There is the option of deferment of TDS on ESOP available, but that is not too practical.

    

4. The status of taxation of AIFs (alternate investment funds) continues to remain another major open area. In 2021, a tax tribunal had declared that even VC, PE, and MF companies operating under trust structure, were subject to indirect taxes on expenses incurred. This refers to the applicability of GST (goods and services tax), which replaced service tax in July 2017. It has been clarified that this would also include the carry fees on fund expenses; which is the part of earnings paid to fund managers based on the performance of the fund. While salaries and other costs are subject to taxation; they need clarity on the taxability of such fees paid to the fund managers. 

    

5. As part of the OECD proposals to promote business in India, India is required to provide a roadmap towards the implementation of equalization levy (EQL) and Significant Economic Presence (SEP) implementation. However, start-ups have some concerns here. Firstly, they want the SEP regulation to only apply to digital transactions which has a metric that is quantifiable. The start-ups are seeking a clarification to eliminate the duplication of SEP and EQL provisions. This will ensure that the eligible EQL exempted income is not attributed to SEP. 

    

6. The production linked incentives (PLI) for specific products have been extremely effective in boosting exports and reducing the import volumes. In areas like mobile phones, India has names like Apple relying big-time on India as a manufacturing base and three is more such gravitating expected. Start-ups want the scope and the sector coverage of the PLI program expanded considerably and aggressively. The are also asking for the introduction of a Phased Manufacturing Plan (PMP) for new products. Start-ups also want a one-time amnesty scheme for subsuming past disputes, but that is highly unlikely in an election year.

    

7. M&A tax or the tax on mergers and acquisitions remains a moot point in India. Most of the PE funds are looking for a delicate balance between profitable exits and fair valuations. That is the nature of the business. One moot point is the compensation to the Promoter for meeting specific performance goals. The question is, if such payouts are taxable, then will the taxation be on transfer or receipt? The demand of start-ups is that to make M&A meaningful to start-ups, such tax should be when the gain is crystallized, regardless of the timing of the transfer. 

These are some of the major expectations. We shall now look at the expectations of the Fintech sector (the breeding ground for start-ups separately).

WHAT FINTECH START-UPS EXPECT FROM BUDGET 2024-25

The fintech companies have been typically operating at the confluence of technology and finance. Here are two of the key expectations of the fintech sector. Firstly, Fintechs have long been demanding GST filing exemptions for smaller fintech companies to reduce the tax burden and also reduce their costs. The whole idea of fintech is to make financial services available to the last mile and exempting them from GST up to a threshold will help hold costs at a lower rate. In addition, the budget should also explore the idea of GST subsidy for fintech and financial infrastructure companies that are specifically catering to Tier II, III, and IV towns. These outfits play a big role in financial inclusion, after all!

Secondly, many fintech companies are into the co-lending business where they provide the last mile specialized connectivity for large banks and financial institutions. Fintechs want modifications to the FLDG (First Loan Default Guarantee) model, where the bank / NBFC reimburses the Fintech company in the event of a default by a borrower. RBI standards for digital lending have been relatively tough. In addition, the fintech companies also expect the Budget 2024-25 to offer some leeway on the rationalization of the input tax credit (ITC) system for GST on co-lending agreements.

Finally, there is the need for more ease of doing business as well as a more responsive regulatory framework. To begin with, we need an environment that facilitates easy credit, reduced rates of interest, longer moratoriums and a slew of innovative financial instruments that are tailor-made for the start-up ecosystem. Broadly, start-ups also want higher allocations for promoting technology, innovation, and skill development. Today, there is a huge gap between the skill sets needed by start-ups and the skill sets available. The Budget can intervene and make focused allocations for skill development programs and training initiatives to enhance manpower employability and bridge the skills gap. Skillsets are going to be the big challenge for start-ups and that is what the budget can focus on this year.