Startup Tax Clause A Bottleneck For First-generation Entrepreneurs

(The Union Budget 2012 has introduced a new clause which will treat all individual investments including genuine angel money in a company as "income from other sources," and these will be subject to a tax of 30 per cent at the hands of the companies including all genuine startups. The move has attracted wide criticism from various corners, as it impacts the still nascent but growing startup ecosystem in India. K. Ganesh has been a serial entrepreneur over the last two decades, starting companies like IT&T Ltd, CustomerAssets and Marketics. His most recent venture is the education firm TutorVista, where he continues as CEO after Pearson acquired 76 per cent stake last year. Ganesh, who is also an active angel investor, sends an e-mail to VCCircle, clearly voicing his take on the recent move by the government. Here's what he says:)

I am stunned by this retrograde step to introduce provision for taxing angel investments. It shows poor appreciation of the entrepreneurial ecosystem in general and risks, rewards and the key contribution of angel investments in fostering entrepreneurship.

Angel investment is absolutely critical for high-growth companies/industries... Google, Facebook and other mega companies first started as angel-funded companies.

High-growth companies create lots of jobs, attract high quality investment from VCs & PEs, and help India compete globally.

Angels play a crucial role in ensuring, otherwise scarce, funding is available for first-generation entrepreneurs to start businesses that potentially employ tens of thousands of employees, create wealth, create value for all stakeholders and help position India on the global map. Without continuous job creation, the much-touted "demographic dividend" will become "demographic disaster," with a growing young population becoming disillusioned and restless – without productive employment avenues. One of the top priorities of the government should be to ensure that thousands of new ventures would start, so that there is a vibrant "new job addition" to the economy by more and more people becoming potential employers than employees.

In this scenario, I am flummoxed that instead of encouraging entrepreneurship by ensuring tax incentives for angels to invest in startups, by creating venture debt through banks and financial institutions by treating early-stage startups as priority sector and by matching angel contributions with equal contribution from the government through debt or equity at soft rates, the bureaucrats are creating dis-incentives. Creating a venture fund through SIDBI shows that the intentions are good. So I hope this has been a step taken without proper homework and without considering all the ramifications, and will be reviewed and scrapped.

I really wish the government had consulted people familiar with the topic, such as angel investors, first-generation entrepreneurs and organisations like TiE, who would have given the right advice.

If this has been done as a knee-jerk reaction due to some high profile companies getting thousands of crores of investments to apply for licences, etc., in a questionable fashion, it is a case of cutting off your nose to spite your face. There are several ways to handle it. For instance, early-stage, lower-ticket angel investments up to Rs 10 crore could have been kept out of such taxes.

The entire concept of fair market price is very subjective and can never be determined, and gives rise to possibilities of malpractices in implementation. Angel investors and entrepreneurs get involved in very early stage, based on an idea, value the idea based on what it can be and invest accordingly. More than 90 per cent such ideas fail and angel investors write off the entire amount. Imagine the government taking 30 per cent off in taxes at the investment stage itself!

I really hope better sense prevails and budding first-generation entrepreneurs do not find more artificial bottlenecks, created by ill-informed government policies!