Why early stage start-ups should be domiciled in India

Naganand Doraswamy |Vaibhav Manek | Updated on: Aug 04, 2022
Startup India is the government’s flagship initiative to boost entrepreneurship, economic growth and employment across the country

Startup India is the government’s flagship initiative to boost entrepreneurship, economic growth and employment across the country | Photo Credit: LIGHTCOME

Decision to invest is best determined by the quality of start-ups and not by where they are domiciled

Dealing with the regulatory environment in India needs constant effort and expending of resources by a founder/entrepreneur. In recent times, many Indian start-ups and companies have been venturing abroad. The current trend for start-ups selling globally is to domicile outside of India, especially in the US and Singapore.

Many start-up accelerators and venture capital funds have been pushing their Indian portfolio companies to flip structure to become US-based.

The key reasons why they prefer to domicile outside India are: getting early access to investors and a better valuation later on; belief that they can get better tax treatment later on; M&As become easier as laws in certain jurisdictions allow several types of corporate business structures; and the belief that flipping is expensive

Form should follow function

What promoters and entrepreneurs often do not realise is that form should follow function, and a company incorporated outside India has some limitations. And they include:

The maximum permissible block limit for overseas investment by all SEBI-registered AIFs (Alternative Investment Funds) and VCFs (Venture Capital Funds) should not exceed $1.5 billion. Moreover, not more than 25 per cent of an AIF’s investible funds can be invested overseas.

Founders being in India, Intellectual Property (IP) still belongs to the Indian entity, and they have to pay tax when they transfer IP.

Need to put structure in place for transfer pricing (TP) and a continuous need for updated TP documentation.

POEM (Place of Effective Management) becomes an issue, as the additional structures are required to comply with the regulations.

Even though there are guiding principles issued by CBDT, final determination depends upon the facts and circumstances of the given case and value of transactions.

Potential issues of round-tripping and not being able to raise angel money.

Foreign companies will still buy Indian companies if they see value.

Startup India is the government’s flagship initiative to boost entrepreneurship, economic growth and employment across the country.

The government understands the current limitations and has been taking structural initiatives to create a business-friendly regulatory environment for residents to dissuade them from setting up entities abroad. Attempts have been taken to make sure that compliance regulations are minimal and/or made simpler.

An Indian resident founder, operating in the Indian market, has every logical reason to have India as the base country to set up a start-up entity. There are ample benefits for India incorporated entities. The intention is not to discourage founders from incorporating entities aboard because that is one of the vital ways of managing global business.

But incorporating an overseas entity or relocating a current company abroad is a complex task that requires a detailed analysis of the country’s legal system, current operations, tax benefits, and financial/logistics flows.

Except for crypto where regulations are yet to emerge, Indian rules are start-up friendly and the government is open to discussion and implementation of more favourable policies. All in all, founding a business in India is not only logical but advantageous for start-ups.

It is time that Indian start-ups convince the world that they should invest in start-ups domiciled in India. Decision to invest is best determined by the quality of start-ups and not by where they are domiciled.

Doraswamy is Managing Partner and Founder, Ideaspring Capital, and Manek is Partner, Business Advisory Services, KNAV India

Published on August 04, 2022
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