Startup spur needs budgetary push

Budget 2023 will need to address the needs of the 87,988 recognised startups in India, which constitute the third largest startup ecosystem in the world. These startups, which are present across multiple sectors—IT services, healthcare, education, professional and commercial services, and agriculture among others—have not just placed India on the global startup map, they have also contributed significantly to the nation’s Gross Domestic Product (GDP) and employment. In September 2022, there were 107 unicorns in India, with an aggregate valuation of USD 341 billion. Further, according to the Department for Promotion of Industry and Internal Trade (DPIIT), as of November 2022, Indian startups had contributed to more than 8.6 lakh direct jobs.

One of the biggest challenges startups face is access to funding, which has been exacerbated in the last year. Thus, while the Covid-19 pandemic, especially in the initial period, witnessed a growth in venture capital funding, the situation has been grim globally since 2022, leading to the usage of terms such as “funding winter”. Indian startups too have witnessed a drop in funding from $37.2 billion in 2021 to $24.7 billion—a massive 35% drop—in 2022. A PwC India report placed the figure for such startup funding in India at $2.7 billion in 2022 Q3, which was the lowest in the last two years.

The government may help startups ease their funding challenges through specific budgetary provisions aimed at startups.

One such budgetary provision relates to easing the requirements for tax exemptions available to startups. Currently, only those entities which meet the definition of startups under the Startup India Action Plan can avail of recognition and tax exemption.Recognition itself is based on the requirement that the entity should have a turnover of less than ₹100 crore in any financial year, should be up to 10 years from the date of incorporation, and further the condition that “the Startup should be working towards innovation/improvement of existing products, services and processes and should have the potential to generate employment/create wealth.” Some of these conditions, especially those pertaining to the requirement of working towards “innovation” may involve subjectivity. Startups may find it cumbersome to fulfill such requirements.

Further, entities recognised as startups need to have an Inter-Ministerial Board (IMB) certification to qualify for available tax benefits. This certification is provided by the IMB set up by the Department of Industrial Policy and Promotion (DIPP) for the purpose. Less than 1% of India’s startups have opted for such certification. With the high rate of startup failures, facilitating startups through friendly and easy tax exemption policies may go a long way towards facilitating a robust startup ecosystem.

Another problem which has prevented Indian startups from truly realising their potential is the Indian business environment. This has led to a phenomenon of “flipping”, where many Indian startups prefer to launch their operations abroad and be headquartered outside India. While having headquarters abroad does help, particularly tech companies, with finding markets, and customer-facing expertise, it also allows them access to cheap funding. Such incorporation of startups outside India, especially the valuable unicorns, would have ramifications for India’s GDP. Further, there have been calls to allow listing of Indian startups overseas so as to allow such startups to tap foreign capital, allow for raised valuations, greater brand recognition and allow for specialised investors to invest in these companies.

The impact of shifting headquarters or listing overseas would mean a loss of domestic wealth, since Indian intellectual property, labour and customers are responsible for such wealth. While the jury is still out on the “merits” of allowing startups (and indeed Indian companies) direct listing , the government in its Budget 2023, may allow for tax incentives to companies which are headquartered and listed in India. Such tax exemptions may be provided to the VCs and investors in such startups as well.

The government may use creative methods to ensure that the benefits of the startups, which receive such tax exemptions, are large and contribute to equity. For instance, startups may be judged as worthy of tax exemptions based on the extent of employment or foreign exchange generated. Those which can additionally contribute to reduction in social problems (those which have a high social benefit ) may be incentivised for longer tax holidays, say 10 years.

A third area which may benefit from government intervention is tax exemption on courses carried out by Higher Education Institutes for promoting entrepreneurship. Currently, only core educational services are GST-exempt. Taxes on courses for MSMEs run by HEIs are also less problematic, since participants can claim the benefit of input tax credit. The same is not true for aspiring entrepreneurs who enrol for entrepreneurship courses. The government may think of allowing a deferred set-off for such fees paid. Finally, the government may also issue specific capital gains bonds to fund early-stage startups. Investors may seek to invest in such bonds to avoid long-term capital gains tax, while at the same time earning interest on such bonds. These bonds may have a lock-in period of five to seven years, and may be used to support and finance the incubators and accelerators in the country.

Startups have traditionally relied on private sources of financing, such as private equity firms, venture capital firms, angel investors and corporate venture capital. A policy push of the sort that Startup India (2016) provided to the startup ecosystem in India would be needed to help startups navigate the turbulent waters of the current business environment, besides the funding winter. There is much hope and expectations from Budget 2023—the last full budget to be presented by the current government—for the Indian startup ecosystem!