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Why startups flip abroad— By Pallav Pradyumn Narang

tax, taxes, calculator

By Pallav Pradyumn Narang

One of India’s most notable and successful angel investors Sanjeev Bikhchandani has come out vociferously against the trend of Indian startups flipping to foreign jurisdictions, particularly the US state of Delaware.

I have linked the article above and have also summarized his main assertions against the concept of flipping below :

  1. It robs India of intellectual property and data
  2. India loses tax revenues
  3. India loses Market capitalization
  4. Indian investors get shut out

I am attempting to respectfully counter Sanjeev’s comments with utmost regard for his work.

Intellectual property and data

This is partially correct, since in a flip scenario the Intellectual Property (IP) ownership is passed on to the new parent company. The nuance here is that in the case of established startups where the IP has already been created, this transaction happens at a certain prescribed value that brings in monies into India and is thus, not a one sided transaction. In the case of fledgling startups, the IP is often valued next to nothing and thus, India does not lose anything.

Overall, by raising funds through a foreign parent, Indian businesses are able to get growth capital. This powers salaries and marketing initiatives in India. While one is free to raise questions on IP and data location, ultimately the value derived by this IP will be subjected to tax in India. With respect to data, my counter question is that when it is stored in an offshore Amazon Web Services (AWS) server, does it really matter if the Indian subsidiary or the foreign parent owns it?

Loss of tax revenue

Businesses that are creating businesses in India by employing people in India and are accessing customers in India do already create substantial value in terms of taxes, both direct and indirect. Further, in the eventual case of an exit, if more than 50% of value is derived from India the proceeds will ultimately be taxed in India. This is enabled by Indirect transfer provision that was enacted post the landmark Vodafone judgement. Therefore again, India does not lose out on tax revenue.

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Even more safeguards have been provided via the Place of effective management (PoEM) rules which dictate that any foreign business which is substantially controlled and operated from India will be considered an Indian business for tax purposes and will be subjected to tax in India. Tax rates in India are very competitive and measure up with the best in the world. With a mixture of the above and General Anti Avoidance Rules (GAAR) it is very unlikely that the Indian exchequer ends up losing revenues.

India loses market capitalization

To this point, I have a simple poser. Does market capitalization mean value to India?

Can Flipkart list in India?

Is access to foreign capital or foreign debt bad?

Would Sanjeev want a look at how most funds are structured ?

Indian investors get shut out

This no doubt is an outcome of the flip. More so because of a September 2019 amendment in the RBI FAQs that restrict Indian participation in foreign entities with Indian subsidiaries. 

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However, founders are making a measured call to choose between Indian investors or their global cohorts. The choice to flip is also governed by the investor as opposed to an outcome of regulations. Even with the friction of the flip and considering that they gain no tax benefits at all.

Should we not instead focus on tangible improvements in the ecosystem that ensures that we are able to nurture and grow these companies with a mix of Indian capital as well as Indian mentoring. Scores of start-ups gush over the quality of advisory and mentoring received from foreign incubators whilst the same quality is very rarely accessible to them in India.

The larger question therefore is, if the Indian investor ecosystem is so great why are founders making a beeline to get money from foreign investors?


A quick Q&A

MediaNama: What drives startups to flip abroad?
Pallav Narang: The benefits of flipping are not driven by a decision to arbitrate between different tax jurisdictions but rather, there are other benefits such as of access to incubators, advisors, financiers, investors and the wider-ecosystem.

MediaNama: Do startups gain a tax advantage by setting up foreign holding companies?
Pallav Narang: On the tax side, it is not so simple to escape tax authorities in India and if the startup is providing a service to foreign market they will have to pay taxes there taxation policies across jurisdictions are competitive, for instance in California the tax rate stands at over 28% whereas in India it is at 25%.

MediaNama: Does the Indian government lose tax revenue through these financial structures?
Pallav Narang: Even if the parent is abroad as the product is being sold in India, revenues are still earned by a subsidiary in India and taxes are being paid. There is no revenue loss when it comes to investments from outside India whether they flow into India or into a foreign jurisdiction first. Ultimately, all that money is coming to be invested in India. All that the startup and founders are doing is bringing the funds from the US to India. All the while the employees, market, products and the founders themselves continue to be in India.

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This article was first published on Pallav Pradyumn Narang’s personal blog. It has been cross-posted with the author’s permission.

Disclosure: Pallav Pradyumn Narang, is a partner with CNK RK & Co in the tax and regulatory space, and advises businesses with respect to Flips and flipping arrangements. Opinions shared here are strictly personal.

Edited by Advait Palepu

**Update (December 11,2020 at 4:25pm). Updated headline and disclosure. Originally published on December 8, 2020 at 5:40 pm.

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