Kafka Devises Renewed Tax Terror for India's Startup Angels
(Bloomberg Gadfly) -- Foreign investors in India aren’t the only ones to be dealt a blow by the local tax authorities: Some startups have it worse.
Last week saw the reintroduction by New Delhi -- after a decade and a half -- of a long-term capital gains tax on equities.
Taxing capital assets is hardly a novel idea. Many jurisdictions, including the U.S., impose a levy on stock-market gains. But usually on their own citizens and companies. India, however, already takes 15 percent of any profits on Indian shares held for less than a year from locals and foreigners.
It also imposes a transaction levy on buyers and sellers regardless of investment outcome, and has closed a loophole through which investors could avoid paying the tax on gains by accessing its markets from Mauritius or Singapore. It has even tried, in the past, to tax investors in India-focused offshore funds, but backed off when fund managers complained about the impracticality of collection.
Now, the government wants to go a step further and demand 10 percent of profits from shares held longer than a year.
This is problematic on several levels. For one thing, the announcement comes amid the biggest selloff in global stocks in seven years. For another, the Indian economy is finally emerging from a long investment slump. Steady improvement in corporate profitability, after years of pressure from stretched balance sheets, is helping to narrow the gap between analysts' expectations of companies' future earnings and what they've earned in the immediate past.
When animal spirits revive in India, they cause domestic demand -- including for imported crude oil -- to spill over and trigger a resource shortfall. To put off foreign investors at this critical juncture is folly.
Worryingly, this isn't a one-time tinkering with what should by now be a settled tax code, but part of a dangerous pattern of overreach. The authorities are taking such a dim view of capital accumulation they're even telling some startups to pay income tax on fundraising. It's being pejoratively referred to as the "angel tax," and it's threatening to crush enterprise:
I went through one such Kafkaesque angel-tax notice. In it, the officer had flatly rejected a young, fast-growing firm's claim that early-stage investors had found it to be worth $350,000. In the bureaucrat’s opinion, the firm's future projections were fabrications, its fair market value based on current assets was negative, and so all the money it had received as share premium must be taxable as "other income."
Imagine how discouraging it must be to raise a bit of capital for a fledgling venture, only to be asked to hand over a third to the taxman. Is this how India is going to produce its own Amazon.com Inc.?
If authorities are worried about money-laundering, it would be a lot more prudent to ask whether the source of financing is legitimate. But for bureaucrats to sit in judgment of what a private firm -- however small -- is worth is beyond ridiculous. It does harm both to entrepreneurs and the millions of jobs they need to create every year.
Hasmukh Adhia, India’s top finance ministry bureaucrat, justified the tax on long-term market gains by saying capital appreciation isn’t the product of any effort, and if he were to tax it, firms would invest more in real assets like plant and machinery. "Financialization of corporate savings" would be kept in check, Adhia said. To see the logical absurdity of this claim, consider the extreme proposition: Would there be a deluge of investment in new factories if India just abolished lazy, effortless moneymaking by shutting down the stock markets?
Separately, finance ministry mandarins are puzzled that, despite very high price-earnings ratios of listed equities, overall fundraising is subdued by historical standards. When a government outlaws 86 percent of the country's cash in one fell swoop, launches a half-baked goods and service tax and allows bureaucrats to determine a firm's equity value, a weak investment response can hardly be a surprise -- especially when companies are sitting on plenty of unused capacity.
Prime Minister Narendra Modi's 2014 election manifesto promised an end to "tax terrorism". Back then, it was the high-profile dispute with Vodafone Group Plc over retrospective taxation that worried investors. Four years later, the situation is actually worse because startups -- which don't have the ability to fight long and expensive legal battles -- are in the firing line.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.
To contact the author of this story: Andy Mukherjee in Hong Kong at email@example.com.
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