Interns from startups FEAST Software, Vegayan Systems and TRI Technosolutions at IIT Mumbai. (Abhijit Bhatlekar/Mint via Getty Images)
Snapshot
  • Indian companies need a level-playing field to compete with global giants. Only one power can provide it — the government.

India is currently amongst the top five countries in the world in terms of startups. Startups have demonstrated promising potential and have been in central focus in India. They also play an important role in economic development given the fact that they have a potential to create jobs across the economic strata of society.

Therefore, building an ecosystem for startups is more than necessary in the coming decade for India as the economy transitions into an innovation economy, which if not adequately backed by favourable policy and government support, can become a potential regret point for the decade after.

India, with its vast consumer and seller base in goods and services, can easily aspire to become one of the world leaders in the space of Internet-based startups, which is currently controlled by entrepreneurs from the US and China. To create the next wave of jobs across the economic strata of society, India has to move beyond its dependency on large industrial houses and big multinationals, as these largely cater to only a skill pool that is either knowledge-based or skill-based, and has a mid to high capability level.

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India has to look at ways and means to boost entrepreneurship, especially in e-commerce space, which promises to be one of the fastest growing sectors with a huge potential to attract investments far beyond the traditional investment areas. Campaigns and programmes like ‘Startup India’ can only succeed if they are adequately backed on the ground by ease of doing business, and fewer onerous regulatory compliances for those operating in India and for those with businesses registered in the country.

Currently, many overseas-based firms operate with unfettered access to Indian markets without having a permanent establishment in the country, and are often found deficient in compliance of prevalent local laws under the cover of self-interpreted international regulations. The Internet sector has the potential to be among the largest in India, as it is in the US/China ($1 trillion-$2 trillion market cap).

Internet is likely to be amongst the largest industries in India — similar to or larger than banking, consumer, healthcare and automobiles. It is critical that the government acts to ensure that Indian Internet-based startups have a significant presence in key sub-sectors of Internet. The largest sub-sectors of Internet-based technology startups are in areas of e-commerce, ride-sharing, travel and accommodation, food tech, search, classified advertisements and social media.

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If the government is able to put in place favourable enabling policies, it can contribute to greater gross domestic product (GDP) growth and to entrepreneurial spirit in the economy wherein innovative companies will emerge to become job and wealth creators for the country.

Currently, almost all of the 10 largest startups in India by revenue are competing against global brands without any government support. In the case of China, the government made it possible for Chinese Internet firms to grow through a ring-fenced protectionist approach. The same, however, may not work in India, as we are administered and run differently as a democracy with an open economy.

In Europe, the entrepreneurial ecosystem did not develop, as governments did not provide support to European firms. According to various estimates, the market value of European Internet firms is only $60 billion (1/15th that of Chinese firms), even though the European economy at $17 trillion is two times the size of China.

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According to Forbes, entrepreneur-driven firms in China were responsible for 75 per cent of GDP growth that occurred in China between 2000 and 2015. With a supportive policy environment, Chinese Internet firms became a favourite of foreign investors and attracted over $300 billion of foreign direct investment (FDI)/ foreign institutional investment (FII) inflows (cumulatively, 2005-2015).

In Europe, where European Internet firms did not have a supportive framework, only $50 billion of FDI/FII was cumulatively raised in 2005-2015. Currently, the US has domination over the global Internet-based e-commerce space followed by China. It is interesting to note here that the US model is led by American corporations, who have grown over time to become large corporations, which have always sought and fought for free and unregulated global flow of data.

The Chinese model, which is a form of state-directed capitalism, has through its innovative adaptations to the digital context, been equally and extraordinarily successful. For the startup sector in India to take off in a big way and become the next billion/trillion dollar enterprise of the future, it is important that the government looks into the following strategies, some of which are short term, some medium term and others, long term.

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Level-Playing Field

A level-playing field should be created between Indian and overseas e-commerce companies (not having permanent establishment in India) on matters of tax, goods and services tax (GST), Reserve Bank of India (RBI) regulations applicability etc.

Currently, all India-based Internet firms rendering services to residents through their website or mobile applications need to register their India operations and pay GST, and also comply with all necessary RBI regulations. But there are many international Internet firms not having permanent establishment in India or which operate through liaison and marketing offices, and continue to serve Indian consumers without having any local entity or direct presence in the country. They, therefore, escape the applicability of GST as well as RBI regulations. This not only leads to tax revenue loss to government, but also makes the services of such companies cheaper than that of any India-based service provider due to lower compliance and tax costs.

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Some of these also leverage even the postal route to deliver goods, bypassing laws of the land. Many of the overseas-based Internet companies that are engaged in any of the e-commerce business, but having no physical entity or establishment in India do not pay GST on the grounds that they do not have physical presence in the country. Hence they are not required to undertake such compliances.

A reference to this was made in the FAQ on tax collected at source (TCS) published by the Ministry of Finance, dated 28 September 2018, wherein vide question number eight, it was clarified that foreign e-commerce operator (ECO) would be liable to collect TCS on such supply, and if foreign ECO does not have physical presence in a particular state/Union territory, he may appoint an agent on his behalf.

The biggest challenge emanating on ground is to ensure compliance by the foreign ECOs. This ideally should be addressed through a clarification that foreign ECOs, not having any physical presence in India but selling in India, would also be required to obtain registration in India and appoint a representative for undertaking necessary compliances under Section 9(5) of the CGST Act. If this is not addressed, it will continue to hurt all genuine e-commerce players, who operate with a sense of compliance to the laws of the land, and they would lose significant market share, thereby stunting growth and promise.

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Another aspect hurting growth of startups in India is the underlying issue of taxation of angel funds. Until the law is suitably amended, startups and emerging companies in the Internet space would continue to suffer angel tax that wipes away a major chunk of investments coming into India. Since 2017, startups have been raising the issue of taxation of angel funds under Section 56 of the Income Tax Act.

IPOs

India has witnessed an unprecedented increase in the number of startups that have grown well in the Internet space. These companies have become major employment generators in India with an estimated 200,000 jobs added every year, and attract foreign investment of $10 billion, annually. The business model of these companies like in the US, China and Europe is to primarily focus on growing revenue or gross merchandise value (GMV) in order to rapidly scale the business in the initial years, and subsequently aim to generate profits.

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In order to grow their businesses rapidly, Internet companies undergo multiple rounds of capital infusion in early stages of their business, mainly from foreign investors, that lead to significant dilution of ownership of the founders. While these companies successfully attract equity investment from strategic foreign investors, there are significant roadblocks for these companies to raise equity or undertake a public offering of securities in the Indian capital markets.

Considering that the regulatory framework in other jurisdictions are more favourable to such business models, Internet companies may consider the option to undertake a public offering on international stock exchanges. Should Indian Internet companies prefer to list on international stock exchanges, it will adversely impact the country’s ‘ease of doing business’ index, tax revenue collection and domestic investors’ ability to participate in mega public offers.

The Institutional Trading Platform (ITP) introduced by Securities and Exchange Board of India (SEBI) is a revolutionary step to facilitate listing of startup companies. However, it may not be suitable for high growth Internet companies (HGIC), which have scaled up and achieved revenues and valuation that is comparable to that of companies listed on the Main Board of the stock exchanges in India (Main Board), but continue to face listing barriers to access the Main Board.

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Additionally, the current regulatory regime restricts retail investors to participate in the public offerings on the ITP. It is advisable to create an enabling regulatory regime for HGICs to list on the Main Board with a dual-class equity shares (DCES) structure. A DCES structure is one where a few shareholders, more often than not the founders of the company, hold a significantly higher percentage of voting rights in comparison to their share in the equity share capital of the company.

In addition, equity shares carrying ordinary voting rights are listed on the stock exchanges, while the equity shares carrying superior voting rights remain unlisted. Dual-class companies have existed for nearly a century globally, going back to the Dodge Brothers’ IPO in 1925 and Ford’s IPO in 1956. Companies like Google, Facebook, Alibaba etc, have had promoters or founders holding less than 20 per cent stock, but higher voting power with 50-60 per cent of control.

Not having a law which allows for a similar scenario in India may see many of our promising startups and growth companies getting sold or acquired soon as founders have no safeguards to control and run their dreams further. India may not be able to boast of trillion dollar valuation companies in the next decade as promoter dilution may have led to takeovers and control from a different perspective.

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GeM

Since the government is one of the biggest buyers and consumers in India, it would greatly benefit the startup and the Internet-based tech companies if they got access to this important segment of the market. After various representations and deliberation on the issue, the government is moving in this direction, which can lead to substantial savings and increased efficiency in government’s procurement of services.

On 13 December 2018, the Government e-Market (GeM) and Department of Industrial Policy and Promotion stated that they are in the process of developing a proof of concept corner for startups and will soon be able to take them onboard the GeM platform. Hence, it is important that Indian government participates and enables the emerging ecosystem of startups by being a contributor as well as a consumer, and supporting the next generation of entrepreneurs and strategic companies to emerge from the country.

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It is also important that the already established Indian companies are introduced in this space by government, immediately. So, startups are very critical to India’s economic and social growth besides being a huge provider of jobs and livelihoods across different economic strata of the society. India needs to create 10 million jobs every year, and global experience and facts show that it is startups and self-owned businesses with an entrepreneurial sense and not large enterprises that create net new jobs in any country.

Startups are increasingly becoming the centres of innovation besides contributing to technological advancements, lower costs and economies of scale. They act as catalytic agent for change, which results in a chain reaction. Once an enterprise is established, the process of industrialisation is set in motion. Developed nations are now looking towards India to gain maximum from this emerging business that has a huge disruptive potential.

It is important for the Indian government to support and help startups promote themselves, and not just in India but across the globe, by ensuring they are a part of key business delegations that go along with the Prime Minister and other key ministers. This will not only lead to promotion of startup ecosystem and livelihood, but also help in India’s long cherished dream of creating the next trillion dollar enterprises of the emerging world.

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Startups in the Internet tech space have been successful job providers not only for India, but also for Bharat, and today truly represent the face of an inclusive industry that has a huge promise. It is also important to note that this sector of the economy also has the potential to create data that will drive artificial intelligence in the future, as nearly everything today gets represented in data. Data-driven digital intelligence is the central element in reorganising us into a digital society and economy, and India needs to work towards creating its companies that will generate this important asset of tomorrow.

US took the first-mover advantage, and China leveraged its great firewall and informal state controls, for global digital leadership. A nuanced, rule-based, data ownership and level-playing field policy backed by access to capital through reforms in the capital market will ensure India’s chance towards this increasingly elusive goal.

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