The recent collapse of the Silicon Valley Bank (SVB) in the United States, and its cascading effect on India’s tech startup ecosystem, has thrown a much-needed spotlight on why such startups domiciled – or resided – in the US in the first place, and why it is pertinent to bring them “back to India”.
Banks like SVB made aggressive bets on tech startups, for instance, by issuing venture debt which is a novel form of a loan collateralised against warrants on companys’ equity rather than tangible assets. Such financial innovation combined with an acceptance of new business models and an easier compliance environment draws startups to domicile in countries like the US. Consequently, approximately 38 per cent of all Indian unicorns are domiciled overseas, and nearly 20 per cent are headquartered outside India. These include recognisable brands such as Meesho, Groww and Razorpay.
Startups are India’s most potent growth engines and pick up on the slack of legacy businesses that have historically underinvested in research and development. Consequently, India’s digital markets outshine even developed economies such as the European Union. Bringing our startups back home can serve as a force multiplier – they will crowd technology investments and spur local innovation.
Bring Indian startups home
The homecoming of tech startups is possible via two policy changes. One option is to allow businesses to redomicile, that is, relocate their base back to India. The second is to allow foreign direct listing, under which overseas startups run by resident Indian entrepreneurs can list their shares on India’s stock exchanges. Both these steps will allow startups to generate local value and enable retail investors to participate in technology markets.
India’s capacity for retail investment has grown multifold over the last decade. The country’s securities market breached the $3 trillion mark in terms of total market capitalisation in 2021. Domestic investors have also matured and increasingly seek avenues to diversify their portfolios. This includes investments in specialised technology markets.
Additionally, with a median age of 28.4 years, India still has a relatively young population. In other words, there are the same number of people who are younger than 28.4 years in India, as there are those older than them. A young population implies a greater propensity to consume technology products and services. India already has the second-largest telecom market in the world with over a billion subscribers and is also inching toward a billion internet subscribers. According to an Indian Council for Research on International Economic Relations (ICRIER) report, “the average Indian subscriber generates 1.55 times the traffic of the G20 [countries] average”.
Policy challenges ahead
Although current trends in market conditions encourage Indian startups to return home, several legal challenges confront them.
A hurdle associated with redomiciling is that cross-border transfers of business and capital assets attract high taxes in countries like the US, which may dissuade foreign investors from enabling their portfolio companies to legally relocate to their primary market. For example, PhonePe’s investors paid approximately Rs 8,000 Crore in tax to shift base from Singapore to India. The move worked in the company’s favour since its investors had a multi-decade investment outlook, unlike private equity/venture capital investors that seek exits within five or seven years.
Enabling overseas entities to directly list on Indian stock exchanges would first require an alignment between the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), and local tax authorities. Subsequently, the government and the legislature will have to introduce a slew of legal and regulatory changes. This will include rules on Initial Public Offerings (IPOs), deposit and transfer of proceeds of such offerings to non-residents, and various compliance obligations in company law.
A 2018 SEBI report examined the tangible and intangible benefits of allowing foreign-domiciled companies to list in India. The former includes deepening of the local financial ecosystem, whereas the latter comprises improved economic diplomacy with trusted jurisdictions, with which we can explore such synergies without worrying about issues such as money laundering. These are atypical considerations for tax policymakers, but it’s time they take a holistic approach.
Develop a POET-approach
The lack of political will prevents the homecoming of Indian tech startups. The relocation of these companies is intrinsically connected to eschewing short-termism in tax policy in favour of more strategic, long-term benefits. For instance, the Place of Effective Management (PoEM) standard is internationally recognised, to determine tax residency and apply local laws. A business’ PoEM is where its key management and commercial decisions are taken. India needs to invent a similar concept – say, a ‘Place of Empowering Technology (PoET)’ – to support businesses that prioritise the country as a destination for product innovation and technology deployment by extending tax breaks and other incentives.
A PoET approach also aligns with the Narendra Modi government’s objectives to make the country self-reliant. Redomiciling and foreign direct listing help India leverage its startup ecosystem to unlock economic gains and help entrepreneurs safeguard themselves against shocks such as the collapse of overseas banks like SVB. And while redomiciling will catalyse taxable economic activity, foreign direct listing will also nominally bolster the exchequer’s coffers in the form of Securities Transaction Tax (STT) collections.
India’s startup ecosystem and tech markets are ripe for reforms. Looking ahead, policymakers must build consensus and take necessary steps to enable Indian businesses, as also markets, to realise their global potential.
