Many of the so-called “Indian startups” are actually registered outside India. It may come as a surprise when you discover the actual numbers. This process of shifting the domicile of a company from one country to another, typically for strategic or operational reasons is called Flipping. These startups employ mechanisms like holding companies in foreign jurisdictions and operating through a subsidiary in India. However, the tide is turning as some of these startups are now choosing to return to India, despite the significant expenses and complexities involved in the process.
One such example is PhonePe, which reverse-flipped from Singapore to India recently. This move required its investors to pay approximately Rs. 8000 crores in taxes to the Indian government. The process of returning to India encompasses more than just tax payouts; it involves merging operations, addressing ESOPs issues, and transferring assets, intellectual property, and personnel from the foreign entity to the Indian entity.
Despite the complexities and expenses, a few promoters and investors have favored reverse-flipping to India. Before discussing the reasons for this stance, we need to understand the initial need for startups to incorporate abroad even when their primary market, personnel, and permanent infrastructure are in India.
WHY DO STARTUPS REGISTER IN ABROAD?
There are a variety of reasons for such a move, necessitated mostly by early-stage investors.
- Access to Dominant Markets: Startups sought registration outside India to gain access to thriving business ecosystems in countries like Singapore, the USA, and the UAE.
- Tax-Friendly Regulations: Friendly tax rules in foreign countries have enticed startups to look beyond Indian shores. These jurisdictions often offer tax incentives, exemptions, or lower tax rates tailored to support fledgling businesses.
- Regulatory Ease and Simple Compliance: The burdensome compliance and regulatory landscape within India have played a significant role in pushing startups away. Complex bureaucratic hurdles, intricate regulatory frameworks, and time-consuming compliance procedures hinder innovation and rapid scaling.
- Absence of Regulatory Clarity: Earlier, the lack of regulatory clarity in sectors like cryptocurrency, drones, and e-commerce had created ambiguity for startups in India. Thus, investors were reluctant to invest in such scenarios.
- Funding Opportunities: Registering outside India helped startups attract foreign investment and funding. Foreign investors too may feel more comfortable investing in a company that is registered in their own jurisdiction or in a well-known startup hub.
- IPO and Exit Opportunities: Certain stock exchanges and mature capital markets abroad may be more attractive for startups considering an initial public offering (IPO) or exit strategies, such as mergers and acquisitions.
WHY ARE THEY PREFERRING TO COME BACK NOW?
Many of those startups have grown to a stage where maintaining an overseas base with distinct consumer markets and operations from India may no longer be advantageous. The complexities associated with multiple compliances and reporting requirements are proving to be a headache.
Moreover, the Indian market has experienced significant growth, presenting lucrative opportunities for these companies. India has widely improved in the “Ease of Doing Business” rankings as the bureaucratic red tape has loosened a bit.
Apart from these, the most important aspect is that the evolving landscape of India’s IPO market has become increasingly appealing. Compared to earlier times, the capital markets in India have matured. Recent policy reforms also have made Indian public markets more accessible and favorable for fast-growing startups. This accessibility to domestic markets provides startups with a smoother path for potential exits here.
PROPOSED MEASURES BY THE GOVERNMENT
The government too has begun to recognize the disadvantages of Indian startups registering outside the country, and it has identified significant steps to counteract the disadvantages associated with this phenomenon. One of the major disadvantages for the government is the loss of tax revenue when startups incorporate abroad. The Economic Survey 2022-23 highlights many measures required for encouraging reverse-flipping:
- Simplifying Inter-Ministerial Board (IMB) certification for startups.
- Further simplification of taxation of Employee Stock Options (ESOPs).
- Streamlining tax procedures and reducing uncertainty due to tax litigation.
- Facilitating capital flows by simplifying procedures and reducing restrictions on the inflow and outflow of capital.
- Chalking up easier corporate laws, drawing on the corporate frameworks of the United States and Singapore.
- Collaboration with established private entities to develop best practices and mentorship platforms for startups.
- Exploring incubation and funding opportunities in emerging fields like social innovation and impact investment.
The government also plans big to attract many of the fintech startups to register in the GIFT city. It has established an expert committee recently to identify the required measures for the purpose.
CHALLENGES
The change in the Indian business landscape and the earlier discussed reasons have provided start-ups with more than enough reasons to flip back to India. But is it so simple?
A common method to shift back to India is through a cross-border merger of the holding company abroad with its Indian subsidiary. However, it is a complex process with many implications. The homecoming may result in huge tax payouts for investors and resets of the vesting period for ESOPs for employees. In addition to the aforementioned challenges, there are other notable drawbacks to consider, including the potential loss of grandfathering benefits and the ability to offset losses in the future. Not many investors would be willing for the startups to shift back home at such staggering costs and disadvantages.
Ultimately, as voiced out by the PhonePe CEO, the issue is that there’s no distinction in Indian law between a restructuring where the pre- and post-beneficial owners are the same. There are many voices within the startup community advocating for further reforms.
Moving forward, it will be crucial to closely observe how the proposed ideals and measures outlined by the government are implemented and executed. While the steps taken by the government to address the challenges faced by startups incorporating abroad are commendable, their actual implementation and effectiveness will determine their impact on the startup ecosystem. Many startups are eagerly awaiting the government’s supportive hand-holding to facilitate their return to India.
