Tax considerations in the Expert Committee Report titled "Onshoring the Indian Innovation to GIFT IFSC"
1.1 Indian startup ecosystem has evolved considerably since the early days of economic liberalization. The startup ecosystem has become an engine of growth and job creation, transforming India into a global hub of innovation and entrepreneurship. Today, India has emerged as the third largest ecosystem for startups globally, with third highest number of unicorns. As per the Economic Survey 2022-231, India has become the most innovative nation in the lower middle-income group overtaking Vietnam and leading the Central and Southern Asian Region.
1.2 While, on one hand, India's startup ecosystem is achieving remarkable growth, on the other hand, a trend of Indian startups externalizing / flipping to offshore jurisdiction has been daunting.
2. EXTERNALIZATION / FLIPPING
2.1 'Externalization' or 'Flipping' refers to a process whereby the entire ownership of an Indian startup (along with potentially all intellectual property and data) is transferred to an overseas holding company ("Offshore HoldCo"). Such process of externalisation or the flight of innovation to overseas jurisdiction/(s) effectively transforms an Indian start-up company into a wholly owned subsidiary of an Offshore HoldCo with founders and investors retaining the same ownership through such Offshore HoldCo.
3. KEY FACTORS FOR EXTERNALISATION
3.1 The process of externalisation or flipping is motivated by several factors ranging from a favourable tax regime, access to foreign capital, prospects for better valuation and ease of operations.
3.2 Tax arbitrage, however, remain one of the most influential factors. For example, India's average corporate tax rate (25.17%) is significantly higher than the corporate tax rate in countries such as Singapore (17%), USA (21%), and UK (19%). Certain overseas jurisdictions offer additional tax benefits such as reduced personal tax rate, participation exemption, capital gains tax exemption, no thin capitalisation rules, etc – which encourages promoters / investors to set-up Offshore HoldCos.
4. IMPACT OF EXTERNALISATION
4.1 Externalization creates a peculiar situation for Indian startups, where the founders are generally Indians, the majority of employees are Indians, the activity being carried out is predominantly in India, but the holding company is domiciled offshore. Such an externalization results in movement of management, intellectual property, value creation, capital raising, etc; from India to the overseas jurisdiction.
4.2 As per estimates, 56% of 108 Indian Unicorn startups are domiciled in offshore jurisdictions2 - with US, Singapore and UK being the most popular countries where Indian start-ups are domiciled.
4.3 Externalisation impacts the Indian economy in several ways as under:
- Economic loss and brain drain of entrepreneurial talent: Externalisation results in relocation of founders and other key managerial persons outside India depriving Indian economy of their potential contributions. This process of brain drain leads to loss of human capital, as well as stalls innovation and technological advancements within the country.
- Loss of Intellectual Property and Technology leakage: Externalisation also results in transfer of IP and technology outside India primarily due to robustness of IP laws and enforcement mechanism in overseas jurisdictions such as in USA and Singapore.
- Tax revenue loss: Externalised Offshore HoldCos pay lower corporate tax in the overseas jurisdiction with respect to value created outside India – resulting in revenue loss in the source country, such as in India.
5. ROLE OF INDIAN GOVERNMENT AND IFSCA IN ONSHORING INDIAN STARTUPS AND SETTING UP OF A COMMITTEE
5.1 Government of India have taken various initiatives to integrate the Indian economy with global financial system. One of the prominent initiatives, is to set-up and operationalise India's maiden International Financial Services Centre ("IFSC") in Gujarat International Finance Tech City ("GIFT IFSC").
5.2 One of the primary objectives of GIFT IFSC has been to "Onshore the Offshore" i.e., to bring back the financial transactions and services business carried out in overseas jurisdictions by Indian entities. Government of India has time and again introduced several favourable amendments in the Income Tax Act, 1961, to facilitate a competitive tax regime for GIFT IFSC in comparison with overseas jurisdictions.
5.3 In line with its primary objective to Onshore the Offshore, GIFT IFSC is uniquely positioned to onshore the Indian startups that have flipped to overseas jurisdictions and has become an ideal choice for reverse flipping of these Indian startups.
5.4 International Financial Services Centres Authority (IFSCA) constituted a Committee of Experts3 ("Committee") to make suggestions on onshoring the Indian innovation to GIFT IFSC. The Committee was chaired by Shri G. Padmanabhan, Former Executive Director, RBI; and comprised of representatives from venture capital funds, startups, fintech firms, law firms and other domain experts. The general terms of reference of the Committee were as follows: Suggest measures to encourage the Indian Fintech / Startups domiciled abroad to relocate to GIFT IFSC.
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2. Data from 3one4 capital.
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