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The Indian startup ecosystem has high hopes for the forthcoming Union Budget 2022. Many are expecting that it will usher in new regulations – especially on the taxation front – to unshackle some of the knots that come in the way of realising the ecosystem’s full potential and sustain the momentum this segment witnessed in 2021.

The year gone by certainly set new benchmarks for the Indian startup ecosystem in terms of funding, the emergence of a record 44 new unicorns, exits through M&As, and listings on the stock exchanges. These have increased the confidence of all the participants – especially founders and investors.

The government recently declared January 16 as National Startup Day, recognising the crucial role that the ecosystem has played in bringing in investments, creating jobs, and mainstreaming technological innovation. Finance Minister Nirmala Sitharaman has long been supportive of the ecosystem, recognising that “they are leading India from the front in the reset and also in lifting the economy”.

Noting that the government has taken many steps to boost confidence in the startup ecosystem, Padmaja Ruparel, Co-founder, Indian Angel Network tells YourStory that a lot more can be done.

“There have been numerous changes for the better that have been implemented by the government over the years to make India the third-largest startup ecosystem globally, but now need those enablers to take it to a different scale,” says Padmaja.

The ecosystem faces significant roadblocks centred around taxation-related regulations that give pause to investors who are looking to fund new and innovative ventures. Padmaja gives the example of the requirement of a tax clearance certificate under Section 281, especially for a non-resident who has made investments into startups, which can become quite burdensome and bureaucratic.

The provision can also be applied to resident Indians upon earning a certain threshold of income, generated and this applies even to startup investments.

Boon of exits

Last year, many startups – including Zomato, Nykaa and Paytm – went public, raising the confidence of investors who now see an exit path for their investments. However, though Indian stock markets may not be able to absorb Indian startups from all sectors, especially the ones not in the spotlight.

V Balakrishnan, Chairman, Exfinity Venture Partners explains, “The government should allow direct listing of startups from overseas, especially those in the US market, as the risk appetite and understanding of deeptech ventures is quite high.”

This has been the key ask of the ecosystem as current regulations stipulate that ventures that are headquartered out of the country need to first list domestically before going public overseas. Industry observers believe reversing the policy would open a route for startups to attract a newer class of investors.

In the present regulatory environment, many startups look to flip their headquarters from India to Singapore or the US to give them better access to foreign stock markets.

ESOPs tangle

The other key impediment has been the high incidence of taxation on Employee Stock Option Plans (ESOPs). This employee retention tool gained a lot of traction last year as numerous startups focused on retaining talent given the high demand.

However, ESOP beneficiaries need to pay tax at points of transaction i.e., during the time of exercise and sale of the shares, which can work out to around 40 percent on the gains made – a steep amount for any employee in a startup. Adding to this, the stock is illiquid ie, these are not publicly listed.

Balakrishnan says, “New laws can be brought in where a provision can be made so that the beneficiaries can carry forward the tax liability till the time of listing of the startup.”

Given the prowess of the ecosystem which attracted more than $30 billion in 2021, leading to 44 startups crossing the billion-dollar valuation mark, many have pinned hopes on Budget 2022 to create an environment for further fund flow.

The proposal from the market regulator Securities and Exchange Board of India (SEBI) has put some shackles on the venture capital industry. Examples like having merchant bankers on the table when a VC fund seeks SEBI approval, or the responsibility of liability on the investment committee of the fund, only adds to the compliance burden.

“We need the unshackle the venture capital industry in the country and bring in regulations that are on par with global standards,” says Padmaja.

Industry observers believe that there needs to be a different yardstick while making taxation rules for startups as these are new-age businesses.

Focus on crypto

Another aspect that will be keenly watched from the forthcoming Budget is the commentary on cryptocurrency. As of now, there is no clarity on the legality of this digital currency, with the government remaining non-committal about the entire issue despite there being a proposal to ban all such transactions.

Sharan Nair, Chief Business Officer, CoinSwitch Kuber believes that crypto would be better off as an asset rather than a currency, given the various payment options in the country, adding that cryptocurrency is the gateway to the new world of Web 3.0.

He notes, “A well thought-out and progressive regularised environment will aid Indians to start their crypto investing journey, align with the government’s vision of financial inclusion, and inspire modern technology startups to build world-class products that are made in India.”

A lot is riding on the Indian startup ecosystem as it has achieved a certain level of maturity while also pushing boundaries in terms of business and technology innovation. The hope is that Budget 2022 give a further boost to enable the ecosystem to open new avenues of business that is in step with the rest of the world.