India: Scaling Up The Start-up Ecosystem – Recommendations Of Standing Committee On Finance

Recently, the Parliamentary Standing Committee on Finance (2019-20) (Committee) presented its Twelfth Report on the subject 'Financing the Start-up Ecosystem' (the Report) to the Hon'ble Speaker on 9 September 2020.

The Committee was tasked with the responsibility of recommending measures to enhance the availability of the risk capital to the start-up ecosystem in India with a particular focus on strengthening the Indian financial system so that more domestic equity capital is available to scale up the start-up ecosystems for building on the goal of Atmanirbhar Bharat.

During the sittings, the Committee acknowledged the importance of the start-up ecosystem in developing an innovation-driven economy and its role in recovery of the economy during and post COVID-19 pandemic. The various steps were taken by the Department for Promotion of Industry and Internal Trade (DPIIT) through different government schemes since 2016 were also noted. The Committee also considered several representations made by the private equity (PE)/venture capital (VC) industry representatives as well as consulted relevant ministries, including the Ministry of Finance (MoF) and Ministry of Commerce (MoC), Department of Economic Affairs (DEA), and various regulators in relation to the representations made.

Basis the above discussions, the Committee, in its Report, has made recommendations for the growth of finance to the start-up ecosystem. The paragraphs hereunder discuss the key recommendations made by the Committee.

Tax recommendations

1. The exemption under the Income-tax Act, 1961 (the Act) for income on investments made before 31 March 2024, in companies engaged in infrastructure as well as a collective investment vehicle (CIVs) subject to the investment being held for a period of at least 36 months should be extended to long-term investment across all sectors.
2. The long-term capital gains tax should be abolished for all investments in start-up companies (as designated by DPIIT), which are made through CIVs for the investments consummated in the next two years. After these two years, the Securities Transaction Tax (STT) may be applied to CIVs so that revenue neutrality is maintained, and capital gains from CIVs should be taxed at the same rates as those from listed companies.
3. The management fees paid by the investors to the fund manager of the alternative investment fund (AIF) should be deducted for computing capital gains.
4. The fund management services provided to foreign investors in AIFs should be treated as export services and not subject to GST in the hands of the fund manager.

Regulatory recommendations

1. The scope of start-ups may be further widened, promoting start-up culture across multiple sectors on a much larger scale.
2. A strong support system to finance the start-up ecosystem should be put in place to drive a sharp post-pandemic revival and sustainably high economic growth thereafter.
3. The dependence on the foreign sources of capital from China and the USA should be reduced so that large domestic growth be fueled by domestic capital to support India's Unicorns. Towards the achievement of this objective, the Committee further recommended that the role of Small Industries Development Bank of India (SIDBI) as a fund-of-funds vehicle should be expanded and fully utilized to play an anchor investor role.
4. The large financial institution in India should be encouraged to channelize their investible surplus into domestic funds, and the following specific measures are suggested to achieve the same:
   1. The Pension Fund Regulatory and Development Authority and National Pension Scheme (NPS) may be encouraged to invite bids from professional fund managers for running a fund-of-funds program. The conditions for investments by NPS in AIFs' should be eased, and that the pension funds could start allocating a small percentage of the corpus into AIFs.
   2. Major banks should join hands to float a fund of funds.
   3. Insurance companies should invest in a fund of funds set-up by the Insurance Regulatory and Development Authority of India (IRDAI) as well as directly in PE/VC funds with higher exposure caps.
   4. Foreign development finance institutions may also be encouraged to participate with local asset management companies to set up a fund-of-funds structure or direct PE/VC funds, particularly in social impact, healthcare and venture/start-up sectors.
5. The Securities and Exchange Board of India (SEBI) should allow VC funds to invest in Non-Banking Financial Companies (NBFCs).
6. The AIFs should be allowed to be listed on capital markets, and emphasis should be placed on the development of more domestic financial institutions on the lines of International Finance Corporation and the German Investment and Development Company.
7. The foreign venture capital investor (FVCI) route should be allowed to invest in all the sectors.
8. The foreign investors should be allowed to make investments in hybrid securities under the foreign direct investment (FDI) route at-least for a limited period to enhance the fund-raising capabilities of companies in these difficult times.
9. The pricing guidelines prescribed under the various laws and regulations by SEBI, the Act, Companies Act, 2013 Foreign Exchange Management Act, 1999 (FEMA) should be made more consistent in order to provide a certain, coherent, and simple framework for facilitating large-scale foreign investments in India.
10. Debt-free companies and LLPs should be allowed to invest in start-ups without being classified as NBFCs. Also, LLPs with up to 20 partners should not be classified as collective investment vehicles by SEBI

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