Startups Flipping To India Gain Pace In Fintech, Other Segments

Flipkart-backed PhonePe last year decided to domicile in India after paying a billion dollars in tax, and several others, including Razorpay, Groww and Pine Labs, have showed interest in doing so, the people cited above said on condition of anonymity. The companies did not respond to requests for comment.

Companies in regulated sectors believe the shift will help in compliance with local laws, while others believe it will help at the time of listing in India.

“Regulated entities are likely to move to India to scale their businesses by complying with regulations and aligning their interests with the regulator’s policy intent, while consumer companies may relocate to take advantage of India’s attractiveness, especially while listing at IPO, as the country will already have a sizable investor base familiar with their brand," said Gopal Srinivasan, chairman and managing director of TVS Capital.

However, software companies may not shift given their US focus, Srinivasan added. According to him, Indian tax laws are designed to be tough to prevent evasion, while the US focuses on facilitating business growth. Unless India eases tax law laws and creates a level playing field, software companies may not move, he added.

Corporate tax rates aren’t significantly different between India and the US; however, actions such as share swaps attract capital gains taxes in India but not in the US. Similarly, US funds can distribute shares to their limited partners without capital gains liability. “Therefore, it makes sense for foreign VCs to encourage their founders to domicile in the US," a tech investor said on condition of anonymity. This is especially true of companies backed by Y-Combinator, a US tech startup accelerator.

Historically, US investors encouraged startups to domicile outside India for lower taxes; however, Indian regulators prefer banking and non-banking entities to be locally registered, and RBI’s insistence on data localization is driving many companies to India.“Beginning with fintechs, the wave of data localization will require other companies across segments such as healthcare to come back to India, says Anurag Ramdasan, partner, 3one4 Capital, an early-stage venture capital firm.

For many startups, the domicile change would mean creating a company in India which would acquire the shares of the foreign entity, resulting in capital gains in India as well as the US. Another way is to acquire a bankrupt company in India and then reverse-merge with the foreign entity to bring down the capital gains outflow. “It is easier to shift from Singapore to India than from the US to India. The tax liability in the US to move out of its jurisdiction is steep," a second investor said.

Tax leakage is the chief consideration for all stakeholders; however, the liability will arise at both levels, but steeper in the US, said the founder at one of the companies cited above.

“Tomorrow, if you go for a deeper licence -- for example, a banking license or payment bank or small finance bank licence -- then getting it through an Indian entity might be easier," a unicorn fintech founder considering the move said.

For fintechs, licence rules are a bigger reason for moving to India than IPO-related reasons, a second fintech founder said. Still, the cost of shifting can be costly, the founder said, adding it could cost between $700 million and $1 billion for his company. Some of the burden is on the company and the rest on the investors. Given the steep costs, there has to be a strong reason for the shift, he added.

The way PhonePe shifted was quick but expensive, while there are cheaper ways to shift that take up to two years, he added, saving $100-200 million. “There are likely to be structures where the burden could be lower," he added.

Software startups have the least incentive to move to India since they don’t fall under regulated entities, and most of their clients are in the US. However, if they choose to list in India, they too may look at an Indian domicile, as such companies could get better valuations locally.

An investor with a homegrown PE fund said most software as a service (SaaS) companies would be valued better if they were listed in India than a large foreign stock exchange.

According to Sudip Mahapatra, a partner at S&R Associates, a law firm, demand for tech IPOs has slowed down. “Once the current situation improves, we are likely to see more many of these companies flipping back their corporate parent to India," he added.

“Indian founders need to actively choose whether to incorporate in India or the US/Singapore. In the early days, most did not think about this choice deeply. While back in the day, it seemed more advantageous to be domiciled outside India, the benefits of being domiciled in India are increasingly becoming clearer. It is tough for companies to move domicile from the US or Singapore to India at a later stage," said Puneet Kumar, managing director of Steadview Capital.