Mumbai: The National Association of Software and Service Co. (Nasscom), has reached out to the Securities and Exchange Board of India (Sebi) and the finance ministry, seeking a viable framework which would enable Indian startups with externalized structures to list on the domestic markets, said two people aware of the development.
Nasscom’s move is significant, given that over 16% of Indian-origin startups are not eligible to access the local markets due to their externalized structures. According to existing rules, only domestically incorporated firms are permitted for listing in India.
Following the global tech valuation downturn, the allure of listing overseas is fading away and a growing number of startups that had initially incorporated outside India, are now eager to tap the thriving domestic liquidity through local listings. For instance, certain startups, like PhonePe, are considering a strategy known as ‘reverse flipping’ to realize the goal. However, this approach has a significant drawback, leading to considerable tax liabilities for both the company and its investors.
In May 2023, it was reported that Flipkart-backed PhonePe’s decision to domicile in India involved paying $1 billion in taxes. Consequently, other prominent start-ups, such as Razorpay, Pine Labs and Groww might also be contemplating similar moves.
“Many tech companies, especially software-as-a-service (SaaS) startups chose the externalization structure for a Nasdaq listing. Besides, some of the private equity investors have a rule that they will invest only in firms that are incorporated in certain jurisdictions,” said one of the two people, seeking anonymity. “Creating an externalization structure is far easier than undoing it as it creates several regulatory complications,” he added.
Externalization is a strategic move adopted by Indian startups, wherein they incorporate a foreign company, say, in Singapore, and designates it as the beneficiary of the Indian firm. In other words, the startup becomes a subsidiary of the foreign company. This effectively makes the Indian startup a Singapore based company that is eligible to list on global bourses. Reverse flipping, on the other hand, initiates a restructuring of sorts, wherein the foreign company established through externalization is dissolved, and the investors holding shares in the entity are subsequently issued shares of the Indian startup.
However, reverse flipping leads to an incidence of capital gains tax. According to the second person, a fund manager, Nasscom‘s pitch is akin to Indian Venture and Alternate Capital Association’s long standing demand to allow dual listing options to Indian startups. However, this would give way to a crucial concern regarding capital account convertibility, which has direct implications on tax liabilities.
“I would suggest the government to open a 9-12 months window to allow ghar wapasi of the top startups and offer either partial a tax waiver or deferment as options,” he said on the condition of anonymity. To be sure, despite Sebi’s decision to float the Indian Depository Receipts (IDRs) to attract foreign companies for Indian listings, the concept failed to gain traction, with only UK-based Standard Chartered Bank opting for a listing using this mechanism.
According to a founder of an early-stage SaaS company, most such startups earn revenues in dollars and hence, if they consider flipping back to India, there will be considerable tax implications compared to the US or Singapore, where the companies are currently domiciled.
Experts said it is easier to shift from Singapore to India than from the US, as the tax liability for moving out of the US jurisdiction is steep. Tax leakage will be the chief consideration for all the stakeholders, but the tax liability will rise at both levels, but steeper in the US, they added.
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