Higher LTCG tax spooks start-up investors, founders, ESOP holders

Those earning Rs 2-5 crore will pay effective LTCG of 26%; those earning Rs 5 cr-plus will have to pay LTCG of 28.5%

Even as the government made an effort to bury angel tax, the rise in surcharge on long-term capital gains (LTCG) tax has spooked start-up investors, founders, and stock options holders. 

If they are earning Rs 2-5 crore per annum, the effective LTCG tax rate is 26 per cent; those earning Rs 5 crore-plus will have to pay 28.5 per cent LTCG. This will discourage start-up investors. 

“The most retrograde step Modi Sarkar 2.0 has taken for start-ups is the heavy tax on their potential long-term gains. A bit worried about the future,” tweeted Anand Lunia, managing partner at venture capital (VC) firm, India Quotient. 

In a series of tweets, Ritesh Banglani, partner at Stellaris Venture Partners, explained why a higher tax burden creates a massive disincentive for investors thinking of investing in start-ups. 

“If you’re an angel investor, would you rather invest in a start-up at 29 per cent LTCG or in real estate where you can avoid LTCG altogether?” asked Banglani.

Angel investments are the lifeblood of start-ups. And today it’s the ‘most expensive’ long-term financial asset available to investors, he said. “Even VC investments by domestic investors have been given a similar disincentive. Then we complain that all our tech start-ups are foreign-owned,” said Banglani.

A foreign investor pays 10 per cent tax vis-à-vis a domestic investor paying 29 per cent tax for ‘owning the same asset’. It’s a perfectly designed scheme to divert Indian capital away from start-ups. 

The revenue generated from this will be minuscule, so there can’t be financial logic to this either. Assuming $5 billion of cash exits happen annually in start-ups, which itself is a wild overestimate, less than 10 per cent goes to domestic investors — $500 million.

If investors make 5x on exit on average, then after indexation (start-ups take about a decade to exit) the capital gain from the entire industry will be $300 million. “The government will starve the biggest value creator in India for a measly Rs 600 crore in tax revenues,” Banglani pointed out. 

“An entrepreneur wanting to do business in India must find an opportunity to earn at least 30 per cent pre-tax return on equity just to earn his capital. Do you realise this is impossible? You are saying no to doing business in India,” said entrepreneur Bhavin Shah, in a tweet tagging the Prime Minister’s Office and the finance minister.