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

Those earning Rs 2-5 crore will pay effective LTCG of 26% and those earning less than Rs 5 crore will have to pay LTCG of 28.5%

Ranju Sarkar  |  New Delhi 

Markets, LTCG tax

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

If they are earning Rs 2-5 crore per annum, which many of them do, the effective rate is 26 per cent (see table); those earning Rs 5 crore+ will have to pay 28.5 per cent LTCG. This will discourage start-up investors and dampen the spirits.

"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 firm India Quotient.

In a series of tweets, Ritesh Banglani, partner at Stellaris Venture Partners explained why a higher tax burden creates a massive dis-incentive for investors thinking of investing in "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?"

Angel investments are the lifeblood of 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 dis-incentive. Then we complain that all our tech are foreign-owned."

A foreign investor pays 10-per cent tax, whereas a domestic investor pays 29-per cent tax for 'owning the same asset'. It's a perfectly designed scheme to divert Indian capital away from startups.

The revenue generated from this will be tiny, so there can't be financial logic to this either. Assuming $5 billion of cash exits happen annually in startups, 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 (startups take about a decade to exit) the capital gain from the entire industry will be $300M. "The government will starve the biggest value creator in India for a measly Rs 600 corre in tax revenues," Banglani pointed out.

"An entrepreneur wanting to do business in India must find an opportunity to earn at least 30% pre-tax return on equity just to earn his capital. Do you realise that is impossible. You are saying no to do business in India," asked entrepreneur Bhavin Shah in a tweet tagging the PMO and the finance minister.

First Published: Wed, July 10 2019. 10:24 IST