Moving your startup to US / Singapore — a commercial perspective
Explained with case studies [1 of 3 part series]
Background
There has been a recent spurt in the movement of holding structures of various startups, in the process of fund-raising from venture investors, outside of India. Singapore or US (that too Delaware) are the only jurisdictions attracting 99% movement.
The main focus has always been to gain more investor interest and seek global capital. Due to the nature of how the global economy has evolved and how it currently operates most often, the subject matter expertise, the wealth, and the patience/mindset required to invest and nurture a young business are available only outside the country either in the western markets or in wealthy Asian countries such as Singapore. Every now and then, we are being asked as to why this is happening.
Now what is driving all of this — let’s seek a few answers around this based on our experience
There are 3 broader considerations i.e. (a) Commercial (b) Legal and regulatory © Taxation. While each of these categories is critical and requires consideration, in order to avoid a lengthy post, let’s focus on the first one i.e. Commercial consideration.
Commercial aspects
Economics for investors works well in inversion structure — Fund economics work better from a tax perspective. Most of the funds have a pooling vehicle in a jurisdiction that is neutral from a tax and regulatory standpoint and doesn’t cast onerous requirements on LPs participating in the fund. But the problem is that if these exempt funds invest in a country which taxes on sources like in India, there is a tax leakage which happens and no one wants to pay taxes twice in such cases.
An example in this context is that a fund may have US LPs who pay tax @15% (assuming long term capital gains — 1 year period) in their home country. The Singapore fund doesn’t pay taxes, but the gains are again taxed in India @40% (assuming short term capital gains — 2 year period in India). At an investment of USD 1 Mn with exit proceeds at USD 10 Mn, first payout of tax will be at India level amounting to USD 3.6 Mn. the proceeds go to Singapore and there is no tax paid over there, but the LPs will pay tax at 15% of USD 5.4 Mn (i.e. Consideration in hand at USD 6.4 Mn minus 1 Mn of Cost of acquisition) amounting to 0.81 Mn. There is no credit offset of USD 3.6 Mn available against this 0.81 Mn. Total tax outflow on gains of USD 9 Mn is USD 4.41 Mn i.e. a whooping 49% tax. This is when the gains are classified as long term in the US and not short term.
Now against this, in an inversion structure, there is no tax in Singapore. The total tax outlay in above case, in hands of US LPs will be USD 1.35 Mn i.e. 15% of gains as against 49% in the previous i.e. when there is an Indian startup. With liquidity coming in only few startups, this can become an issue from generating an IRR for the fund wherein so much returns go away in tax leakages.
Having said that, there is no clear tax advantage for Indian founders considering that the tax is payable in India. But we have also seen founders shifting overseas prior to exit, so they don’t remain tax resident of India at the time of exit and thus saving on tax leakage on the proceeds.
Customer proposition — there was a startup working on the SAAS side in the security domain. The customers were mainly in the US and Europe. The reflection on the app store, of the app belonging to an India company, was keeping most of the potential customers away from adopting the same. The startup was not left with any choice but to invert the structure to the US, post which there has been great traction coming in. This may work only when you are pitching for a global customer base. If the customers are mainly in India, then this may not be a proposition to look at.
Further, the revenues will start falling in a country with a low tax rate (like Singapore) and thus, there is saving on that front too. However, this may also have another issue wherein the application is not SAAS based and you are targeting customers in India which may have issues in making payments to overseas jurisdictions.
Example — Practo has a large base of customers in the form of doctors in India. For them, taking payment outside India requires all their doctors to undergo filing of Form 15CA / 15CB, going to the bank for making remittances, etc, meaning that the whole purpose gets defeated in the long run. So, in such cases, getting revenues
Global investors mandate not to invest in Indian Cos directly — Due to Indian and regulatory restrictions, many global investment funds have investment ideology/mandates not to invest in Indian incorporated startups.
Also, Startups can take advantage of investments from sovereign funds floated in jurisdictions like Singapore who are focused on startups incorporated in that jurisdiction only (as part of their mandate). Some of these sovereign funds also pro-rate with existing Singapore based funds. The terms at which such investments by sovereign funds are made are quite favorable for the investor making the investment in the startups. This can be explained with an example
For example — in a scheme, a sovereign fund participate on 1: 2 basis with an existing Singapore based fund in a Singapore based startup. Further, the Singapore fund has the right to buyback the shares of that startup, at a pre-defined IRR which is nominal. This essentially means, that the Singapore fund can take benefit of the IRR earned by the sovereign fund by co-investing in a startup as just before the liqudiity event, the former can by out the shares of the soveriegn fund and increase the overall IRR for their investors.
More conducive jurisdictions — Foreign jurisdictions provide a more relaxed environment in terms of infrastructure, tax regime, regulatory complications making operations there more conducive for entrepreneurs.
Just an example may help summarize — Indian tax laws are complex in terms of transactions to be undertaken with overseas vendors. Whether withholding tax triggers on a particular transaction or GST is applicable, everything depends upon a maze of complex regulations that often end up in litigation with jurisprudence having different stands.
Companies like Microsoft have been struggling in Indian courts to contest if the software they are supplying in India is goods or services, wherein the latter warrants levy of withholding taxes as royalty.
Moving to Part II in next post
There has been a quantum jump with more & more startups going to follow suit. The above are primarily commercial factors, but there are certain tax and regulatory considerations as well which needs to be seen as driving inversions. Will deliberate the same in a subsequent post
