The fuss about Startups getting taxed. The Angel Investor just got poisoned.

This 2012 budget has introduced a controversial tax provision that demands that if Startups receive money from Angels that are not ‘Venture Capital Funds’, then they will have to pay a hefty 30% ‘Income Tax’ on the money received.

Check out the coverage of the news here.

First let me explain who this is really meant for.

Let’s assume that there are two partners in a Company called Chor and Chori and their Company is called Chor & Chori aka ‘CC’ Company.

(Hmmm – I guess it’s best to call it CC Company going forth).

Now for business, CC Company does lots of black market stuff. They buy goods from dealers without bills, they sell those goods to other people & dealers without bills and generate some nice quantities of Black Money profits.

Over the past few months, Chor and Chori have begun to realize that they can’t survive like this in the long term; and need to start an e-Commerce portal that connects their consumers to them, so that they can service them better. This way, CC Company can get inquiries and then service them in the usual offline ‘black market’ way.

The real opportunity and plot is to start an e-Commerce site (yeah!! isn’t that the biggest and most glamorous business around?) and then build it and sell it to a buyer at a big valuation.

Now, given the good karma and past of Chor and Chori and the CC Company, they know that they will not be in a position to get funding from others – so it’s best that they fund it themselves.

When the two partners meet their local CA called Mr. Gafla, he tells them, “Arre bhai log – Chor and Chori, don’t be silly in starting an e-Commerce Company like a normal Company.”

Mr. Gafla suggests this plan to the CC Company promoters:

“Start by incorporating a Company with a Capital of 10,000 shares of Rs 10 each – so that becomes Rs 1 lac as the paid up Capital.

Then create some nice site design etc etc and show all the CC Company goods on it and create some fake accounts to buy the stuff (basically buy your own stuff).

Then Mr. Gafla will show a nice valuation certificate and suggest that CC Company is valued at 1.50 crores!

After this, one Mr. Havawala of Dubai will send CC Company a term sheet (via Mr. Gafla of course), saying that he likes CC Company and wants to invest Rs 50 lacs in it.

Mr. Havawala is the ANGEL Investor for CC Company.

After some e-mail negotiation, CC Company will agree and Rs 50 lacs will come from Dubai as a remittance into the CC Company.

Since the Company is valued at 1.50 crores + 50 lacs new cash = 2.00 crores,  Mr. Havawala will get 25% of shares (Rs 50 lacs divided by 2.00 crores)!!

Yipee! Now CC Company will be a 2 crore Company, and after a few more fake funding rounds, Chor and Chori can value the CC Company at 10 crores and then sell it to some innocent bakras.”

When the partners (Chor and Chori) hear this, they choke. They think the plan is great. “But who is Mr. Havawala?”, they ask Mr. Gafla. “Why will anyone give CC Company Rs 50 lacs??”

Mr. Gafla explains, “You guys are really innocent! There is NO Mr. Havawala in Dubai. You will give me Rs 55 lacs in CASH. Then I will send it by havala (method of sending cash money all over the world) to some Marine exporter in Dubai who has lots of White ‘official’ money (Dubai has no taxes) and then he will send Chor and Chori a CHEQUE in the name of CC Company for Rs 50 lacs and sign as Mr. Havawala.”

One of the CC partners says, “Wow, and why should we give you Rs 55 lacs to get back Rs 50 lacs?”

Mr. Gafla the accountant says, “C’mon, guys – I mean I also need to make some money, naa? I will keep 2.50 lacs and the Marine exporter will keep 2.50 lacs. But you will have official money remittance from an ANGEL Investor in your Company, so that can show a good valuation.”

CC Company agrees and a few weeks later the deal is done.

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Now, this is the kind of deal that the new budget wants to set right!

If the Investing Angel – Mr. Havawala is NOT a Venture Capital fund, then the Company – in this case the CC Company will have to pay 30% on the 50 lacs it received as angel investment – or 15 lacs as tax.

If you read the example above, it’s simple to see the logic – the 50 lacs was anyway the original promoters’ Black Money that has come back via this ‘Angel’ route and hence it has to be taxed.

These are my views:

– I think that there has to be some precedence, some knowledge in the past of such cases that led to this rule. So there is no Hava without Havala – no smoke without a fire. Let’s give the government that much credit. 

– I guess that if honest, genuine Angels want to invest money, then this is going to be a sharp setback to them. Also, given that ‘consortiums’ like the Mumbai Angels and the Indian Angels Network only assemble angels who in turn do independent deals – then this becomes a real road block.

– Concepts like getting convertible debt etc will not fly. If the intent is to keep Black Money coming back into the system, then it will cover Debt deals also.

– Conceptually, this is the DUMBEST and STUPIDEST and MOST IDIOTIC idea I’ve seen in a long while!

There have been many Amnesty schemes in the past that encouraged Black Money to come back to India. These deals required the money to sit parked in some silly Bank deposits etc – ‘coz the Govt. has always been bankrupt and would prefer to receive the money themselves.

I think that the Govt. should ENCOURAGE getting money ‘from any source’ as long as they come into Startups and nowhere else!

This will allow:

– Black, white, grey, green, yellow and purple money to come into India.
DID U READ? COME INTO INDIA. That’s what matters!

– It will create a nice level playing field for the VCs – they will have competition and NOT exclusivity that seems to be handed over to them right now…

– ENTREPRENEURS will be trusted a bit more!!! I mean, do we look like chors and thugs to get all kinds of smuggler and hoodlum moneys into our Companies?

I think this govt. doesn’t get it.

Startups need money. Money needs Startups. Why fuck up such a beautiful equation????

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