Unicorns flipping to avoid Indian regulations

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SME Times News Bureau | 30 Aug, 2021
Twenty four unicorns had either flipped or were incorporated abroad mostly due to foreign investors' asking.

All of them have Indian founders who started off in India. A significant number have operations and their primary market in India. Nearly all have developed their IP (Intellectual Property) using Indian resources in India (human, capital assets, government support etc.).

Experts say flipping results in materially adverse impact on national economic interest as the nation loses out on significant tax revenues while ownership of critical data as well as IP is also transferred abroad.

It effectively becomes a structure to transfer value creation from India to overseas since most of the business is still being done in India with teams based here too. It becomes a way for foreign investors to gain from India's wealth of resources and advancement by bypassing its laws and regulations.

Among the reasons for flipping is avoiding the Indian regulatory landscape, Indian tax laws, and scrutiny by Indian authorities.

Various international investors force their investee companies to flip abroad and sometimes even keep this as a condition precedent to their investment in these startups as they want the data and IP to be headquartered overseas where they will put their money.

Most of the business is from overseas clients and these clients want to contract with overseas parent company only although this is not a valid reason though because contracting with an overseas subsidiary could serve the same purpose without flipping the company. Moreover, Indian IT services firms like Infosys, HCL etc. have managed to do meaningful business in various overseas territories while being headquartered in India.

Favourable foreign policies that nations like US and Singapore have adopted also attracts startups and investors. Some of these policies are lower corporate tax, fixed GST, zero capital gains tax rate, double taxation avoidance treaties, simple majority vote on critical issues, evolved IP protection laws etc.

Unicorns also desire to publicly list overseas with the assumption that valuations are higher due to deeper pools of investors.

The implications of flipping is that it leads to immense economic and national loss as an Indian company becomes a wholly-owned subsidiary of the foreign corporation despite 90 per cent value creation from India, resulting in loss of all future tax on capital gains, public listing, operational profits etc.

Current economic outlook is dominated by industries that started in the 1980s and 1990s. One such sector is IT services. Similarly, the Indian economy's future is expected to be dominated by modern day tech disruption. If these IT giants would have flipped abroad in their early years, India would have lost out on the country's GDP growth attributable to these companies becoming big along with the national pride of having such homegrown entities that create millions of jobs a year.

Moreover, various such companies hold critical consumer data and IP whose ownership essentially transfers abroad. Most of these companies are growing 100-200 per cent annually and are increasingly capturing more and more critical consumer data. Flipping imposes a security threat on all critical data and also results in substantial loss of possible future value creation from all associated IPs of that company.

Flipped startups circumvent Indian tax law and other legal regulations and gain unfair advantage over their domestic counterparts. Due to foreign HQ structures, the Indian government can't determine source of money backing these companies which can result in security issues for the nation, in case war like activities arise in future. For example, money from neighbouring countries is only allowed in India-domiciled startups after the requisite approvals but overseas headquartered startups do not need any such approvals. This further incentivises flipping.

Foreign investors are keen to take advantage of India's growing economy and flipping makes it possible for them to circumvent coming to the country.

This sets in motion a vicious cycle then as more and more overseas investors start seeing flipping as a legitimate ask without concern of loss to India.

Loss of depth in Indian public markets as all these flipped startups will also list overseas.

Experts say that among the possible ways to disincentivise flipping is the need to simplify compliances for startups and rationalize taxation so that their limited cash reserves and operational bandwidth are not blocked

The need to simplify AIF registration norms and reduce current restrictions on domestic AIFs to unlock additional capital, enable smoother incorporation and exit norms and laws for foreign investors, create advantages for India-domiciled startups in sectors that have sensitive data around Indian consumers and merchants like financial services, defence, healthcare.