What I think the Indian budget for 2015–2016 means for startups in India

Note: I wrote this in March 2015, as a way to vent my angst at the budget’s ineffectual “startup friendly” components. Once I wrote it out, I decided to let it sit for a while, and see if I still felt like this a few weeks down the line, to ensure this wasn’t just a flare-up reaction. Fast forward 3 months, and sadly, I still think this is justified, so it’s going up.

Warning: This is a very long post (a rant really), written over a week, that meanders a fair bit into the contexts that influenced my thinking, before covering the points, eventually, which, I assure you, are the actual intent of this post.

Background:

You might be wondering what exactly qualifies me to write about the budget, especially within the context of startups. The short answer is, not a lot. All I have going for me is the fact that I happen to be an entrepreneur who runs a couple of startups (note the plural) in India, for whom the budget was pitched as the “promised land”. In short, this impacts me personally so I’m reporting from the trenches, and am sharing the challenges I’m expecting as a result of this so-called “bumper” legislation.

Main Story:

To be perfectly honest, until this year I’ve never really given much thought about the budget, beyond knowing what it’s impact was going to be on my personal tax return, and the general impact on the economy at large. Given the fact that:

a) until 2014–2015 my startups were primarily generating revenue from overseas (so service tax wasn’t a major issue for us), and
b) we hadn’t broken the 1 crore per annum revenue target yet, we thought the budget changes were the problems/benefit of the “big boys” (whom we certainly weren’t or aren’t).

The morning of Feb 28 2015 started off as any other, with me casting a vaguely interested eye towards the budget, amongst the myriad of other concerns I have going on. Then suddenly, my interest was triggered by the phrase “service tax is increased to 14%”.

With that, my focus was purely on the budget. This was no longer a big boy problem, this impacted me and the other little guys as well. Suddenly, I remembered all those soundbites and snippets I had skimmed over the past few weeks in the papers, and in the news. This was supposed to be a budget that would “help startups”!

“How the hell does increasing service tax help startups?”, I started asking everyone I could, starting with my dad, who very patiently tried to explain about how this was a preamble to GST, and it means savings down the line, starting from 2015–2016 (when GST is supposed to come into effect).

My response?

“That’s all fine, but how the hell are startups targeting the domestic market supposed to survive until then when they have to convince customers to pony up 14% on top of whatever the charges for services are, and not ignoring the fact that ALL of our expenses are going to go up”?

Why I Care Now
A reason, I suspect, for my increased sensitivity towards this topic has come from co-founding and running TheWorks@ project (shameless plug) since June 2014, where we work extensively to provide a support base for entrepreneurs (especially new or early stage companies) to startup and run their businesses. Originally started as an experiment to see if co-working would be effective in Chennai, we now provide a platform to support entrepreneurs through their operational lifecycle. So, we are intimately aware of the challenges and impacts of catering to, and running, startups for the domestic market.

We’ve been on the receiving end of many a “negotiation” where the question of service tax becomes a bottleneck, where the perception is that it’s a burden that “we”(TheWorks@) need to sort out if “we” want business from “customers” (startups). It’s at times frustrating when we get penalised for enforcing the law which has been thrust on us and mandates us to charge the customer the additional cost. We’ve had many scenarios of people walking away as the added cost of tax makes things “too expensive”. From their perspective, it’s not hard to empathise, considering their cost is not just the cost of product/service, but also the tax enforced by the government.

Back to the story at hand
I spent the entire morning the Sunday after the budget was announced, reading the complete text of the Finance Minister’s speech and the annexures (http://www.thehindu.com/news/resources/full-text-of-budget-201516-speech/article6945026.ece). Not what I envisioned for a Sunday morning. But, before I started rebutting the so-called “startup-friendly” budget, I wanted to ensure I wasn’t reacting to incomplete information or paranoia/hysteria fuelled through social and news media channels.

Boy, was I in for a shock. The damn thing had some mention of yet another startup fund for entrepreneurship and initiatives targeted at making it easier for investors to manage their investment in startups, but the rest of it read like a quagmire for startups. The really sad part is that it’s really going to hurt startups that are targeting the domestic market more than others.

Why you ask? (If you didn’t, I’m going to assume you did anyways).

Here’s why:

  1. The increase in Service Tax is going to impact sales of services offered to local consumers
    Effective April 1st, 2015 (UPDATE: this came into force June 1 2015), your customers are going to have to pay more to enjoy the same level of service. This might not be a big deal for services priced at <Rs. 10,000 (the 1.64% increase works out to a maximum impact of Rs. 164), but when you start looking at 6-figures and up (>Rs. 1Lakh) contracts, that additional amount starts looking big enough to care. For organisations that offer specialised services such as architects, designers, consulting, etc., this could lead to renegotiation of lower rates (i.e. less money coming in), delays in payments, or even cancellation of services if renegotiation doesn’t work.
  2. Profitability is going to go down even if sales aren’t affected
    Even if you manage to convince your customers to accept the increased costs, the problem doesn’t stop there. Your operating expenses will jump by 1.64% from April 1, 2015(UPDATE: June 1st, 2015). Your ISP, telephone, utilities, rentals, anything that you consume as a service is going to be more expensive. Again, from a percentage perspective, this might not be a huge jump, but from a cashflow perspective, this can impact significantly, especially for those running low margin, high volume businesses.
    Granted, in this case it affects everyone equally not just the domestic startups, but that’s a minor parity when comparing the overall impact on domestic vs global focus startups.
  3. Salaries are going to go up as cost of living just went up
    If your costs just went up, then so did your employees’ costs of living, as the service tax impacts any consumer of services, including bank loans, EMIs, etc. So, I predict that a lot of employees are shortly going to be looking for salary increases to maintain their standards of living. And obviously they won’t settle for 1.64% as an increment. Startups need to be prepared to offer attractive increments to retain talent, which impacts Point 2 above. Recruitment of new talent is also going to become more challenging, as its going to become more expensive.
  4. More companies will focus on export income and ignore domestic customers simply as a way to avoid extra taxation.
    Startups that sell to the international market don’t have to worry about charging service tax. So, the service tax increase is purely the problem of those startups who are trying to sell to the Indian domestic market.
    Why is it an Indian company that sells to Indians is taxed more than a company that sells to foreign markets? Is the government so obsessed with export income and generating more foreign currency holdings that they’re actually penalising companies that don’t focus on exports? Where is the sense in that?
    Think about it. If I provided a service to a domestic customer, I have to charge them 12.36% (today, 14% from April 1st 2015) on top of my fees. However, I could charge the same amount for the same service to a customer outside India, and not charge them the 12.36%. The message is loud and clear. You’re more profitable if you focus on export markets, not just because you can earn in foreign currencies. It’s also because you pay LESS TAXES! In other words, “Make in India, NOT FOR INDIA!”
    This may fit with our PM’s “Make in India” vision, which is so blatantly export oriented, I wouldn’t be surprised if this move wasn’t intentionally designed to promote more export oriented units.
    However, as Raghuram Rajan (current RBI governor, and IMO the only person of influence in India who actually knows what he’s doing and talking about) said in a speech in early December 2014, the global economy “is growing more slowly, and is more inward-looking, than in the past means that we have to look to regional and domestic demand for our growth-to make in India primarily for India.” (Full text of the speech here: http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=930).
  5. The government seems to think that startups are only technology companies.
    Wrong! What about tech-enabled startups? I run a shared workspace infrastructure. I sell physical and virtual services. I use technology to make my business more efficient. Why don’t I qualify for any special sops and privileges? What about new food businesses, agro-tech companies, etc? Why don’t they qualify as startups? Because, under the text of the budget here, the babus in charge will only look for “startups” because “startups” = “technology” = “IT companies”, as thats how the budget is presented. I’ll cover this in more detail in a bit.
    I can’t stress how bad this is. Yes, IT was a huge player in transforming India. But, this is flogging a dying horse. We need to leverage the foundations that IT has created and encourage other disciplines and industries to benefit from them. Otherwise, when IT fails, and believe me it’s already starting to, there will nothing to help India deal with the vacuum that creates, and there’ll be huge issues for the country at large as we’re not encouraging the development of transferable skills as a society.

So, as should be very obvious, my opinion is that this budget is going to cause a lot of grief for startups. There is, however, some good news.

  1. Bankruptcies can be resolved faster. Though, IMO this is a Pyrrhic victory at best, as it allows entrepreneurs to move on faster from failures, and get on with their lives, unlike the years of strife that happen today.
  2. Royalties on Technology transfer attracts a lower tax rate. Innovation can happen faster as we can leverage existing tech from other countries vs having to reinvent the wheel simply because royalties are prohibitively expensive.
  3. Corporate tax will go down by 4% over the next 4 years to 25%. This is a no-brainer. Less tax is definitely better.
  4. GST is almost certainly going to happen in the year or two, and that’s a good thing. Right now, we pay a whole slew of taxes on the various services and products we consume as input costs. There are minimal provisions for us to offset these taxes against the taxes we collect from our customers. Service tax can be offset if you’re providing services, sales tax can be offset if you’re providing products. But, a service company can’t offset tax paid for products, and vice versa. So, the government actually gets quite a bit of extra tax on top of the “direct taxes” we pay. With GST, everything gets consolidated into a single tax mechanism, and we can offset across products and services irrespective of the nature of our business. TL;DR: More offsets = Less Tax to be paid at the end.

So on the whole, there’s some good and some bad stuff. Yes, with GST coming in and the lower tax rate, things will actually be cheaper in a couple of years. But the challenge that I foresee is how do you ensure you can sustain a viable business until such time as these things actually happen?

The reason for my skepticism is that I suspect the government doesn’t really understand what entrepreneurship is and what it can actually offer the country. If you read the whole text of the 2015 budget speech (here: http://www.thehindu.com/news/resources/full-text-of-budget-201516-speech/article6945026.ece), what really stands out is that the government is making the assumption that preparing people for employment through better skills development and training will help to improve the standard of living for the nation, and that’s enough.

An admirable goal, but I have to ask “Who’s going to provide the jobs for these people to work in? What’s the point of creating all this talent, if there are not enough jobs?” In the FM’s speech, entrepreneurship is projected as an alternative to employment for the young people who are seeking jobs, not as a creator for more opportunities for employment for these people. That begs the question, is the government only looking at established companies and export oriented units to provide employment opportunities? Without a strong domestic economy and service sector, how does the overall economy really benefit from all the export income?

Even I, with my layman knowledge of economics, can see that just bringing in more foreign currency is not enough. The money needs to be channeled into the domestic economy to maximise the impact across the largest part of our population. And to do that, you need to have as many businesses who can provide the necessary products and services for the domestic market, to ensure that demand is met.

That’s what China has done. China boasts some of the most modern civic and urban infrastructure in the world, which our PM wants to emulate, and for that I applaud him. It’s a worthy goal. But, what must also be recognised is that for years, they invested huge amounts of their profits earned from export income into building a strong domestic economy, to the point where today companies like Alibaba, Xiaomi, Huawei, WeChat, etc., which originally started off targeting their domestic market, are huge global players with massive market capitalisations. For years, local players enjoyed unprecedented control over the domestic economy, while huge international brands struggled to get a foothold into those markets. It’s only recently that China’s markets have opened up to international brands, but still local players enjoy a strong foundation in the domestic economy.

Personally, this domestic focus has to be nurtured equally in parallel to the export-focus to ensure that the capital earned from exports is put to work as quickly as possible. Sticking the money in the banks does little, unless the banks in turn make access to that capital easier, allowing more entrepreneurs to benefit from lower interest rates, and more favourable terms, that will ultimately create more value for the domestic economy, resulting in more jobs, more services, more sales, more profits, higher incomes, better standards of living, etc. Yes, this is a very simplistic representation, but it’s fundamentally how economies work (or are supposed to at least).

But, the reality is that even with more capital in the banks, access to capital is extremely difficult for many entrepreneurs. Our banking system in notoriously conservative, and our interest rates are so prohibitively high that servicing interests creates a major burden. Schemes like CGTSME, which were supposed to make bank funding more accessible to entrepreneurs who previously were not eligible for bank loans, have been abused and mismanaged to the point where today the banks are reluctant to fund these initiatives as they end up bearing the burden of failure, and actually advise customers NOT to go for these schemes.

Yes, the government created a Rs. 10,000 crore fund for startups last year and allocated Rs. 1,000 crore this year, both intended to help create more successful startups (NOTE: There has been some confusion if the Rs. 1,000 crore is in addition to the Rs. 10,000 crore budget from last year or the first tranch under that scheme). But how accessible really is that funding? Frankly speaking, not very. By not providing a clear execution roadmap on how the funds were to be disbursed and utilised, this fund has become a target for the “the money is there, lets’ get it and splurge on whatever we want” institutions.

Let me illustrate why I’m convinced the government’s “Startup Fund” approach is doomed to fail. Given my experience running shared workspaces to support entrepreneurs, and as part of my role as Co-Manager of the Chennai Chapter of the Google Business Group (a volunteer community promoting the adoption of technology across businesses, and promoting entrepreneurial development) I have been approached by several colleges and universities in Tamil Nadu over the course of the past year to help them setup “entrepreneurship cells” and “incubators” to promote entrepreneurship. In most cases, the persons tapped up to run these programs have absolutely no clue on what these facilities entail, nor do they even have clarity on how to run these programs. One person actually told me (paraphrased and summarised as this was a while back), “I don’t know how to do all this. I’ve just been told to set this up. I know the funding is there. We need to just show them a plan to set this up and we’ll get the funding. I want you to tell me how to set this up. I’ll give you a room. Will a 15ft by 10ft room be enough for the incubator?”

What really puzzled me was that institutions that had no relation to technology (liberal arts colleges for example) wanted to create “techno-preneurship cells”, and I couldn’t figure out why. It took me a while and some digging to realise that the reason for this sudden interest is that each college was being offered crores to setup entrepreneurship cells. Somewhere along the way, they assumed that startups = technology, so they need to show that they’re working on technology startups, not just any startups. Given the way most colleges in Tamil Nadu (I don’t know enough to generalize at a national level) operate, they will grab at any opportunity to make money. Grant funding is perceived as free money, and who could pass that up?

Sadly, when you actually look at the impact of these cells, you see that:
a) not many actually have any organisations that remotely resemble a startup
b) often are dormant, or inactive

There are a handful of cells that are really providing impact, but for the amount of money actually involved, is a handful really enough?

My biggest complaint with this whole fund creation approach, is that it again applies bias towards who actually benefits from the funds available. As I shared earlier, a lot of people assume startups are only about technology. This is where the bulk of the problems start, in my opinion. The dictionary definition of a startup is “a newly established business”. Yes, there are more rigorously defined parameters to quantify what is a startup accordingly various schools of thought, but at its most basic level, that’s what it is.

A new restaurant can be considered a startup. An architecture firm or a furniture manufacturer can be a startup. A legal firm could be a startup. But, these kinds of organisations invariably don’t qualify for the funds made available through these programs. Instead, they are treated like a normal business, subject to prohibitive taxation, poor access to capital and funding, complex governance and compliance regulations, etc.

I could go on and on about the inefficiencies in the entrepreneurial ecosystem in India, and how things suck. But the reality is that while things could be a lot better, it’s still a worthwhile effort and there are some great initiatives and people who are doing a lot to improve the ecosystem. However, when the government does takes inane and ineffectual measures like what I’ve illustrated here, you are only increasing the probability of more startups failing, and so fewer people will take the plunge into entrepreneurship as the risks and challenges seem greatly magnified, with not enough of an economic incentive to attract with them.

Ideally, I would love it if the government actually made it less painful to run a startup by providing some schemes towards the startup community in the form of tax breaks, etc. Get rid of the Angel tax for one (right now startups that raise funding from private investors (non-institutional) are subject to a heavy taxation on the money raised as it’s interpreted as a form of capital gains). Brings back schemes like STPI that helped a lot of startups develop. Expand it to cover other disciplines and skillsets.

If the challenge is with the ensuring the funds allocated are not misused, allocate more funding to rigorous enforcement and make the penalties stricter. Make the fund managers accountable. Don’t just outsource the responsibility and hope that things will work out. Reward those that actually follow the rules, and punish those that don’t. More importantly, I would like to see the government also encourage more domestic focus startups to ensure that there is a strong domestic economy to benefit from the greater inflow of export-income.

But, at the very least, if the government isn’t going to help startups, don’t hinder us by taxing us out of existence, and making it more difficult for us to operate. Our challenges are hard enough, as is.

P.S. In the few days it took to write this up initially, this topic was been done to death, and various interpretations and perspectives have been shared on its impact on various aspects of the startup ecosystem. C’est la vie. It was a cathartic experience to finally put to words my feelings on this matter, and if that isn’t a reason to blog a rant, I don’t know what is. I end by saying, this post is purely my opinion, and is based on my interpretation and readings of the FM’s budget speech and other materials referenced here. I’d love to hear your thoughts on this topic, and correct me if I’ve made any mistakes here. Hopefully, the debate will result in some interesting and useful outcomes.

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