In a notable trend, well-established startups such as PhonePe, Pepperfry, and Groww have chosen to move their headquarters back to India. Companies like Razorpay and Flipkart are also contemplating similar moves, signaling a surge in the practice known as “reverse flipping”.
But before I explain what’s reverse flipping, let’s understand why a lot of Indian startups have been registering their headquarters outside India.
Why do Indian startups register outside India? (a.k.a. Flipping)
Generally, Indian startups who raise funds from foreign VCs tend to register their parent company in the same country as their investors. This is called flipping.
Now there can be many reasons behind this like:
- Better access to investors and capital
- Conducive startup ecosystem
- Fewer regulatory challenges
- Lower tax regimes and more.
What’s the harm to India from flipping?
The flipping of Indian startups results in value creation in foreign jurisdictions rather than in India.
Further, India also incurs a loss of intellectual property and potential tax revenues from businesses that register abroad.
What is reverse flipping?
Reverse flipping refers to these startups changing their domicile back to India i.e. relocating their headquarters or legal registration to India.
Why are Indian startups reverse flipping?
See, there are quite a few reasons behind this sudden love for India.
One of the primary reasons is that a lot of these startups are now planning to go public.
And since these companies have their consumer base and goodwill in India, they will be better valued on Indian stock exchanges. Moreover, the Indian equity markets have been fairly strong as compared to other markets leading to an increasing participation from retail and foreign investors.
Further, fintech firms seeking banking licenses need to align with the RBI guidelines and hence moving back to India looks like an obvious choice.
Capital gains tax implication due to change of domicile to India
Investors are issued fresh shares of the newly formed company when a foreign company shifts their domicile back to India. Hence, capital gains might accrue for investors if they receive shares at a higher valuation than the existing valuation.
Now even if the investors of a startup are not residents in India, they will be charged income tax on these accrued capital gains because of the Territorial Nexus Rule.
PhonePe’s investor Walmart paid nearly $1 billion to move their domicile from Singapore to India.
What is Territorial Nexus Rule?
The territorial nexus rule talks about how we approach tax on accrued capital gains. With this rule, the focus shifts to taxing gains based on where the asset is located rather than the residence of the investor. This not only simplifies tax calculations but also ensures a fairer distribution of tax burdens across jurisdictions.
Income tax applicable on transfer of unlisted shares
Now let’s talk about how would the capital gains arising from transfer of the unlisted shares be taxed.
As per Section 112 of the Income Tax Act, 1961, below are the tax rates:
For companies reverse flipping back to India, any losses from previous years cannot be set off or carried forward. So startups who focused on growth at any cost resulting in losses year after year, will have to forgo benefits of loss setoff, which can increase their tax outgo.
Additionally, since fresh ESOPs must be issued to employees for the newly formed company, employees will have to wait for at least an year before their options can vest as per Rule 18(1) under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021.
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