Time was when the Indian authorities and the Indian startup ecosystem was worried that some of the top new-age companies were shifting base to salubrious climes such as Singapore, Dubai, and the US for faster fundraising and more favourable taxation norms. However, things are starting to change, albeit slowly but perceptibly at least for growth-stage fintech and consumer internet startups.

These fintech companies, who are itching to return home in the manner of the prodigal son enticed by enormous business opportunities in the financial space which however can be grabbed only when one falls in line with the strict regulatory drill mandated.

PhonePe, the payments major that Walmart acquired as part of its acquisition of Flipkart, is the first major company to do this. It is shifting its registered headquarters from Singapore to India. PhonePe is also currently in the process of demerging from Flipkart and raising a new round of funding. In fact it has already registered itself in Mumbai going by the name PhonePe Private Ltd which has been valued at US$ 12.5 billion as opposed to the 2020 valuation of just US$ 5.5 billion.

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The homecoming is in a substantial measure to savour the fruits of such a high valuation in India where lion’s share of its business is done. Flipkart will not be a shareholder in PhonePe Private Limited. Instead, Flipkart’s key shareholders, such as Walmart, Tiger Global, and Softbank Vision Fund, will get a direct stake in PhonePe. This will mirror their holdings in Flipkart. Since all of them are strictly getting stakes in the Indian company to mirror their stakes in the Singaporean company, the swap would be squarely covered by ‘exchange’ that is among the types of transactions covered by the definition of ‘transfer’ contained in section 2(47) of the Indian Income Tax Act, 1961 (the IT Act).

Walmart has had to shell out US$1 billion as tax as the shares it has got in the Indian company in lieu of what it held in the Singaporean company command considerably higher valuations. To be sure, this tax is on the notional value. There would be yet another round of capital gains tax if and when the Indian shares are actually sold.

Even as PhonePe charts a course back to where it was born, several others, including unicorn payments giant Razorpay, are exploring moving their registration from overseas to India. Some of the major fintechs with overseas parent companies are Razorpay, Groww, Cashfree, and Pine Labs. All of them will have to grin and bear the capital gains tax on the notional capital gains engendered by the swap or exchange.

The tax on notional profits always bristles with difficulties. How would one pay the tax when he has not actually sold the shares unless he has deep pockets like Walmart. Small wonder, many of the PhonePe shareholders are liquidating part or all of their stake in order to be able to cough up the tax. Several smaller investors like Accel, which have less than a 1% stake, are selling their entire stake as part of the transaction

Most of the companies considering shifting back to India are in the fintech space. One key reason for this is that financial services is a highly-regulated industry, with the regulators Reserve Bank of India (RBI) and capital markets regulator Sebi rightly insisting on safeguard customers above anything else. This has meant cracking down on fintechs and increasing regulations which protect consumer interests. With the help of DLG (digital lending guidelines), the government has ensured that players who want to create some profitable businesses need to set up Indian entities to carry out regulated businesses like insurance and lending.

In 2020, startups such as BharatPe, Jupiter, and CarDekho faced issues in getting an NBFC licence from RBI due to greater scrutiny of investments from China. Many companies were incorporated in overseas jurisdictions, while all their operations were in India, and run through step-down subsidiaries. Under the new Foreign Exchange Management (Overseas Investment) Rules, 2022, founders will have to register in India, especially if there are any Indians on their cap table. This is because of the robust definition of “Control”, which, apart from other aspects, says that if there are Indian individuals holding more than 10% voting rights in the overseas company, then such companies cannot have a subsidiary and will have to function under the aegis of an Indian company.

There is also a growing realisation among investors and entrepreneurs that the Indian capital market has enough capacity to absorb large initial public offerings (IPO) and also has a growing base of domestic investors. Many feel that going for smaller IPOs—with valuations below $5 billion—in the US market are not likely to attract as much investor. These IPOs will attract more investor interest in India. Hence flipping back to India or what can be felicitously put as the return of the prodigal aided in large measure by the realisation that a lot of the business models emerging in both fintech and the consumer internet space are more specific to India, and don’t have an exact parallel in the US market. As an aside, it may also be said that India is one nation which countenances mind-boggling valuations even for loss-making companies. That is the unstated gravitas for the prodigals.

—The author, S Murlidharan, is a CA by qualification, and writes on economic issues, fiscal and commercial laws. The views expressed in the article are personal.

Read his previous articles here

(Edited by : C H Unnikrishnan)