Tag Archives: Startup

National Policy on Software Products, 2019

The Ministry of Electronics and Information Technology released the National Policy on Software Products, 2019 (“the Policy”) aimed at stimulating the software products ecosystem in India. The Policy acknowledges that the Indian IT/ITeS industry is primarily service oriented. The Policy cites NASSCOM’s Strategic Review, 2017 which claimed that the global software products industry was valued at 413 billion USD, while the Indian software products industry’s contribution stood at just 7.1 billion USD.  The Policy aims to develop India as a global software product hub which is driven by innovation. The Policy aims to help start-ups related to software products in conducting their business in India while dealing with regulations and compliances in a hassle-free manner. MeitY had introduced the draft of the Policy back in 2016, which was commended by the industry bigwigs. The salient features of the Policy are summarised below.

The Policy defines a software product as “a programme used or produced by a computer or network which can be stored or transmitted through an electronic medium and offers some form of utility. In addition, such a product can be protected in India through permissible Intellectual Property Right laws and can be commercialized for use through licensing”. In order to determine which companies would be able to avail the benefits under the Policy, an Indian Software Product Company (“ISPC”) is defined as “an Indian company in which 51% or more share-holding is with Indian citizen or person of Indian origin and is engaged in the development, commercialisation, licensing and sale /service of Software products and has IP rights over the Software product(s).

Some key missions of the Policy include:

(a) Achieving a ten-fold increase in India’s contribution towards the global software product industry by 2025.

(b) Nurturing 10,000 tech startups including 1000 such startups in lower tier cities and towns leading to employment of 3.5 million people by 2025.

(c) “Upskilling” a million IT professionals, motivating 100,000 students and producing 10,000 leaders for the Indian industry.

(d) Developing 20 strategically located clusters to support software product companies with ICT infrastructure, R&D and mentorship.

For achieving the goals envisaged in the Policy a National Software Product Mission (“NSPM”) would be established under the aegis of MeitY. The NSPM would be responsible for designing strategies for the development of the industry, monitoring of the special funds created under the Policy and facilitating Government agencies in the promotion of Software Products.

Ecosystem Development

The Policy envisages the creation of an Indian software product registry to provide a trusted trade environment and conception of an environment that allows software product companies to participate in the capital market. A single window platform would be established to allow the industry to deal with regulatory issues pertaining to imports/exports and incorporation/dissolution of ISPCs. ISPCs would also be able to set off any taxes payable with respect to R&D. For the classification of software products in a logical fashion, a model Harmonised System Code would be created.

Promotion of Entrepreneurship, innovation and Employment

A “fund of funds” called Software Product Development Fund (“SPDF”) with a corpus of Rs. 1,000 crore would be created for participation in venture fund to promote the scaling up of market ready products, with the ultimate goal of having at least 100 ISPCs with a valuation of Rs 500 crore or employing more than 200 employees. An incubation program would be initiated to provide startups with adequate mentoring, seed fund, R&D and testing facilities and marketing support. Rs. 500 crore would be set aside by the Government to support innovation and research in institutes of higher learning, with the objective to support industry-academia research. 20 dedicated challenge grants would be initiated to encourage the industry to tackle issues related to pressing societal needs such as sanitation and healthcare. A centre of excellence would be set up to specifically promote design and development of software products. The Policy envisions the creation of an “upgradable” infrastructure to help software product startups to identify and tackle cyber vulnerabilities.

Human Resource Development

Considering the pace with which technology is changing, the Policy wishes to enable Indian students and professionals to have future-ready skills. The Policy acknowledges that the existing course curriculum needs to be revised. Further, short term skill development programs and national level competency tests would be developed.

Promotion of Trade

The software product registry (discussed earlier) would be integrated with Government e-market[i]. The Policy states that the industry would be encouraged to create and use open APIs for improving interoperability of Indian software products and enable incremental innovation. Indian software products would be given preference vis-à-vis Government procurement in accordance with the Public Procurement (Preference to Make in India) Order, 2017. Indian software products would be showcased abroad through various events and specialised infrastructure to be set up in India and abroad. Further, Indian software products would be integrated in India’s foreign aid programs. The industry would be encouraged to develop products which would help people overcome language barriers, so that all sections of the Indian populace are included in this digital boom.

 

Sources:

  1. https://gem.gov.in/
  2. National Policy on Software Products (2019)- https://www.meity.gov.in/writereaddata/files/national_policy_on_software_products-2019.pdf

 

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Estonia: The ‘Smart’ Country

Estonia: The ‘Smart’ Country

We had an opportunity to visitTallin, the capital city of Estonia and what a rich experience it was, as we went from exploring the Enterprise Estonia showroom and the e-Residency opportunities to having interesting discussions with legal partners and witnessing the high energy, high technology ambience of Tallinn Science Park, Tehnopol.We have been connected to the Estonian innovation eco-system earlier but witnessing that in person and at close quarters was indeed a great experience

Enterprise Estonia

Enterprise Estonia showroom, where Media Team Member FredericoPlantera took us through the pulse of Enterprise Estonia – a short presentation (enter e-Estonia) on how with just a population of about 1.3 million the country is managing to be in the top tiers of theWorld Bank, OECD and other similar ratings. With 99% of services being online (excluding a few like divorce, marriage and buying and selling real estate), the country boasts of having recognised Internet as a social right, providing smart ID cards to all its residents (not citizens) and having 7% of its GDP coming from the Information, Communication and Technology (ICT) sector. Innovation is digital-by-default and incorporation of a company is a matter of 18 minutes in this country; add to that the facilities of e-taxation and e-residency (see our post on e-residency here); and there is a high potential of having a magical combination.

We also got a glimpse into how X-Road, the ‘highway of e-Estonia’, works. X-Road is basically the infrastructure and backbone of e-Estonia that connects various databases, ERPs, tax boards, state portals, banks, telecom companies, population registers, et al. across the country, thereby facilitating over millions of transactions per year. We are told that the technology of X-Road is largely similar to and a predecessor of today’s block-chain technology (having been in existence since 2001). It is also being exported and there are talks of exporting this technology to other EU countries like Finland, Netherlands, with the creation of a digitised EU market being the ultimate goal.

Amongst other things, Enterprise Estonia also provides ‘Start-up grant’ of up to €15,000, subject to certain terms and conditions. It is also the focal point for receiving various other grants and funding, made available through the Ministry of Economic Affairs under the Organisation of Research and Development Act, which is an enabling legislation for baseline funding, research grants.

Legal framework and taxation: We had the opportunity of meeting some of the top law firms in Tallin with detailed discussions on legal structure and taxation. You’ll be glad that there isno corporate income tax in Estonia on retained and reinvested profits; 20% corporate income tax on distributed profits (actual and deemed); dividends paid to non-residents being not subject to any withholding tax; DTAA between India and Estonia; 20% value added tax rate; no mandatory auditing for private limited companies below certain thresholds; easy foreign direct investment in Estonia; minimum share capital requirement (for private limited) of €2500, but the company can be established so that the share capital is paid later on; etc.

Incubation space: We also had the opportunity of visiting the incubation space of Tallinn Science Park, Tehnopol, which has supported companies such as Skype, GuardTime (the block-chain service provider to the Estonian government).Tehnopol is one of the biggest tech hubs in the Baltic region and works extensively with companies in the green technology, ICT and health technology sector, often times providing supports to companies, even at prototyping phases. The average incubation period is up to 2 years and till a company raises capital/generates the first sale. It invests up to € 10 000worth of expertise to start-up companies to find the first seed investment or reach export markets, providing access to 30+ business coaches working hands-on with start-ups, 70+ trainings, investor panels, sales, pitching and networking events annually, co-working center, and last but not the least, access to € 300,000prototyping fund PROTOTRON (prototron.ee). (For more details, see here).

So there, if you as an Indian enterprise wish to expand to EU, perhaps Estonia can be your landing place.

Deal structuring with the ‘startup tax’

The Finance Act 2012 brought in an amendment to tax the share premium which is above the fair value of investment by the resident angel investors and not proven satisfactorily to the tax assessing officer.  This amendment is effective 1 April 2013.

The fledgling Indian startup ecosystem has now started to thrive on the early stage investments by the angels, who invest based on startups creating value. Startup tax is anti entrepreneurship.

Many of you came back asking for possible structuring of investment deals for residents.  Before suggesting, here’s the relevant context (boring) but please read, and may be you can come up with some suggestions yourself.

The amendment to section 56 of the Income Tax Act, which is effective from 1 April 2013 provides for the following terms:

–       Consideration for issue of ‘shares’ in a ‘private limited company’ from a person being ‘resident’ in India.

–       Which exceeds face value, (the aggregate consideration received for such shares as exceeds the fair market value of the shares)

–       Fair market value means (i) “a value determined with such method as may be prescribed” or (ii) “as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is high”

–       Amendment to section 68 of the Income Tax Act, requires explanation about the nature and source of money.

This now requires a substantiation of the valuation at which investors invest in the new and smart startups where the product, service, IP is to be proven with revenues. That is quite a task!

When we read the Direct Tax notification on “valuation of shares and securities

The fair market value of unquoted equity shares = (Assets-Liabilities) * (Paid up value of equity shares)/ (paid up equity capital)

Well, not that simple and each of the term has a norm to be followed for calculation.  But you get the idea…

However, the valuation rules for ‘securities other than equity’ is based on ‘price it would fetch if sold in open market’ supported by a valuation report from merchant banker or CA. (This was as per 2010 Direct Tax notification)

The updated Direct Tax notification refers to “the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.” However, no clarity on valuation for securities other than equity shares is provided for.

Reading through the above requirements, then there are some possible structuring of investments that can be beneficial to the startup and the resident investors.

–       If the investment is from non-resident, NRE, FCNR account, then the startup tax is not applicable.

–       If the investment is from a VC, then the startup tax is not applicable.

–       We could ‘assume’ that if a resident angel investor, co-invests with a VC, then the valuation is somewhat proven. But sources of funds is still be explained to the Income tax authorities.

–       If the investment is in equity shares, then the valuation will be very low.  Then, proving to the satisfaction of the income tax officer will be hard.

–       Securities other than equity shares is valued at fair market value with valuation certificate by a merchant banker or a CA. Compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCD) are construed as ‘equity’ as per RBI norms, but the Direct Tax Circular refers to ‘equity shares’.  So, a possibility is to use CCPS and CCD as an instrument.  Other instruments that can be used are optionally convertible debentures, debentures, redeemable preference shares.

–       If the issuance is at a convertible debt, which converts to equity, then the conversion ratio and conversion price has to be carefully looked at.

–       One of the things to look at, in terms of control (voting), is to have a small number of equity shares (can be less than 10 numbers too) with differential voting rights.

We would love to hear your comments, leave them in the comments section.

DisclaimerThis is not a legal opinion and should not be considered as one.  Please check with your attorney before taking any actions.