Startups

software startups: SaaS startups may come under tax lens for adopting flipped structure

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Software product startups that have taken their intellectual property (IP) abroad by adopting the so-called flipped-structure method could come under the tax department’s scanner.

Revenue authorities feel that India is getting shortchanged because of this method adopted by some companies, not just on the potential asset value created by the IP, but also on tax collection, two people aware of the matter said.

Many startups that provide software as a service (SaaS) have replicated the Indian shareholding pattern in other jurisdictions — or flipped structures — before they opted for a large funding. This would mean a foreign entity would own the Indian business including the IP, which in many cases holds the most value.

Many large investors are reluctant to invest in startups if they do not own Indian assets through a holding company registered in jurisdictions such as Singapore or Mauritius, the people said. This is mainly because investors feel it would be easier to take these companies global later if they are not based in India. Also, several global investors do not wish to deal with Indian regulators and tax authorities directly, they said.

“Startups looking to externalise need to be mindful of several issues like application of roundtripping and tax impact on flipping and subsequent exits. In case of SaaS startups, which have a global clientele, flipping can result in significant value being captured outside India without corresponding taxes being paid in India. The Indian arms would typically be remunerated at a cost-plus model while the overseas entities would be earning much higher returns due to exploitation of IP,” said Amit Maheshwari, a partner tax and consulting firm AKM Global.

The tax department could look at scrutinising whether these structures hold water, or whether there is substance in the country that they have holding companies.

“Many startups have changed structures and now hold Indian entities through foreign holding companies, but when it comes to Singapore, substances have to be created and very often we see one or more of the promoters move there, along with transfer of IP assets,” said Pier Counsel partner Vatsal Gaur. Several Indian startups have been active on the SaaS front lately as they have been creating alternatives for well-established software products.

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