Report of expert committee on ‘Onshoring Indian Innovation to GIFT IFSC’

International Financial Services Centres Authority
(A statutory authority established by Government of India)

Press Release

Report of the expert committee on ‘Onshoring the Indian Innovation to GIFT IFSC’ submitted to IFSCA

A Committee of Experts to ‘Onshoring the Indian Innovation to GIFT IFSC’ constituted by International Financial Services Centres Authority (IFSCA) submitted its report to Chairperson, IFSCA on August 14, 2023. The committee was chaired by Shri G. Padmanabhan, Former Executive Director, RBI. The committee members comprised representatives from leading Venture Capital funds, Startups, Fintechs, Law firms, Tax firms and other domain experts and the constitution of committee can be accessed through the link: https://ifsca.gov.in/IFSCACommittees

The main focus areas of the committee were directed towards understanding the reasons for shifting of Indian startups outside India and suggestions to avoid externalization of startups in the future and also to persuade startups that are presently externalized to redomicile back.

The committee has provided its recommendation that are critical to the development of GIFT IFSC as a global Fintech Hub, besides suggesting measures to encourage new Fintechs to have global outlook to set up their commercial presence in GIFT IFSC. The committee also has identified challenges and recommended measures for the development of the International Innovation Hub at GIFT IFSC. The report has suggested various measures/ action points to be undertaken by various stakeholders including ministries, regulatory bodies and others in implementing the idea of onshoring the Indian innovation to GIFT IFSC.

The committee report offers a comprehensive comparison of India’s approach to holding company setups with other leading jurisdictions like Singapore, the Netherlands, and Delaware , known for successfully implementing such setups. By highlighting the manifold advantages and addressing potential challenges associated with holding company regimes, the report unveils the immense potential of reverse flipping to drive India’s economic development to great heights. The Committee has inter-alia recommended aligning the tax and regulatory laws within the IFSC with international best practices, to create an environment that actively incentivizes and supports holding company structures. The committee has also examined in the report several push-pull factors are responsible for Indian founders flipping to overseas jurisdictions.

The Committee is of the view that the insights presented in the report will help drive dialogue in the ministry and will contribute to achieving Hon’ble Prime Minister’s grand vision of making India a 5 trillion-dollar economy and a global powerhouse. The Committee Chair Shri G. Padmanabhan, on submission of the report expressed his gratitude to IFSCA for affording an opportunity to work on the extremely topical issue.

Chairperson, IFSCA thanked the committee of experts for their comprehensive recommendations.

The report of the committee can be accessed through the weblink: https://ifsca.gov.in/ReportPublication/index/aadg9ruDI%20M=

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Report of the Expert committee on ‘Onshoring the Indian Innovation to GIFT IFSC’

Onshoring the Indian Innovation to GIFT IFSC – August 2023

August 21, 2023
Gandhinagar

Foreword

As per the latest economic data, India is currently a $3.75 trillion economy. To become ‘one trillion-dollar’ it took India 60 years post-independence. The next trillion dollars were added in just 7 years and the third tril­lion were added in just 5 years. With such a tremendous growth in the economy, it is expected that for the next 14–15 years India will consistently add a trillion in its economy in an average span of two years. The Centre for Economics and Business Research (CEBR) has forecasted that India will become a ten trillion-dollar economy by 2035. 1

The startup industry has played a crucial role in fostering India and played a crucial role in growth of the country and is expected to play a vital role in increasing financial inclusion and digital adoption of the economy.

The Indian startup ecosystem is emblematic of “New India”—assertive, dynamic, and focused on lifting aspirations. ² With more than 108 unicorns, and nearly over 100000 recognized startups, India constitutes the third largest startup ecosystem in the world ³ and is continually gunning to create ever greater impact, commensurate with the extraordinary latent potential of its entrepreneurial cohort and demographically gifted consuming class.

Between January 2014 and May 2023, Indian startups have attracted funding of about USD DS 141 Bn. ⁴ Out of these, a total of 66 billion dollars was raised in 2021 and 2022. ⁵ It has experienced an exponential surge in funding over the last few years, attracting massive investments from major private equity and VC players in the industry.

As startups grow and begin to have a global footprint, one sees a steady increase in founders wanting to exter-nalize/flip their structure. Flipping is a process of shifting the head office of the startup to an overseas juris­diction like Singapore, USA, UK etc. This is primarily done due to several reasons including stronger value of currency prevalent in the overseas jurisdiction, favorable tax structure, proximity to investors, and reduced compliance burden. These externalized/flipped startups constitute a majority of India’s unicorns.

In order to avoid flipping/externalization of Indian startups, the report delves into the startup landscape, regulations and the forces shaping the future of this industry. Insights presented in this report, will highlight upon the reasons for flipping of Indian startups and suggestions that may be implemented to avoid external­ization of startups in the future and also to make an effort in order to persuade startups that are presently externalized to redomicile back to India.

We hope that the insights presented in this report will help drive dialogue in the ministry and will contribute to achieving our Hon’ble Prime Minister’s grand vision of making India a 5 trillion-dollar economy and a global powerhouse.

Executive summary

The startup ecosystem in India has evolved significantly since the early days of economic liberalization in early 1990’s. Today, the Indian entrepreneurial talent is driving the global knowledge economy with cutting edge innovation, value creation and wealth generation. If Silicon Valley built the first billion internet users in the world, India is building for the next 7 billion internet users of the world. The vibrant startup ecosystem is a shining example of India’s technological prowess, entrepreneurial spirit, and innovative workforce.

Today, not only is India the third largest startup ecosystem in the world with nearly 1,00,000 registered startups, but it also has the third highest number of unicorns globally (startups with 1 Bn plus valuation). Over the last decade or so, the startup ecosystem has witnessed tremendous amount of activity in terms of growth of new startups, increased funding for startup ventures, influx of global investor, development of enabling regula­tory architecture, creation of new employment opportunities, global mergers and acquisitions, and interna­tionalization.

The startup economy is transforming India as a global hub for innovation and entrepreneurship. The exponen­tial growth in the startup ecosystem is not only contributing to India’s economic growth but is also providing an avenue to the young and talented workforce to exhibit their talent and skills.

While on one hand, India’s startup ecosystem has achieved remarkable growth and recognition, on the other hand, a worrying trend of Indian startups externalizing or flipping to overseas jurisdiction has also come to the fore. Externalization or flipping refers to a process of transferring the entire ownership of an Indian startup entity to an overseas entity, accompanied by a transfer of all IP and data hitherto owned by the Indian company. It effectively transforms an Indian startup (company) into a 100% subsidiary of a foreign entity, with the founders and investors retaining the same ownership via the foreign entity, having swapped all shares.

Accordingly, this Committee was set up to examine the entire gamut of issues that had led to “flight of inno­vation” to overseas jurisdictions, make recommendations to reverse the situation including making IFSC in GIFT City as the first destination of choice for such Indian Startups.

A vibrant holding company regime in IFSC will act as a catalyst, attracting foreign investment and positioning IFSC as the preferred destination for multinational corporations (MNCs) and enterprising Indian startups seeking to establish their regional or global headquarters. Central to this transformation is the fostering of a supportive tax and regulatory environment, streamlining bureaucratic processes, automation driven approach, enhancing transparency, ensuring accountability and most importantly the ease of doing business. Recognizing the significant impact of policy changes in direction of holding companies’ attractiveness, this report also seeks to review and recommend aligning of the tax and regulatory laws within the IFSC with international best practices, creating an environment that not only welcomes but actively incentivizes and supports holding company structures.

This report offers a comprehensive comparison of India’s approach to holding company setups with other leading jurisdictions like Singapore, the Netherlands, and Delaware, known for successfully implementing such setups. By highlighting the manifold advantages and addressing potential challenges associated with holding company regimes, this report unveils the immense potential of reverse flipping to drive India’s economic development to great heights. Drawing inspiration from the success stories of these pioneering jurisdictions, India is poised to harness the full potential of holding company frameworks.

This process of setting up Holding Companies (HoldCos) by Indian startups in overseas jurisdictions is moti­vated by several compelling factors ranging from favourable tax regime, agile regulatory environment, ease of operations, prospects for better valuation with access to foreign capital markets as well as preference of inves-tors/founders. Flipping essentially creates a peculiar situation for Indian startup ventures, whose founders are Indian, employees are majority Indians, activity is predominantly in India, but the holding company is domiciled overseas.

The externalization/flipping of startups impacts the Indian economy in several ways. One, a direct conse­quence of flipping is the brain drain of entrepreneurial talent from India. Young, skilled, and innovative founders relocate to overseas jurisdictions, which results in loss of human capital, stalling of innovation and technological advancements within the country. Two, flipping of startups results in value creation in foreign jurisdictions rather than in India. Home grown innovative ideas and disruptive technologies contribute to the startup ecosystem and economic growth of other countries. It also results in the loss of Intellectual Property and Tax Revenue for the country.

The committee examined several push-pull factors are responsible for Indian founders flipping to overseas jurisdictions. In the preferred jurisdictions overseas, startup founders are able to benefit from favourable busi­ness & regulatory regime, ease of doing business, tax incentives, better IP protection and higher valuation for their ventures with easier access to capital. In several instances, foreign investor influence has also been a major factor for Indian startups to flip overseas.

To bring back the flipped startups to onshore India and prevent further flight of Indian innovation to over­seas jurisdictions, the maiden International Financial Services Centre (IFSC) in GIFT City can play a signifi­cant role. Being an offshore jurisdiction within the country, GIFT IFSC offers several advantages to the Indian startup community including flexibility to transact in foreign currency, hassle-free movement of capital and investments, business friendly regulatory environment, reduced compliance burden, attractive tax regime & financial incentives, access to vibrant and growing PE/VC ecosystem as well as access to world class FinTech Hub.

More importantly, GIFT IFSC has been developed as a distinct international financial jurisdiction within the country to onshore the offshore international financial services business and act as a gateway for global capital inflows into and out of the country. Therefore, the objective of facilitating reverse flipping of Indian startups integrates very well with the overall objective of GIFT IFSC i.e. “Onshoring the Offshore”.

The Committee met several times and held discussions with various stakeholders. Besides, different sub-groups were formed to look into various aspects and have extensive discussions with stakeholders. A comprehen­sive discussion of startup ecosystem across different countries was attempted. The Committee has identified several issues that need to be addressed to create a facilitating environment. These cover several areas as under:

• Company law and regulatory aspects
• Tax related issues
• Listing of startups on IFSC Exchanges
• Peripheral issues
• Other regulatory issues
• Automation related issues
• Infrastructural issues
• Intellectual Property related issues
• Perception issues

Issues have been flagged and specific recommendations made that would address these issues. Recommenda­tions are summarised below in a tabular format:

Sr. No.	Issue	Recommendation
A	Company Law and Regulatory Issues
1	Holding Company Structure	Holding Company structures with simplified incorporation processes and procedures to be permitted in GIFT IFSC.
2	Incorporation of Companies	Designing and implementation of “Common application Form” to consoli­date company incorporation and IFSCA approval under one form / review. IFSCA to be the single point nodal office for CAF.
3		All applications for incorporation of companies or setting up of branch offices in GIFT IFSC should be processed by a dedicated MCA official in GIFT IFSC.
4	Relaxation of certain compliances under Companies Act, 2013	With respect to certain filings to be made with the registrar of companies, it is recommended to grant exemptions / relaxations to IFSC companies.
5	Liberalised Remittance Scheme	LRS limit for the purpose of investment in IFSC should not be clubbed with other investments / activities i.e., instead of keeping the LRS limit for invest­ment purposes at par with the other general activities, it should be grouped under a different head with a higher investment limit than the current USD 250,000 per financial year.
6	Overseas Investment Restrictions on Indian AIFs and Mutual Funds	Investments made by Indian AIFs and Mutual Funds into entities domiciled in GIFT IFSC to be excluded from the aggregate limit set by RBI for making overseas investments.
B	Tax Related Issues and Proposals
1	Tax neutrality on relocation of offshore holding company to GIFT IFSC	In order to incentivize movement of offshore holding companies in GIFT IFSC, efforts should be made to ensure tax neutrality, so as to not trigger adverse tax consequences for the offshore holding companies and their stakeholders.
2	Participation exemption for GIFT IFSC holding company on levy of capital gains tax	In order to incentivise the movement of holding / parent companies to GIFT IFSC, it is recommended to have a “participation exemption” mechanism to provide for exemption on capital gain tax on transfer of shares, subject to meeting prescribed conditions.
3	Rationalization of tax rates with respect to disposal of shares held by GIFT IFSC holding company	Upon relocation, efforts would need to be made to ensure that when the offshore holding company would relocate / re-domicile as GIFT IFSC holding company (i.e. an Indian resident company), the applicable tax implications on transfer of shares held by GIFT IFSC holding company in Indian subsid­iary should not be disadvantageous as compared to the tax implications, had no relocation of holding company taken place.
4	Concessional tax regime for dividend in the hands of GIFT IFSC Company/ divi- dend distributed by GIFT IFSC Company	Dividends received by an IFSC holding company from investment in over-seas subsidiaries or Indian subsidiaries should be tax exempt, subject to meeting prescribed conditions i.e. holding a certain percentage stake and / or equity participation meeting certain acquisition value.

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Sr. No.	Issue	Recommendation
1	Residential status of foreign subsidiaries of GIFT IFSC holding company	In case of relocation of offshore holding company to GIFT IFSC, there should be no adverse tax consequences for the subsidiaries of GIFT IFSC holding companies merely because its effectively managed in India via the IFSC holding company. This can be ensured by way of an express clarification that PoEM will not be triggered merely because the holding company is based in GIFT IFSC.
2	Angel tax exemption	To encourage flipping of offshore holding company into GIFT IFSC and for that matter even to encourage greenfield investments in holding compa­nies to be setup directly into GIFT IFSC, angel taxation provisions should not apply to GIFT IFSC holding companies
3	Transfer tax levied in offshore jurisdic- tion	For startups reverse-flipping into GIFT IFSC, the Government may consider permitting carry forward of the losses or provide enhanced tax holiday period instead of the existing 10 year tax holiday.
4	Stamp duty exemption	To encourage startups to consider GIFT IFSC for set-up of holding company, stamp duty exemption should be provided.
C	Listing of Startups on IFSC exchanges
1	Listing of start-ups on IFSC stock exchanges	To relax or provide exemptions from the applicable conditions for the listing of startup in GIFT IFSC, which would allow the start-ups to raise capital from the global markets.
2	Issuance of Indian depository receipts (IDR) on Indian stock exchange	To liberalize the IDRs guidelines that will provide Indian resident investors with an opportunity to invest in foreign companies without directly trading on foreign stock exchanges and dealing with foreign currency conversions.
D	Peripheral Issues
1	Exemption from ‘deemed gift tax’	Tax exemption from applicability of ‘deemed gift tax’ under the provisions of section 56(2)(x) of the Income-tax Act, 1961 should be enacted for relocation of holding companies in GIFT IFSC.
2	ESOP Taxation	Tax neutrality to be ensured for investors/ shareholders of the offshore holding company when they acquire shares of the company established in GIFT IFSC in lieu of the shares of the holding company.
3	Convertible Notes	The tax treatment of CNs ought should not deviate materially from the tax treatment of other convertibles and to this effect the taxation regime for CNs should be clearly laid under the law.
4	Personal taxation for non-resident indi- viduals	In order to boost the relocation of the non-resident high skilled profes-sionals with offshore holding companies to India, India should consider aligning its personal income tax rates for such non-resident individuals with the competitive jurisdictions globally (preferably less than 20%).
E	Other Regulatory Issues
1	Expanding ODI for GIFT IFSC entities	To allow ODIs in entities in GIFT IFSC which have Indian subsidiaries.
2	Issues related to offshore merger	In order to flip the holding companies back in India, recommended to exclude mergers from the purview of NCLT and other complex processes.
3	Smoother and faster exits	Rationalization of the exit and winding up procedure of companies incorpo­rated in India.
F	Dispute Resolution
1	Special courts and arbitration	Establishment of special courts in GIFT IFSC that can provide a faster, simpler and efficient dispute resolution mechanism.
2	Advance ruling authority	Establishment of an advance ruling authority to address any regulatory questions that the investors/entrepreneurs may have with respect to any transaction.
G	Operational Issues
1	Escrow mechanisms in India	Streamlining usage of escrow arrangements in India such that the rules governing the same are in conformance with the global practice.
2	Treatment of deferred consideration	Certain measures are possible such as widening the tenure of deferment, increasing the cap limit of deferred considerations etc.
3	Automatic IMB approval for IFSCA regis- tered Fintechs	IFSCA may explore an understanding with DPIIT, and the IMB such that the approval of Fintech Companies by IFSCA may be relied upon by the IMB to certify such companies as “eligible start-ups”.
H	Automation Challenges
1	Administrative procedures which require human intervention	Introduction of an automated framework in various areas including company registration and compliance, regulatory reporting, risk manage­ment etc.
I	Infrastructure Issues
1	Inadequate infrastructure facilities in GIFT IFSC such as lack of commute options, restaurant chains, bars, recre­ational facilities etc.	Improving the infrastructure facilities available in GIFT IFSC.
2	Lack of state-of-the-art Incubation centres	Creation of world class incubation centre with adequate infrastructure, avail-ability of sectorial mentors that can enhance the startup ecosystem in GIFT IFSC.
J	Intellectual Property related issues
1	Challenges with respect to IP laws in India including delays in processing of patents and trademark applications, lack of awareness regarding the IP laws amongst the startup community etc.	Formation of a committee to review the delay in granting patents and inclu-sion of software and business methods under patentable matters. Various awareness campaigns where expert advice is provided to the applicants.
K	Perception related issues
1	Lack of understanding in the startup ecosystem regarding the amendments made to the Indian regulations including the benefits provided for entities in GIFT IFSC.	Creating awareness of the benefits provided by such regulatory amend-ments amongst the start-up community. This can be done by holding town-halls with industry to seek their issues, holding meetings with investors promoting offshore flipping etc.
L	Other Aspects
1	Raising of capital through SAFE instru- ments, SPACs, VCCs and listing on offshore exchanges	Rationalization of the corporate laws in India which allows companies to raise capital through contemporary means.
2	Convertible Notes	Modifications to be made to the CN framework prescribing no time limit for issuance of CNs by start-ups and allowing CNs to convert into mandatorily convertible equity instruments.