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Start-ups: Capital gains
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LIGHTCOME
With several prominent Indian start-ups leading the way by ‘reverse flipping’ from overseas holding structures back to Indian entities, many other India-focused start-ups are expected to follow suit in the near future.
Typically, ‘reverse flipping’ enables all shareholders and investors of these start-up companies, to hold their stakes directly in the Indian flagship entity (which could potentially list in India), rather than holding through a foreign holding company indirectly.
Over the past decade or so, many of the Indian start-ups had set up their holding company outside India (generally the US or Singapore), primarily driven by commercial considerations like strong preference from foreign investors, ability to list overseas, flexibility in regulatory/ overseas laws, tax considerations and so on.
However, with the rapidly expanding Indian start-up ecosystem and the successful public listings of several start-ups on Indian stock exchanges in recent years many India-focused start-ups/companies are eager to pursue listings in India.
Government initiatives
The government has actively engaged in facilitating this process efficiently by enabling cross-border mergers, including fast-track mergers for foreign companies with its wholly-owned Indian subsidiaries.
Key advantage associated with such mergers include the expectation of a largely India tax neutral outcome, which means that the companies can undertake the reverse flip without any significant costs, making the process financially attractive.
Additionally, the shareholders stand to benefit from grandfathering provisions, which allow them to retain their original cost basis and holding period for their investments — ensuring shareholders do not face adverse tax implications in the future.
SEBI has proposed to provide grandfathering of the holding period of convertible instruments issued on inbound merger in respect of OFS (offer for sale) look-back conditions, which require an investor to hold shares for a minimum of one year before offering to sell under OFS in IPO.
SEBI has also proposed certain relaxation for stock options held by founders (who are likely to qualify as promoter on IPO), whereby such options may continue to be held by founders after the IPO.
These relaxations would certainly go a long way to further stimulate the trend of homecoming for start-ups.
Despite the various government measures, some issues need to be addressed, such as clarity on grandfathering for stock options — in relation to a vesting period as well as for ex-employees..
Similarly, to avoid any ambiguity/litigation, it may be specifically clarified that the tax losses of the Indian company should continue to be protected pursuant to inbound merger since ultimate shareholders continue to remain the same.
Further, the RBI could consider issuing a clarification that no specific approval is required with respect to fast-track inbound mergers (akin to existing exemption for regular NCLT mergers), and for issuance of shares to existing investors from neighbouring countries (PN3 investors) pursuant to inbound merger — this would be very helpful and would further streamline the overall process.
Lastly, while the MCA’s recent initiative (in line with the Finance Minister’s announcement in the last Budget) to broaden the fast-track merger route to include merger with any subsidiary (not limited to just ‘wholly-owned’ subsidiaries) is a positive move, it would also be very helpful to extend this flexibility to inbound mergers as well.
All in all, given the ample liquidity and overall optimism in the Indian capital markets, now may be the perfect opportunity for India to ease some of these tax and regulatory aspects, motivating many more start-ups to return to the country.
Sisodia is Tax Partner, EY India. Susanjit Praharaj, Director-Tax, EY India, also contributed to the article
Published on May 14, 2025
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