Tax-wise, $-foolish: Saving Dalal Street could come at a cost to Startup Street

It's deja vu all over again. Nifty and rupee are under pressure, FPIs are net sellers, and there's talk of tax cuts to stabilise markets. While band-aid solutions exclusively for listed markets have been tried in the past, India has evolved to a point where a listed market-only solution would impose significant long-term cost on the economy by damaging domestic risk capital and startup ecosystem.

A decade since Startup India's launch, India has over 2 lakh recognised startups, and nearly 125 unicorns. Domestic AIF commitments stand at ~₹16 lakh cr. Sidbi Fund of Funds for Startups (FFS) has committed ₹12,000 cr across 150 AIFs. SBI Caps Self-Reliant India (STI) fund has deployed ₹22,000 cr across 72 AIFs. The ₹1 lakh cr Research, Development and Innovation (RDI) scheme has made its initial allocations of ₹7,000 cr. Successive policy changes have permitted EPFO, NPS and insurers to invest in AIFs within prudent limits - pools so large that even small allocations represent significant long-term domestic institutional capital.

Entrepreneurs are no longer competing on labour arbitrage and price, but building companies that represent the frontier in deeptech and R&D-driven innovation. A generation of fund managers has grown alongside, pooling government capital with private capital, taking commercial risk, rather than administering a scheme. This ecosystem - ambitious founders, commercially-minded managers, co-invested public and private capital - is hard-won intangible infrastructure.


India's entrepreneurial successes of the last two decades were funded almost entirely by Mauritius-routed foreign capital. Without those funds, the entrepreneurship ecosystem would have been abysmal. With LTCG on listed equity at zero from 2004 to 2018, domestic investors sensibly preferred public markets, and private risk capital was ceded to Mauritius-routed foreign funds under the 1982 India-Mauritius DTA.

From the 1990s, the establishment welcomed foreign capital without questioning Mauritius substance, a position Supreme Court endorsed in 'Union of India v. Azadi Bachao Andolan' (2003). India exported the fund management industry in the 90s, and only in the last decade has it imported it back.

In 2017, the Mauritius treaty was closed for new investments, with grandfathering protecting prior investments - in the same spirit as the grandfathering that accompanied the 2018 reintroduction of LTCG on listed equity. Both were examples of the state honouring terms under which capital had been invested.

But the consensus in the establishment on grandfathering has broken with the recent judicial reversal in the Tiger Global case, the pledge by policymakers not to use Gaar, and invocation of Jaar by some tax officials. Given this history, a listed market-only solution, which will need to be closed later, would be an avoidable misstep.

Rationale for a tax cut is that global capital has choices, and Indian taxation lags Asian peers. But domestic capital has choices too. If rates are cut for listed shares only, listed exposure becomes more attractive than risk capital for every investor at once. Domestic HNIs will sensibly reallocate away from private markets. Even foreign capital may prefer listed companies and leave a gap in private markets. Indian entrepreneurship suffers.

AIF managers raise government anchor commitments but struggle to match them with private capital. Fundraises stretch, fund sizes shrink, and next-gen fund managers can't launch.

If, instead, the FM cuts rates for listed shares only for FPIs, honest domestic capital feels like a hostage and a round-tripping arbitrage opens for the dishonest. Tax enforcement spends the next decade trying to catch evaders. Foreign capital also shifts focus to listed companies as a competitive low-tax route to private markets is not available.

There should be a universal cut - applied equally to listed and unlisted shares, and to foreign and domestic investors - which would address immediate pressure points without recreating wedges India has managed to close. If the FM wants to address foreign investor concerns specifically, they can be taxed on dollar gains rather than rupee gains, a proposal that compensates for a real economic asymmetry - only foreigners bear exchange rate risk.

A separate, complementary move would be to expand investment avenues for tax-exempt foreign pensions and sovereign funds beyond infrastructure. This wouldn't be a favour. These entities are tax-exempt in their home jurisdictions, and we would want the same treatment for EPFO and NPS whenever they invest abroad.

While competitive tax policy is required, the larger goal is for Indian policy to be perceived as calm waters, not rough seas. A fair policy ruthlessly enforced is necessary. An unfair policy with whimsical enforcement corrodes the social contract. The FM has an opportunity to signal that India's commitment to a vibrant risk-capital ecosystem is settled policy, and not something to be traded away for one cycle of foreign portfolio flows.