I get this question quite often enough – Why aren’t any big Tech companies coming up from India like a Facebook or a Google? Let me try to answer this question and see if this is something to do with Indian Environment as a whole for Tech companies or Indians aren’t qualified enough to make such a big mark on Internet.
The biggest challenges for startups is managing the finances and so let us look at the taxation and see if it is something that helps Indian Tech Startups to grow or prosper or it becomes a hindrance to the growth.
Sales or Service Tax
Sales or Service Tax of 12.36% on Gross Turn Over
If a company has a turn over of just 10 Lakh (1 million) Indian Rupees or above, they should be paying service tax on the gross turn over of the company. Remember on Gross turn over and not on Net Profit that is Income less expense. 10 Lakh or 1 million per annum means less than 1,00,000 Rs per month which is quite low for any REAL company. Once a company reaches 80%+ of the limit of 10 Lakh or 8 lakh, they need to get a service tax number.
So now lets see putting some numbers into it. Let’s say a company has come up with some really cool product like an iOS + Android Application or a cool mobile game or something similar. Company is selling that product for say 100 Rs. If the company makes sales 800 unit, they don’t need to be paying any service tax but they need to be registered for the service tax numbers but once they make 1000 sales, they make 100,000 and so need to be paying 12.36% as service tax which means they will be paying 12,360 Rs as service tax on sale of 1000 units irrespective of the company is able to make profit or not out of those sales.
My view is the limit of 1 million per annum for companies means that dummy companies who have no businesses whatsoever don’t need to be paying service tax but any business that want to be growing should be paying that amount.
If you take away 12%+ on gross turn over (remember not on profit) I don’t see companies can prosper in such environment. Yes on Net profit, it is something that can be worked upon but on gross turn over it is something that becomes too much of a burden for small Indian tech companies to prosper.
The argument is – pass service tax onto the customers.
If you are dealing with Indian customers, you can always add extra service tax thing to the final pricing but then for tech companies, customers are more often global than India and so the service tax actually cannot be passed onto the customers but has to be paid from the price of the product. On top of those smaller companies who want to be making more sales cannot pass onto such prices to the global customers for obvious reasons.
Income Tax of 30% on Net Profit (i.e. Gross Income less Expense) and 3% of Education CESS on Income tax and Surcharge paid.
Income Tax is something that company pays only on profit, which is something that is always acceptable and it is almost a norm worldwide and so I don’t think it is something that can hinder a companies progress being in India. Companies as big as Apple can save billions on Tax if they are innovative enough.
Numbers to See How Bad this is for Indian Tech Startups
Let us take an example of a small company that makes a turn over of 3 million Rupees per year and has a profit margin of 40%, which I think is pretty normal for tech companies, and see how the numbers unfold. In the outset a 40% margin looks really impressive isn’t it?
Turn over of 3 million and the company makes a profit of 1.2 million or 12,00,000. Now they pay a service tax of 370,800 and so the net profit becomes 8,29,200. Remember even if the company does not make any profit whatsoever they still need to be paying 370,800 as service Tax.
Now on a profit of 8,29,200 they pay a 30% tax of 2,48,760, which reduces the company profit to 5,80,440. Now we need to be adding 3% of Education CESS on Income tax of 2,48,760, which is 7462.8, and so profit reduces to 5,72,977.2
So a whooping profit margin of 40% reduces to 19.1%
Companies fewer than 1 million Gross turn over and they don’t pay any service tax and only Income Tax on Net Profit. If the company is big enough service tax (and income tax) can be waived off by moving their operations to SEZ (Special Economic Zone) but to get a space in SEZ means investment of few millions clearly indicating environment better for larger tech companies only.
Hope I have answered the question why Indian tech startups aren’t able to prosper. The environment is quite ok for companies targeting Indian audience because they can pass the service tax expense to the customer and pay income tax only when it is profitable. This does not work for companies targeting global customers.
Update: September 21st 2013 : Further To what I wrote in thehindubusinessline.com – India’s small entrepreneur effectively does not enjoy the benefits of limited liability
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