By Sean Wolfe

It was another shot heard around the world.

Statements made Wednesday by India’s Union Finance Minister P. Chidambaram kept tax attorneys in Silicon Valley up late, firing off emails and alerts.

Silicon Valley

“Every exemption that has to be removed will be removed,” Mr. Chidambaram said, noting that India’s government would take another look at all of its tax exemptions with an eye to killing off most of them.

India

The objective, he said, was to establish a new exemption-free tax regime. But what worries attorneys the most are those related to stock options granted by foreign companies that have operations in India.

India

Of most concern to VCs are new regulations contemplated for options granted to employees in India after India’s 2007-2008 budget plan goes into effect April 1.

India

The new budget plan would tax outstanding options as “fringe benefits,” at a rate of 35 percent, to be paid by the employer.

Last-Minute Email

When Tahir Naim, a senior associate at Fenwick & West, learned about the contemplated changes, he had just finished penning an option agreement for a client operating in India.

India

He had to send an email to the client telling them to hold their horses. The law, if passed, would affect not just options issued after April 1, but those that have already been issued but had remained unexercised.

As in the United States, options in a company are a key way to attract and retain talent, and a way to reward entrepreneurial teams at software, biotech, and other technology companies. An overly onerous tax, many fear, will cap the boom in venture capital investing in India. VC investment had been projected to double in 2007 and perhaps break the $1-billion mark.

India

Mr. Naim, who is half-Indian, sounded both perplexed and resigned on learning the news.

“From my understanding, their budget process is much like the U.K.’s,” he said. “Deals are cut beforehand and the coalition behind the budget is put together, so it just goes on to pass. It’s likely to be a done deal. Hopefully someone will say something, because they’re shooting themselves in the foot here.”

U.K.

He compared the situation to the United Kingdom’s effort to tax employers on exercises of options in order to fund its national healthcare plan. “That didn’t apply, fortunately, to already outstanding options, so this is potentially much worse,” he said.

United Kingdom

Getting Tough with Taxes

The Indian government has been progressively tightening its legal system to ensure it gets what it deems its fair share of tax revenues.

Because most venture-backed companies operate from offshore—the African island of Mauritius is the favorite offshore location for VCs, with Cyprus and Singapore as runners-up—India has been changing its tax structure to lure companies onshore.

islandCyprusIndia

Part of that program taxes companies in key industries—biotech, software, nanotech, and others—the same as if they were incorporated offshore.

VCs Launching Funds

All this comes at a time when U.S. VCs are launching new funds in India. One of the largest VCs, New Enterprise Associates, recently announced a $200-million fund to invest in Indian technology startups, particularly in the telecommunications, media, and outsourcing industries (see NEA to Invest $200M in India).

NEA to Invest $200M in India

Venture capital firms tucked $508 million into Indian startups, according to a recent report from Venture Intelligence and the U.S.-India Venture Capital Association. That was up 124 percent from the 2005 levels in terms of dollars, when VCs ponied up $224 million. Deal count rose proportionally as well, with 92 deals in 2006, up 109 percent from 2005.

The big question on the minds of many VCs with Indian operations, to say nothing of many more Indian entrepreneurs, is whether 2007 investment patterns will resemble the recent rocket ride the country has enjoyed, or if 2006 is the apogee before the crash.