By Sean Wolfe

Sean Wolfe

Proposals by India’s government to ratchet up taxes on local companies is raising concern among Silicon Valley venture capitalists, just as they seem poised to double their investments in the country’s burgeoning technology sector.

U.S. lawyers and overseas tax experts said recent statements by Finance Minister Palaniappan Chidambaram, who proposed a 35 percent tax on stock options issued by Indian companies and threatened to shut down an offshore tax haven, could stifle growing VC interest in the country.

“Hopefully someone will say something, because they’re shooting themselves in the foot,” said Tahir Naim, a senior associate at law firm Fenwick & West’s offices in Menlo Park, California.

Mr. Chidambaram’s comments come just as VC investment in India is poised to ramp up. Venture capital firms pumped $508 million into Indian startups during 2006, according a new report from Venture Intelligence and the US-India Venture Capital Association. That was up 124 percent from 2005 when VCs invested $224 million.

The National Venture Capital Association has forecast that VC investment in India will rise to $1 billion in 2007. One of the largest VCs, New Enterprise Associates, recently announced a new $200- million fund to invest in Indian technology startups, particularly in telecommunications, media, and outsourcing.

Optimistic Forecasts?

But some observers said that forecast could prove optimistic if the Indian government acts on the finance minister’s proposal to tax stock options. Under the proposal, employers in India would be required to pay a 35 percent levy on all outstanding stock options issued to employees. The law, if passed, would be retroactive, affecting not just options issued after April 1, but those that are currently issued but unexercised.

As in the United States, options are a key to attracting and retaining talent and rewarding entrepreneurial teams developing software, biotech, and other technology companies. An overly onerous tax, many fear, could slow innovation and investment in India.

Another key issue is the Indian government’s proposal to clamp down on the Indian Ocean nation of Mauritius as an offshore tax haven. The two nations have a double tax avoidance treaty, which has made Mauritius the top source of foreign investment into India and the primary route for the majority of U.S. venture capital entering India. Critics have long argued the agreement allows Indian companies to avoid paying capital gains tax in India.

Observers at this point are unclear whether the two proposals will become law. The government has still not even released a formal budget proposal, but Mr. Naim said Delhi’s parliamentary process makes it likely the proposals will go into effect without substantial change.

Others including Raj Judge, a partner at Silicon Valley law firm Wilson Sonsini Goodrich & Rosati, and head of the firm’s India practice, said it was far too early to predict the shape the final budget.

“The dust hasn’t settled yet,” said Mr. Judge. “It’s difficult to figure out what the rule will be based on one quote from the finance minister. There has to be compromise. Many parties have their own agendas.”

Others said they would not be dissuaded from investing in India, regardless of whether the tax proposals become law. Said Rob Chandra, managing partner at Bessemer Venture Partners: "The long-term opportunity in India is too compelling to be materially impacted by some tax changes.”