By Achint Das, Policy Fellow, Engine Foundation
This week, President Biden and members of his Cabinet met with their Indian counterparts to discuss a range of pressing issues, including the war in Ukraine, the pandemic, and the administration’s trade engagement in the region as they build the Indo-Pacific Economic Framework (IPEF). First announced last October, the IPEF is designed to strengthen U.S. ties in the region and is envisioned as a series of “modules,” several of which will focus on issues important to startups — including digital trade, tax, and supply chains. Participating countries have not been announced, but India’s inclusion could help reduce barriers for American startups looking to operate there.
India is one of the foremost emerging markets, with a large English-speaking population and an even larger pool of Internet users. These factors attract interest from U.S. startups looking to expand abroad. However, regulatory burdens like recent intermediary rules changes, digital taxes, and data localization diminish the appeal of the Indian market for startups. The Indian government has erected barriers for foreign businesses, protecting domestic interests at the expense of economic openness and growth. Much of this protectionism has been through rhetoric, but the Indian government has also proposed and implemented policies that impact U.S. startups looking to operate in India. Fortunately, direct and regional engagement — including through the IPEF — stands to help reverse some of these trends and chart a path toward friendliness for U.S. startups.
Last spring, India noticed and implemented new rules to govern intermediaries in the country, adding to a regulatory environment encumbering U.S. startups looking to operate there. The intermediary liability guidelines have severely restricted the social media and digital news sectors by increasing costs, compliance burdens for organizations, and workloads for employees. Though the provision has yet to be enforced, the encryption requirements in the rules threaten to undermine end-to-end encryption and have drawn legal challenges. Reviews of compliance reports — documents required by the rules — reveal that companies have increased the use of proactive monitoring systems. Such systems are expensive for startups and ultimately imperfect. And companies in India still struggle with moderation.
India’s years-long efforts around creating a needed data privacy regime raise concerns about data governance and data localization. The proposed law will create separate classes of data subject to different rules — including “critical data,” (a category to be defined by the government) which must be processed locally in India, and “sensitive personal data” which may be processed elsewhere, but a copy of which must be locally stored. The tech industry and U.S. government officials have engaged with senior Indian officials to highlight concerns about restrictions on the cross-border flow of data and have underscored the dubious restrictions in a report on foreign trade barriers. Data localization requirements create particularly onerous barriers for startups, as they increase the investment required to enter or comply in markets with local data storage and processing rules. As Rishi Ranjan, the founder of AR/VR cloud computing startup GridRaster, points out, because of the increased costs such measures bring, companies “will have to really start choosing to keep local data or drop it if it might not be worth it price-wise for customers.” The IPEF’s digital trade principles are likely to promote cross-border data flows, and India’s potential participation can help move the country in a positive direction.
Digital services taxes (DSTs) have also been a serious concern for American and other foreign startups because, even if startups are not directly subjected to the tax, the taxes are likely to increase costs for startups. These increased costs — which would largely impact startups through advertising and marketing activities that are critical to reaching customers in a new market — create barriers to entry for startups. On top of those issues, DSTs often contravene tax norms by applying to revenue rather than profit. Many DSTs tend to have high thresholds intended to target the largest companies, but those costs would likely be passed on to startups and others in practice. By contrast, India’s DST, known as the Equalisation Levy, has a very low threshold to trigger the tax, all the more threatening to negatively impact American startups. In 2021, countries reached an agreement through the Organization for Economic Co-operation and Development (OECD) designed to dial back DSTs around the globe, which helped the U.S. to reach an agreement with India to pause its DST. The agreements, however, are conditional on the implementation of the OECD deal, meaning DSTs in India (and globally) can return to threaten American startups.
As India has sought to limit entry by foreign startups, the Indian government has also endeavored to boost domestic entrepreneurship, especially in tech. Investment in their domestic startup ecosystem is increasing, and the government set up a fund of funds to spur startup investment, with those efforts resulting in a number of IPOs during recent years. The government has also placed a huge emphasis on technology and entrepreneurship in the Indian Budget for 2022. The inclusion of digitization and emerging technologies initiatives such as drones, animation, visual effects, gaming, comics, and cryptocurrency shows a strong willingness to adopt new technology and innovation.
Yet, such support does not offset the harsh and excessive regulation regarding digital information and technology that harms all actors. While domestic companies can benefit from India’s protectionism, the regulatory burdens and lack of transparency in the digital space have angered many domestic entrepreneurs. In fact, many startups tend to register their businesses outside of India for regulatory, investment, and tax benefits.
American startups and other non-Indian companies share this frustration and have had to adapt to new Indian legal frameworks in order to remain in the country and not run afoul of the law. The difficulty of doing business, underpinned by high regulatory compliance costs and excessive penalties for non-compliance, has turned away many budding international entrepreneurs. Those who stay must have the resources, funding, and bandwidth to significantly adjust their strategy and operations. This is evident from small startups to large, established companies, when reviewing responses to the new intermediary rules, for example. As a direct consequence of the discriminatory measures within the law, larger companies like Snapchat have hired Indian public policy specialists, while smaller startups do not have such resources and have had to continually innovate with new moderation technologies.
Though the Indian government may think it’s acting in its best interest by buffering domestic actors from competitive foreign entrants like U.S. startups, it is counterproductively hindering innovation, allowing for inefficient business practices, and stifling its own growth by pursuing a protectionist entrepreneurship policy. Fortunately, international pressure has an important role for evening the playing field and scaling back regulations. Such pressure is already an integral part of the Indian legislative process. Historically, the first draft of most Indian legislation is typically excessive, and pressure from foreign governments and businesses works to reduce the unreasonableness of such legislation and promote friendliness with foreign businesses, large and small. Trade fora — including the IPEF — can be an important avenue for this engagement, helping to mitigate protectionism and boost opportunities for U.S. startups within India.
Engine is a non-profit technology policy, research, and advocacy organization that bridges the gap between policymakers and startups. Engine works with government and a community of thousands of high-technology, growth-oriented startups across the nation to support the development of technology entrepreneurship through economic research, policy analysis, and advocacy on local and national issues.