A startup raising capital through convertible notes or compulsorily convertible preference shares incurs a cluster of advisory expenses—legal fees, due diligence costs, valuation fees, merchant banking fees and accounting support. The GST questions that arise are distinct from the income-tax questions. The first is whether the issue of the convertible instrument itself attracts GST. The second is whether the GST paid on advisory expenses is available as input tax credit to the startup. The two questions have different answers, and conflating them is a common source of error.
The Instrument Itself Is Not a Taxable Supply of Services
Convertible notes and compulsorily convertible preference shares are securities. The issue of securities is not a supply of goods or services under the GST law; it is treated as a transaction in money or securities and falls outside the charge of GST. A startup that issues convertible notes to investors is not making a taxable supply by reason of the issuance, and the consideration received is not subject to GST.
The characterisation of the instrument as debt before conversion and equity after conversion is relevant for accounting and income-tax purposes, but it does not convert the issuance into a taxable service. The conversion of the note into equity is also not a taxable supply; it is a change in the legal form of the instrument, not a supply of a service to the investor.
Advisory Expenses: The Input Tax Credit Question
The GST paid on legal fees, due diligence, valuation, merchant banking and accounting support is input tax on services received by the startup. Whether that credit is available depends on whether the services are used in the course or furtherance of business, whether the invoice is in the name of the registered startup, and whether the input falls within a blocked category under Section 17(5) of the CGST Act.
Fundraising is ordinarily a business activity. Legal and professional services procured for a capital raise are used in the course or furtherance of the startup’s business, not for personal consumption. If the startup is registered under GST and the invoices are in its name, there is a reasonable basis for claiming the credit, subject to the general conditions and the blocked-credit exclusions.
The blocked-credit categories must be checked. Credit is blocked on certain goods and services, including works contract services for immovable property and goods or services used for personal consumption. Advisory services for fundraising do not ordinarily fall within these exclusions. However, where an invoice covers a mix of fundraising advice and personal or non-business advice, the credit attributable to the non-business component should be reversed.
Registration Timing and the Pre-Registration Cost Problem
A startup that incurs advisory expenses before obtaining GST registration faces a timing problem. Input tax on goods held in stock on the day before registration can be claimed within the Section 18(1) window, using Form ITC-01 within the prescribed period. Services consumed before registration do not have an equivalent route; their GST ordinarily becomes a cost.
This means that the timing of registration can materially affect the recovery of GST on fundraising costs. A startup that registers early enough to receive advisory invoices in its registered name can preserve the credit. A startup that registers after the fundraising round is completed may find that the GST on advisory services has become a sunk cost. The decision should be modelled against the expected advisory spend, not assumed.
Documentation and the Name on the Invoice
The single most common reason a startup loses input tax credit on advisory expenses is that the invoice is not in the name of the registered person. An invoice issued to a founder in a personal capacity, or to a predecessor entity, does not support the registered startup’s credit claim. Where the invoice is in a personal name, the startup should explore whether the vendor can reissue it in the company’s name; if not, the credit is ordinarily lost.
The startup should also ensure that the invoice description matches the service actually received. A generic “professional services” description across legal, valuation and merchant banking invoices creates ambiguity if the credit is later reviewed. The vendor master should record GSTIN status and the nature of each supply.
What the Startup Should Control
The startup’s GST position on convertible notes and advisory expenses depends on three variables: whether the instrument issuance is correctly treated as outside the charge of GST; whether the advisory invoices are in the registered startup’s name and relate to business use; and whether the timing of registration preserves the credit on pre-registration advisory costs. The startup that controls these variables avoids both overpaying GST on the instrument and losing credit on the expenses that surround it.
Call to Action: We advise startups and founders on GST treatment of convertible instruments, ITC on fundraising costs, registration timing and documentation. For a transaction-specific review, contact office@anujdesaiassociates.com, Ph No. 9619456656, Website https://anujdesaiassociates.com, LinkedIn linkedin.com/in/ca-anuj-desai-122547230.