The Profitless Engine: How India’s Tax Code Fuels a Startup Bubble of Growth at Any Cost 

Zerodha founder Nithin Kamath argues that India’s tax structure is a primary driver of the country’s boom in unprofitable startups, creating a “tax arbitrage game” where investors and founders are incentivized to prioritize growth over profits. The significant disparity between a ~52% effective tax on dividends from profits versus a flat ~14.95% capital gains tax on share sales encourages venture capitalists to funnel money into user acquisition and revenue growth—even at a loss—to build a narrative that inflates valuation.

This strategy allows them to exit via IPOs at a much higher multiple, paying the lower tax, while simultaneously making it difficult for smaller, profitable competitors to survive the cash-burn wars. Kamath warns that this dynamic, compounded by a lack of M&A options, forces unsustainable “growth at all costs” models and creates businesses vulnerable to market downturns, raising questions about the long-term resilience of the startup ecosystem.

The Profitless Engine: How India’s Tax Code Fuels a Startup Bubble of Growth at Any Cost 

In the bustling bazaars of India’s startup ecosystem, a strange and counter-intuitive reality has taken root. The most celebrated companies are often not those turning a profit, but those burning cash the fastest. For years, we’ve accepted this as the price of disruptive innovation—a necessary sacrifice on the altar of future dominance. But what if the driving force behind this “growth-at-all-costs” mania isn’t just venture capital (VC) ambition, but something far more structural: India’s own tax code? 

This is the provocative thesis put forth by Nithin Kamath, founder of the highly profitable fintech giant Zerodha. In a sharp analysis, Kamath pulls back the curtain on what he terms a “tax arbitrage game,” a financial engineering loophole that quietly encourages startups to shun profitability, potentially at the cost of long-term resilience. 

The Math of the Escape Hatch: Dividends vs. Capital Gains 

To understand the game, you need to understand the two main ways wealth is extracted from a company. 

• Dividends (The Profit Route): A company makes a profit, pays corporate tax on it (around 25%), and then distributes the remainder to shareholders as dividends. These shareholders then pay income tax on that dividend at their slab rate, which for top earners can be up to 35.5%. Kamath calculates this effective tax rate at a staggering 52%. 

• Capital Gains (The Valuation Route): Instead of taking profits out, a company reinvests every rupee into marketing, discounts, and user acquisition—even if it means reporting losses. This “burn” fuels a growth narrative, which inflates the company’s valuation. An investor then sells their shares to a new buyer (often via an IPO) and pays tax on the gain. For long-term holdings, this tax is a flat 14.95% (including cess). 

The choice is stark: 52% vs. 14.95%. 

“For an investor, especially a VC, the math is simple,” Kamath notes. “Reduce corporate tax by showing minimal profits or losses. Spend (burn) on acquiring users, build a growth narrative, and then sell shares at a higher valuation while paying much lower tax.” 

This isn’t a minor incentive; it’s a financial siren song. The system actively penalizes traditional, profitable growth while lavishly rewarding revenue growth, even if it’s drenched in red ink. 

Beyond Tax Savings: The Valuation Multiplier Effect 

The “tax arbitrage” is only the first layer. The second, more powerful layer is the valuation multiplier. The market, particularly in its bullish phases, has shown a voracious appetite for growth stories. 

As Kamath explains, “A company doing ₹100 crore revenue with 100% growth might get a 10-15x valuation multiple, while a profitable one with a stable 20% growth might only get 3-5x.” 

Let’s break that down. The unprofitable, hyper-growth company isn’t just saving 37% in taxes; it’s potentially creating a 3x higher exit valuation for its investors. This creates a perverse feedback loop: 

• VCs demand hyper-growth to hit their fund return targets. 

• Founders are compelled to burn cash to deliver that growth, forgoing profitability. 

• The market rewards this narrative with lofty valuations, creating the illusion of success long before the fundamentals are proven. 

This loop effectively forces even the most sustainability-minded founders to join the cash-burn race. If your competitor is buying market share with discounted services funded by VC money, you have little choice but to match them or risk irrelevance. 

The Ecosystem Squeeze: Where’s the Innovation in All This Burn? 

Kamath makes a crucial distinction that often gets lost in the hype: much of this spending isn’t on deep technology or research & development. “We’re not discussing R&D spending here, which, incidentally, is very low in India (0.7% of GDP),” he points out. 

Instead, the capital is often funneled into customer acquisition wars—discounted ride-hailing, subsidized food delivery, and cashback-driven e-commerce. While this does drive adoption and build habits, it often amounts to a transfer of wealth from VC pockets to consumer wallets, rather than an investment in building durable, proprietary technology. 

This has a cascading effect on the entire ecosystem: 

• It Crowds Out Sustainable Businesses: Smaller, bootstrapped, or profitable competitors cannot compete with the artificially low prices funded by endless rounds of VC capital. 

• It Limits M&A Activity: A healthy startup ecosystem sees larger companies acquiring smaller, innovative ones. But when every startup is burning cash and holding out for a multi-billion dollar IPO, smaller, strategic acquisitions become less feasible. As Kamath says, “With almost no M&A opportunities in India, IPO is often the only way out,” creating immense pressure to go public before the company is truly ready. 

The IPO Cliff-edge and the Resilience Question 

This leads to the final, and most dangerous, part of the cycle: the exit. After 7-8 years, VCs need liquidity. The preferred path—an IPO—forces these unprofitable, cash-burn machines into the harsh, transparent light of public markets. 

We are now seeing the consequences. As Kamath observes, “Many VC-backed startups that went public in recent years… continue to show little or no profit partly due to this structure.” Public market investors, who are often more risk-averse and focused on bottom lines, are growing wary. The post-lockup period often becomes a cliffhanger, with early investors rushing to exit, leaving retail investors holding the bag. 

The most significant long-term risk Kamath highlights is a lack of resilience. “Once you run a business this way, it’s extremely difficult to switch,” he warns. A company built on a model of perpetual fund-raising and customer subsidies has not developed the operational muscles to withstand a prolonged market downturn. When funding winter arrives, as it periodically does, these are the companies that face an existential crisis, forced into desperate layoffs, fire sales, or collapse. 

A Necessary Re-evaluation 

It’s unlikely the government designed the tax code with this specific outcome in mind. The intent was probably to encourage reinvestment and fuel economic activity. But as Kamath’s analysis reveals, even the most well-intentioned policies can have unintended consequences. 

The question now is one of balance. Has the pendulum swung too far? Is the short-term boost in economic activity worth the potential creation of a generation of fundamentally fragile businesses? 

The conversation needs to evolve from celebrating fundraising rounds and valuation mark-ups to a more mature discussion about unit economics, path to profitability, and genuine innovation. The “tax arbitrage game” has been a powerful, hidden engine of India’s startup boom. The challenge for the next decade will be to build an ecosystem where profitability and sustainability are not just afterthoughts, but the very foundation of value creation. The market’s survival may depend on it.