I recall a conversation with Alok on this topic, on the day the budget was presented. The Economic Times has an article today that outlines the issue, but presents no clear resolution one way or another. Would some of the knowledgable folks here comment?
The worst isn’t over for venture capital funds (VCFs). The million-dollar question before funds now is the rate at which their earnings will be taxed. Will it be 10% that stock investors pay on “capital gains” or, will the IT assessing officer use his discretion and treat the earnings as “business income” and slap a 30% tax?
There is no straight answer to this: while one may argue that VCFs buy stocks with the clear purpose to invest and hold on for a few years, it is also perceived that trusts are set up for the “business of investment” and hence what they earn is business income.
More so, since VCFs invest in unlisted stocks, where long-term gains are also taxed. A 30% tax could deal a body blow to VCFs, making them significantly less attractive as invesment vehicles. The tricky issue has cropped up even as funds are finding it difficult to come to terms with the new proposal that brings most VCFs under the tax net.
- Mary Meeker’s 2014 Internet Trends report - May 28, 2014
- Andreessen-Horowitz raises $1.5B for its new fund - February 1, 2012
- WestBridge launches India “evergreen” fund - November 15, 2011
See what ICICI Venture fund is doing:
http://economictimes.indiatimes.com/ICICI_Venture_ready_to_recast_fund/articleshow/1830355.cms
Essentially, it’s going to make the investment through a trust and pass on the tax through to the taxpayer.
Also, this rule only applies to SEBI registered VC funds. If a VC fund is registered as a trust, but not with SEBI, it still has a pass through status (I think).
Krish,
Not sure if I agree with that. I think NBFCs can only invest in debt, not equity. The latter carries more risk, so by definition, belongs to the same asset class as venture capital. If you ask any fund manager, venture capital, private equity & hedge funds belong to the same asset class as they invest via equity participation.
Unless NBFCs can participate via equity (which I don’t think is the case because they raise money through term deposits that can be as short as one year), it is incorrect to treat PE & NBFCs similarily even though they may invest in the same sectors (hospitality etc).
VCFs, PEs & Hedge funds are all funded by what is called limited partners, who invest for the long run – as long as 10 years.
Even PE (growth capital) is about creating jobs, so I don’t follow any part of your argument.
Ashish.
The confusion is about tax treatment of VCF income –
” Will it be 10% that stock investors pay on “capital gains” or, will the IT assessing officer use his discretion and treat the earnings as “business income” and slap a 30% tax? ”
With the Pass Thro status of VCFs now allwed only to eligible investments, Taxmen are left with a larger *catchment* area to flex their discretionary muscle – especially when Private Equity (PE) funds disguised as VCFs began to invest in listed / unlisted real estate, hospitality and entertainment, they looked no different from a corporate NBFC. They were getting away with quick listing gains with no `Venture Risk’ in it either. Thus Taxmen could classify it as legitimate *Business Income* liable to applicable rates of tax ( 30%+Surcharge+Edu.Cess) and not *Capital Gains* eligible for concessional / zero tax. That way they were also upstaging the FDI sectoral cap for investments which had been exempted for SEBI registered VCFs only.
They also satisfy other parameters for Business Income ( prescribed by Authority for Advance Ruling of CBDT ) category such as – having a Permanent Establishment in India, increasing frequency of transactions, shorter lock-ins, no fledgling entrepreneurial / green field risk and rapid repatriation of funds. So Mr.Chidambaram said, ” enough is enough” !
The M/o Finance felt these *Fund Managers* [ as opposed to General Partners who are normally operational veterans in a typical VC ecosystem ] by behaving like `Got No Soul’ type Hedge Funds with obligations for outperforming the stock indices with hot money, were asking for trouble. They were fully aware of this overhang of `tax risk’ as such stray investments were ill-advised tax evasion mechanisms that had catastrophe written all over it, as opposed to efficient tax planning ( which is organizing its business activity in a way that qualifies it for eligible exemptions, deductions and rebates by squarely fitting within the legitimate tax framework ). They perhaps regarded themselves as `smart’ – and dared to stomach the risk since it was other people’s money at stake anyway !
Taxmen had this grouse because VCFs were originally exempted because they are not an *Asset Class* for investors ( it employs / is founded by operational people with strategic venture expertise seeking to create value / jobs etc., and hence considered valuable to economy ) whereas PE is purely another Asset Class available to investors like Hedge Funds. But when VCFs started alternating their objectives for lucrative returns wherever they deemed fit, the Department is now playing catch up. That’s all.
Incidentally, the US is also going through a similar debate – should gains from VC / PE investments be taxed as capital (15%) or income (30%). Though there is clear reason why the senator is attempting such regulation – to increase the tax base and decrease the deficit.
Does anyone know why the Indian government proposed these changes?
Correct me if I am wrong, but isn’t this applicable only to Domestic Venture funds, and not the the ones that invest through Maritius. I know there are some domestic venture funds, but many funds do come in through tax-friendly domiciles which are not affected by recent regulations.