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
Krish, an asset class is not defined by the person who runs it, but by the risk / return profile. Ask any LP who allocates money across diffferent asset classes and he’ll tell you that VCs, PE funds & hedge funds all belong to the same asset class called “Alternate Investments”.
The risk / return profile of VCs, PEs & Hedge funds (and also the compensation structures) are similar, further evidence that they belong to the same asset class.
This distinction is fundamental to your argument that VCs were begining to act more like PEs and hence should be subject to income tax instead of capital gains tax. Given that distinction itself does not exist, I am not sure if the remainder of your argument is valid.
So not sure I understand
Deepak,
You are absolutely right here. Trusts are created for holding some assets `in trust’ for a specified beneficiary. The Trust Deed will clearly spell out the terms and conditions governing the relationship between the Trustee and the Beneficiary and shall be registered ( either with Charity Commissioner / Registrar depending on the objectives of the Trust). A copy of the registered Trust Deed will have to submitted along with application for exemption before the Income Tax authorities and if IT department approves it and recognizes the trust, it shall be eligible for Tax exemption, with or without conditions as may be stipulated in the certificate of exemption so granted.
Krish,
Thanks for that. If you are registered with SEBI as a VCF then you have to be under the SEBI guidelines. But “trusts” (not just venture funds as trusts, but trusts per se) can be tax transparent. All mutual funds in India are trusts, that issue units. They are tax transparent, and in fact can retain earnings and not pay tax on them until redeemed or distributed. You can own a trust that does not pay (capital gains) tax and invests in other companies – In fact a huge part of the Tata Sons shareholding is owned by trusts.
I’m not sure if trusts other than mutual funds can retain earnings.
I didn’t know about the sectoral caps – interesting.
Ashish,
NBFC is a Corporate undertaking Non Banking Financial activities approved by RBI thro issue of a License to that effect. Besides the governing provisions of Companies Act, they also will be governed by RBI rules governing NBFCs ( like filing of Annual Returns to RBI, Net Worth / Solvency certificate, Returns of Deposits etc. )
Eg. Sundaram Finance Limited, erstwhile Kotak Mahindra Fianance Ltd ( now a Bank ), L&T Finance Ltd., Bajaj Auto Finance Ltd. etc. There is nothing to bar them from investing in Debt or Equity. Equity investments by an NBFC will not be eligible for capital gains since they will be regarded as `Stock in Trade’ for IT purposes, since such transactions will be regarded as having been in their *ordinary course of business* and the income thereof will be treated as Business Income. In turn they can set off their Business Expenses against such income and benefit of set off and carry forward of Losses are also available to NBFCs.
As regards the issue of Asset Classes, Venture Capital is not regarded as an Asset Class in the same sense as PE / Hedge Funds. A typical VC firm has General Partners who are operational experts ( say Alok Mittal in Canaan who was a previous consumer internet entrepreneur himself ) and not Fund Managers like a Samir Arora had been for Alliance Capital earlier.
Hope I’ve made myself clear.
Deepak,
Some corrections.
Under SEBI VC guidelines 2000 ( as amended ) VCFs can be constituted either as Trusts or Pvt.Ltd.Companies only. ICICI VCF is already a Trust or a Pvt.Ltd.Co.
[ In that report, ICICI VCF is attempting to disengage itself from being a *custodian* of shares on behalf of its investors (to whom it issues units in support of its holdings, like a Mutual Fund does to its investors ) and transferring the shares directly to the concerned investor. This mechanism is to avoid the VCF from being subjected to tax.]
One more correction. As per the IT Act, the Pass Thro Status is available ONLY to SEBI registered VCFs. Others will not be eligible for tax benefits available to VCFs under the Act.
The apprehension here is that by resorting to such tax transparency ( when holdings are transfered to identifiable investors ) the sectoral cap for FDI investments ( like 24%, 49%, 74% etc. ) will be reimposed. While as VCF investments such limits were not applicable.