PE players for avoiding double taxation in investments

Seek pass-through status for private equity and venture capital investments in companies.

The booming private equity (PE) industry in the country has come up with certain suggestions to encourage investments in companies. The Indian Venture Capital Association (IVCA) has asked for granting the pass-through (taxation) status to PE/VC investments. In a representation to the Finance Ministry, it sought the removal of trust taxation implied on PE companies. IVCA, the largest private equity association in India, has 141 members.

According to IVCA, double taxation for investments, except for sectors eligible for the pass-through status with regard to investments by Venture Capital Funds (VCFs), will adversely impact the flow of investments and capital in other sectors.

Worldwide, VCFs are considered as pass-through vehicles with tax paid on returns earned by investors. Similarly, in India, Section 10 (23FB) and 115U of the Income-Tax Act, 1961, provided pass-through status to VCFs. However, the same was restricted and diluted by the Finance Act, 2007. The Act amended Section 10 (23FB) to restrict the pass-through exemption made by VCFs for certain sectors (nanotechnology, information technology, seed research & development (R&D), biotechnology, R&D in new entities in the pharmaceutical sector) only, the representation said.

Nitin Deshmukh, CEO, Kotak Private Equity, and executive member of IVCA, said, “Significant capital is required not only in select sectors now identified under Section 10 (23FB), but also across a wide range of sectors such as textiles, automotive components, industrial equipment and machine tools, logistics and warehousing, specialised construction and engineering. It is, therefore, recommended that sector-specific restrictions in Section 10 (23FB), which primarily impact domestic investors and domestic fund managers, should be removed to encourage growth and innovation across all sectors of the Indian economy.”

VCF regulations mandated by the market regulator, Securities and Exchange Board of India (Sebi), do not provide for any sectoral restriction in investment, except for those in businesses considered in a short, negative list.

“Sebi should be regarded as the nodal authority for regulation of VCFs. The investments made in accordance with the Sebi VCF regulations should be eligible for the pass-through status,” it added.

“Most VCFs are set up in the form of trusts. With the pass-through status not being available for investments in sectors other than the specified ones, these trusts will be governed by provisions of trust-taxation. It is humbly submitted that the provisions of trust-taxation are archaic. These are meant for private trusts and are difficult to apply in the context of contributory trusts/pooling vehicles. The outcome of trust-taxation principles to a VCF adds to complexities and results in more uncertainties for investors,” it said.

Deshmukh said, “Given the interplay of global and local forces, it would be difficult to seek development in a specific sector without creating an enabling environment across all related sectors.

India-based investment vehicles and management teams are an imperative for positioning it as an Asian financial powerhouse. Hence, such restrictions in the regulatory regime, which affect these domestic vehicles and fund management expertise, need to be reversed.”