Finance ministry panel mulls 'broad-based' regulations for PE/VCs

FinMin panel has sought inputs from the Big Four audit firms

A high-level panel set up by the finance ministry to look into issues being faced by venture capital (VC) and private equity (PE) investors is examining the feasibility of introducing a “broad-based” rule for alternative investment funds (AIFs), which include PE and VC funds. Currently, AIFs do not have any broad-based regulation, requiring a large number of investor representations.

PE and VC funds, which typically invest in start-ups or unlisted securities, hold money for a small group of investors or even a single investor.

The six-member panel — chaired by former Sebi Chairman M Dam­odaran — is learnt to have discussed whether a broad-based parameter as applicable on mutual funds should be introduced for AIFs, too, according to two persons in the know.

Currently, mutual funds have broad-based requirements. According to the norms, every MF scheme needs to have a minimum of 20 investors and a single investor cannot account for more than 25 per cent of total assets managed by that scheme.

“There is an impression that a small group of investors can influence portfolio configuration and fund manager. Having clear criteria shall give a sense of investors’ valuation practices, nature of business, and so on,” said one of the sources. 

The source further explained: “Such parameters will also help understand the intent and approach of big-ticket investors and investee companies, which are raising money through privately placed AIFs.”

The expert panel has sought detailed inputs from big four accounting firms and other industry stakeholders, including the Indian Venture and Alternate Capital Association (IVCA), a body representing the interest of the PE/VC industry.

“This has been done to ascertain regulatory friction and other concerns of the industry,” said one of the two sources. The person further said that the panel is also consulting regulators, including Sebi, and other concerned departments to identify loopholes in the existing regulations.

The panel will meet this week to form a view on the inputs it has been gathering. It is expected to submit the final report by December 7, the sources said.

Experts, however, say tweaking of rules should not be as stringent as in the case of MFs.

“AIFs being a private placement vehicle, unlike mutual funds, don't have any investor broad-basing requirement, at present. While this should ideally continue the same way, if the regime were to change, then only some form of light-touch broad-basing may be prescribed for certain categories of AIFs, and not as a general norm,” said Tejesh Chitlangi, senior partner, IC Universal Legal.

According to the existing configuration, PE and VC funds typically hold money for wealthy investors, comprising sponsors and managers. The manager enters into an agreement with the trustee (on the behalf of the fund) and is given authority to manage the fund.

The sponsor, on the other hand, has to put in Rs 5 crore or 2.5 per cent of the fund corpus —whichever is lower. If the manager or sponsor entity is foreign-owned (holding above 50 per cent), these AIFs can’t be construed as domestic entity, and they must follow India’s FDI rules.

Unlike international PE funds, AIFs are formed in India and they are allowed to raise money from domestic and foreign investors to invest in Indian companies.

The panel also received inputs on tax treatment and regulatory compliance for the PE/VC industry.

The industry has been pitching for bringing private equity funds at par with public equity in terms of tax treatment. At present, there is a long-term capital gains tax of 10 per cent on public equity, while private equity attracts 20 per cent.

“There needs to be some parity, if not absolute, between taxation of listed and unlisted securities in terms of tax rates and holding period, for determination of the short-term or long-term nature of tax,” Chitlangi said.

The panel also received inputs on the contentious issue of “carried interest”.

Funds treat carried interests as ‘capital gains’, which attract a tax of 20 per cent as VC funds primarily invest in unlisted companies. But, if they are treated as ‘performance fees’ for certain services provided by the manager, it would mean an outgo of 18 per cent GST, and full income tax of over 30 per cent on the balance amount — taking the overall tax on the manager to more than 40 per cent. Many funds have received tax queries from the department on the carry issue.

About the panel
 

The expert panel has to comprehensively study, using a systems approach, the end-to-end frictions and potential accelerants from regulatory policy and taxation to facilitate ease of investing, as well as to encourage investments in India.

What’s happening

• Panel has sought inputs from the Big Four audit firms
• It’s consulting industry stakeholders on pain points
• In talks with Sebi to identify loopholes in existing regulations
• The industry for bringing PE funds on a par with public equity in terms of tax treatment
• It’s likely to submit final report by December 7