Budget wishlist: Alternative funds seek angel tax breather, GST rate cut

Other demands include pass-through for losses, tax cut on management fee

Private equity (PE) and venture capital (VC) entities want alternative investment funds (AIFs), used to invest in starts-up, to be exempted from Section 56(2)(vii-b) of the Income-Tax Act — popularly known as “angel tax” — in the Union Budget.

At present, only VCUs (venture capital undertakings), a sub-category of the Securities and Exchange Board of India (Sebi)-registered Category-I AIF, are exempted.

Other items on the wish list of PE and VC entities are pass-through for I-T to address end-of-life losses, tax parity of unlisted shares with listed ones, and reduction in the goods and services tax (GST) from 18 per cent to 5 per cent on management fees for services provided to AIFs by fund managers.

Rajat Tandon, president, Indian Private Equity and Venture Capital Association (IVCA), said many start-ups receive funding from Sebi-registered Category-II AIFs. “Sebi has also recommended this (exemption for Category-I & Category-II AIFs),”  according to industry sources, adding that this would boost the flow of capital to early- and growth-stage start-ups.

Tandon said a pass-through tax regime should not distinguish between gains and losses. A pass-through entity is a business structure that reduces double taxation; such entities do not pay taxes at the corporate level, but corporate income is allotted to owners, and taxed at the individual level. 

Such a formula has already been approved for the net income of start-ups by the Central Board of Direct Taxes and Sebi, on the recommendations of the IVCA.

The PE/VC industry is now recommending that net losses incurred by unlisted AIFs, under any head, should also be allowed to be passed on to the original investors. This would make India an attractive destination for foreign fund managers and capital pool allocators.

At present, investors in AIFs are not allowed to offset the expenses incurred by them in terms of management and other fees. This leads to investors paying taxes on an amount higher than their real gains from AIF investments. 

The industry has recommended that management fees be allowed to be set-off before reckoning taxable income from investors on a proportionate basis to the extent of such expenses incurred.

Correcting this anomaly would align the Indian tax system with the tax regimes of global markets, thus making it more attractive for funds to set up operations in India, claimed the PE industry.

Sources said current laws taxing capital gains of investors in unlisted company, many of which were start-ups, was a deterrent in fostering growth of the start-up ecosystem. 

The disparity has been on account of a period of holding and consequential rate of capital gains tax. Parity will give a boost to the start-up ecosystem, thereby channelling incremental funds toward primary capital and sequentially help attain balance in the Indian capital markets.

AIFs managed by India-domiciled asset managers are liable to the GST at a rate of 18 per cent. This is a significant friction cost and deters on-shoring of funds. The lower rate of 5 per cent would help in alleviating the tax cost borne by foreign investors to onshore AIFs.

This will result in on-shoring the foreign pools of capital in India and expanding domestic capital pools. 

Global VC/PE funds are now earmarking a sizeable share of their capital pie for India, but there is a lingering concern that over 85 per cent of funds earmarked for India are still pooled in overseas jurisdiction. Thus, it would be a big enabler for on-shoring the offshore pool of capital and the exponential growth of AIFs. Sunil Goyal, managing director and fund manager, YourNest, said the government should take more initiatives to enable increased investment in the start-up sector.

“Allowing charitable trusts to commit a small portion of their corpus to venture capital will go a long way towards catalysing increased investment opportunities,” he said. “This will also result in large-scale job creation.”

Budget wish list

• Exemption for AIFs from Section 56(2) (viib) of the Income-tax Act to boost the flow of capital to start-ups
• Allow complete pass-through regime for income tax will make India an attractive destination for fund managers
• Reduce GST rate from 18% to 5% on management fee on the services provided to AIFs by fund managers
• Consider mandating some part of EPFO corpus to be invested in venture capital