Govt evaluating measures to bring down tax burden on PE/VCs in India

It is expected to be introduced in Parliament's monsoon session

4 min read Last Updated : Mar 21 2023 | 11:27 PM IST

The government is evaluating measures to bring down the tax burden on foreign investors that put money in alternative investment funds (AIFs), which include venture capital (VC) and private equity (PE) domiciled in India. The move follows the report submitted by a panel led by M Damodaran, former chairman of the Securities and Exchange Board of India (Sebi), in December.

Some key proposals include granting “zero-rated or export status” to India-based AIFs having foreign investors, bringing uniformity in taxing “carried interest”, easing norms for employee stock option plans, and aligning capital gains taxes for listed and unlisted securities.

“A framework for PE/VC investment is in the works and it could address taxation and regulation faced by this class of investors. It is expected to be introduced in the monsoon session of Parliament,” a senior government official told Business Standard.

According to the official, inter-ministerial consultation is going on, deliberating the possibility of implementing some proposals of the panel’s report.

The framework encourages PE investment from both domestic and foreign players and considers amendments to all related regulations, corporate law, listing norms, tax, etc, he said.

Among the key proposals, the panel suggested taking a uniform view and treating carried interest as “return on investment” and hence keeping it out of the purview of goods and services tax (GST).

Carried interest, or carry, refers to the part of a fund’s profit allocated to its fund manager and is proportional to the performance of the fund.

Fund managers in India have been structuring carried interest as a return on investment by tagging it to the redeemable units of the fund.

However, a tribunal ruling in 2021 had rattled them because it had said carry was neither interest nor return on investment. The matter is still pending.

“The PE/VC industry is concerned that if carried interest is not treated as return on investment, it will result in 18 per cent GST, which will have to be borne by fund managers,” an official privy to the discussion said.

Funds treat carry as “capital gains”, which attract a tax of 20 per cent. But, if it is treated as “performance fee” for a “service” provided by the manager, it would mean 18 per cent GST.

“The matter of GST applicability needs to be clarified by reaffirming that the principle of mutuality is applicable, notwithstanding the recent amendment. It is also necessary to set at rest the speculation on the applicability of the CESTAT (Customs Excise and Service Tax Appellate Tribunal) decision by stating that it pertained to the erstwhile service tax law,” said M S Mani, partner, Deloitte India.

Another suggestion is with regard to zero-rated status. The panel is learnt to have suggested that fund management services should be treated as deemed exports under Section 147 of Central GST. This is for fund managers providing services to an AIF and to the extent it constitutes foreign investment.

At present, PE/VC funds located in an offshore jurisdiction are exempt from GST.

Other than these, the panel batted for bringing capital gains tax for investors on a par with that for foreign portfolio investors.

At present, long-term capital gains tax on unlisted stocks held for more than 24 months is double that of listed equity shares held for a year. Tax on private stock investment is 20 per cent, while that on public stock investment is 10 per cent.

“As a policy measure it would be ideal if parity was brought in taxing long-term capital gains on listed as well as unlisted shares,” said Sudhir Kapadia, national tax leader, EY India.

“In the US, long-term capital gains tax is 10 per cent on securities, regardless of listing status. It will give a boost to the growing start-up ecosystem in India if this tax is made 10 per cent on unlisted shares.”

The government had constituted the panel to suggest ways of scaling up VC/PE investment, according to a circular released on September 13, 2022.

The committee will “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”.