VCs vexed at denial of tax pass-through

Welcome Direct Taxes Code proposal to exempt long-term capital gains from tax.

The Venture Capital fund sector is both pleased and disappointed at the proposals announced in the Direct Taxes Code. The latter because it was promised a tax pass-through in all sectors in the earlier DTC drafts and this hasn’t happened in the final Bill. Pleased, since the earlier proposal to tax long-tyerm capital gains has been withdrawn.

A pass-through means an exemption from paying taxes by the exempted group.

At present, this is allowed to investments in only nine sectors — information technology, biotechnology, nanotechnology, poultry, dairy, bio-fuels, hotels and hospitality centres, seed research and chemical research & development — under the Finance Act, 2007. The earlier draft had proposed that pass-through status be extended to all registered VC funds. This would have mean that funds investing in even non-specified sectors would not have to pay tax on gains at every exit. However, this hasn’t happened.

VC players said this would impact investment in sectors which need long-term investments, such as infrastructure. Instead, there would be higher taxation of income and lower returns for investors.

Representations by VC associations had asked for treatment at par with foreign VC funds, which are exempted from paying tax in India across segments. At present, there are 137 Sebi-registered domestic VC funds and 135 foreign ones.

“DTC in the current form is a dampener for the VC industry. Foreign funds will continue to have the advantage,” said Rajesh Singhal, managing partner, Milestone Capital Advisors.

“This is the watered-down version of the draft proposal,” said Bharat Banka, chief executive officer, Aditya Birla Private Equity.

However, he and others conceded it was good news that the DTC has proposed no capital gain tax if the securities are held for more than a year.

Rahul Khanna, director, Clearstone Venture Advisors, defines it as a mixed bag.

“The code has gone through revision and recommendations. We are excited about the (capital gains) tax treatment announced in the Bill.” However, the proposed regulations’ failiure to provide a level playing field for domestic and foreign funds was a “big setback”.

“The industry proposed huge chunk of presentations. It is going to limit the amount of money flowing in some sectors. There is a need to visit the proposals again,” said Rahul Patwardhan of India Co-Ventures Pvt Ltd. “There is no level playing field for domestic and foreign funds. This is a valid concern,” said SMC Capital Equity head, Jagannadham Thunuguntla.