Unhappy with surcharge, private market investors bat for tax parity

Private market investors are miffed on not being considered for a waiver on surcharge on capital gains as was extended to foreign portfolio investors (FPIs) last week.

Last Friday, the Union finance minister had cancelled the enhanced surcharge levied on long-term and short-term capital gain for FPIs, and for domestic portfolio investors.  

This move has widened the tax gap between listed and unlisted shares. The tax rate on long-term capital gain (LTCG) from the stock market is 11.9 per cent, while gains from start-up investment is taxed at 28.5 per cent, says Ritesh Banglani of Stellaris Venture Partners. “This differential tax treatment will  have the effect of choking the flow of domestic capital to start-ups,” he says.

Sunil Goyal, managing director at YourNest VC and member of the Venture Capital Council at Indian Private Equity and Venture Capital Association, says entrepreneurs struggle for years. A few earn handsomely if rewarded on the sale of their shareholding, which happens once or twice in a lifetime. A higher capital gains tax discourages talent, innovation and entrepreneurship. 

With investors raising such concerns, the Central Board of Direct Taxes clarified on Wednesday that “the differential regime between domestic investors (including AIF category III) and FPIs existed even prior to the 2019 Budget and was, therefore, not the creation of the Finance (No 2) Act, 2019 or the announcement made by the finance minister last Friday”.

While agreeing that the differential regime existed earlier, Goyal said investors were raising a different issue. The private market has been levied with more tax now, while the enhanced surcharge has been rolled back for the public market and FPIs. This is despite the private market creating more employment for the investment made. “We need parity and must have it fast,” he says.

The LTCG tax is 20 per cent for domestic investors and start-ups.  The enhanced super rich tax of 43 per cent for income above Rs 5 crore in Budget 2019 increases this by another 8.5 percentage points. Critics say LTCG in most developed markets is not more than 15 per cent. With the enhanced surcharge, this would make entrepreneurs opting to incorporate a company from abroad, rather than in India.

Besides, in this situation, if an entrepreneur moves to become a Non-Resident Indian in the year he or she sells own shares, the tax rate would come down from 20 per cent to 10 per cent even in the earlier situation. Now, even including the super-rich surcharge, the income tax would be only around 14 per cent, half the combined 28.5 per cent tax. 

So, the high rates on start-up investments will ensure these strategic assets will be almost entirely foreign owned. It will also lead to the companies themselves moving base to foreign countries, as many infotech start-ups have already done. Both these effects will be severely detrimental to India in the long run, says Banglani.

Gopal Srinivasan, chairman, TVS Capital Funds, has tweeted that Alternative Investment Funds (AIFs) are still neglected. “Foreign capital has been given preferential treatment over ‘desi’ money. Indian AIF-3 funds which invest in derivatives required to pay full surcharge; similar FPIs specifically exempted.”

 Aparna Rammohan, governing council member and treasurer, TiE Chennai, said there would be some impact on pre-Series-A investments in start-ups due to this. However, this could be a first step to support the market and could be later extended to private market investments which are comparatively smaller and long term.