Budget 2018: PE investors seek pass-through of losses at end of fund life

As per existing regulations, if there are losses in a fund at the end of its life, the same cannot be passed onto its investors

At a time when Finance Minister Arun Jaitley and his team would be getting set for Union Budget 2018-19, the private equity industry is seeking a pass-through of losses at the end of fund life for Category 1 and Category 2 alternative investment funds (AIFs).

According to the existing regulations, if there are losses in a fund at the end of its life, the same cannot be passed onto its investors. ‘‘This is a big issue with VC or infra funds. Over a fund life of eight-to-nine years, a fund may end up with one or two loss-making firms,” says Gopal Srinivasan, chairman, Indian Private Equity & Venture Capital Association. 

The regulations say that profits can be passed onto investors, but losses have to be kept at the fund level. Interestingly, Sebi’s original venture capital regulations of 1996 allowed this. These were replaced by Sebi’s AIF regulations in 2012. ‘‘If the pass-through is allowed, investors will take more risks. They won’t mind taking losses in one or two companies if they know they will get the full benefit,” says Srinivasan.

The industry is seeking a similar pass-through of losses at fund level for Category 3 AIFs or hedge funds, which had an investible pool of Rs 226 billion last year. ‘‘Hedge funds is not mentioned in the Income Tax Act. As a result, each assessing officer takes an independent view on them. What we are saying is please bring a formal tax regime for AIF-3 with some kind of pass-through system,” says an investor. 

AIFs, which grew 55 per cent in FY17, contributed 19 per cent of VC/PE inflows in FY17. The changes could increase the flow of domestic capital into AIFs, which is only 16 per cent in India compared to 60 per cent in China. IVCA has also suggested that larger charitable and religious trusts, be allowed to invest in AIFs.  The industry is also seeking lower long-term capital gains tax (LTCG). 

Public market investments are exempted from LTCG if they are held for one year while PE/VC investments in unlisted shares are taxed at 20 per cent LTCG if held for more than two years. Vishal Tulsiyan, managing director & CEO of Motilal Oswal Private Equity says that PE invests with a long-term horizon and are putting money in illiquid stocks. ‘‘To make it attractive, they should make LTCG PE/VCs pay at par with listed stocks,” he says.

KEY DEMANDS

• Restore pass-through for losses at fund level in Category-I, II AIFs
• Bring a pass-through system for AIF-III, public market fund
• Make LTCG on sale of unlisted stocks at par with listed stocks
• Allow large charitable, religious trusts to invest in AIFs