PE entities expect policy, tax reforms in Budget

The sector wants domestic capital pools for PE/VC funds, levelplaying field for domestic AIF managers

India's private equity (PE) sector has high hopes on Narendra Modi government's first Budget. PE players expect the Budget to have tax- and policy-related reforms. Among the major demands of the sector are to create a levelplaying field for domestic Alternative Investment Fund (AIF) managers and developing domestic capital pools for PE/VC (venture capital) funds. They also want the government to take steps to remove the hurdles in PE/VC exits by relaxing the norms for the lock-in period of shares acquired by swaps or merger.

In a memorandum submitted to the government, the Indian Private Equity & Venture Capital Association (IVCA) has highlighted the significance of the PE/VC sector such as long-term investments (five to 10 years on an average) and healthy job creation (PE and VC firms have provided about $75 billion to Indian enterprises).

The main sources of domestic PE/VC in most countries are domestic capital pools such as pension funds, insurance companies and charitable endowments. "In India, these sources are constrained by current regulations; we recommend these be liberalised so that pension funds be permitted to invest in AIFs, unlisted shares, unlisted convertible bonds, mezzanine capital and real estate investment trusts (REITs)," IVCA said in the memorandum.

Another major demand of the sector is that 'pass-through' status be provided to all the categories of AIFs. Under pass-through taxation, an entity or fund is not directly taxed because the tax burden is passed on to the investors. It will avoid double taxation.

"Any income earned by an erstwhile VCF (venture capital funds) or VCC (venture capital company) registered under the Sebi (Venture Capital Funds) Regulations and all categories of AIF should be exempt. This suggests the tax pass-through process in terms of section 10(23FB) read with section 115U of the IT Act should be made available to erstwhile VCFs/VCCs and all categories of AIFs in respect of any income earned by such entities," IVCA noted.

On retrospective tax's impact on PE firms, Khaitan & Co, a law firm, says the 2012 law does not define what constitutes 'substantial value', thus leaving it open-ended. Besides, the firm says, the PE/VC funds should be excluded from the purview of these offshore transfer taxes so as to avoid double taxation where investment is being provided for growth, restructuring, or financing capital expenditures.

Further, the section has retrospective effect, which means an additional tax burden for taxpayers which was not contemplated at the time of doing transactions and would work in a counter-intuitive manner. "We, therefore, recommend the provision be made applicable to tax offshore transfers only from FY13," Khaitan said in a report.

On PE/VC funds, the law firm says investments by financial sponsors should be excluded from the purview of the tax on offshore transfers to genuinely avoid double taxation, as investment is for growth or restructuring or capital expenditure.

The PE sector also demands that foreign funds and foreign VC funds should be treated equally as far as areas of investments are concerned. "While foreign funds are allowed to invest in almost all sectors subject to sectoral limits, foreign venture capital investors are restricted to invest only in infrastructure and nine specified sectors," IVCA noted.

To facilitate smooth PE/VC exits, the sector demanded a change in the period of lock-in of shares acquired by way of share swaps or through merger of investee company with the de-merged entity of listed company.

"Under current ICDR (Issue of Capital and Disclosure Requirements) regulations, the swapped shares are locked-in for a period of one year from the date of issue. It is necessary that whilst calculating the lock-in period, the original investment period (a period prior to such swap taking place) should be considered," said IVCA.
WHAT THE PE/VC SECTOR WANTS

• Domestic capital pools for PE/VC funds
• Levelplaying field for domestic AIF managers
• Change in lock-in period for share swap
• Permit AIFs to REITs/infra trusts convertibility
• Pass- through status for all categories of AIF
• Avoid double-taxation of income earned by the VC/ PE Funds