Into the tax net: Pooled fund not service providing entity, says IVCA

Indian Private Equity & Venture Capital Association (IVCA) has written to the government saying a recent ruling by a Bengaluru-based tribunal pertaining to venture capital funds has created substantial confusion within the domestic fund industry and among limited partners, or LPs.
 
Last month, the Customs, Excise and Service Tax Appellate Tribunal, Bengaluru, had held that since trusts were treated as juridical persons for the purpose of Securities and Exchange Board of India (Sebi) regulations, there was no reason why they should not be treated as such for the purpose of taxation.
 
Going by the ruling, trusts could be seen as entities providing fund management services to contributors or unit holders, implying that the expenses incurred by them would be subject to goods and services tax (GST). GST on expenses charged by these vehicles could translate to a tax levy running into hundreds of crores. This could raise costs significantly for investors as well as funds, and pave the way for tax litigations, said experts.
 
Specific to AIFs, the IVCA said the funds are a mere pooling vehicle and not a service providing entity. The fund manager is the service provider to the AIF, which charges GST on the management fees it receives.
 
The tribunal had also ruled that ‘carried interest’ or performance fee – a share of the profits of an investment paid to the investment manager if the fund’s returns meet a certain threshold or hurdle rate – ought to attract service tax in the form of GST at 18 per cent.

“On carried interest, globally, many popular fund management jurisdictions have clarified that subject to certain conditions, carried interest (in the nature of a profit share) will be treated as pass through investment income,” the IVCA said.
 
According to Gopal Srinivasan, chairman of TVS Capital Funds and a non-official member of National Startup Advisory Council, a body formed by the government to seek advice from key individuals representing the startup ecosystem, piecemeal application of extant policies to AIFs had led to the current conundrum, creating similar turbulence as angel tax did for start-up investors.
 
“India is at an inflection point and to open trillion dollar of start-up value we must unleash domestic capital and domestic fund managers with international capital,” he said.
 
According to Srinivasan, all AIF income should be characterised as capital gains, with short-term and long-term rates applicable as per the rate in force. Moreover, profits of AIFs, whether distributed or retained, including carried interest, should be classified as capital gains and hence not subject to GST.
 
REITs, InvITs, AIFs and MFs all operate within a trust structure, with a few common entities such as sponsors, trustees, the asset management company and the asset manager.