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March 23, 2015

Impact of Finance Bill 2015 on Private Equity in India

By Sesh AV, Managing Director, Basiz Fund Services

The finance bill of 2015, proposed by Shri.Arun Jaitley has made some important big bang reforms for the Private Equity & Venture capital Industry in India. An Industry that invests into the entrepreneurial community every year, has finally been recognized by the government as one of the important contributors to “The Make in India” Programme.

I would opine that this bill gives impetus to channeling domestic capital to vehicles like Alternate Investment Funds, that invest into risky areas that need venture and growth capital by introducing a level playing field between domestic and foreign capital.

However there are shortcomings still, which one would hope will be considered for suitable rectification / modification. 

Analysis of impact on Private Equity & Venture Capital industry  in India:

Foreign investment allowed in AIF

The bill proposes to allow foreign investment into AIF. However a 10% withholding tax on distributions made by the AIF puts foreign investments at a disadvantage while coming through domestic AIF v/s an offshore fund. Clearly there needs to be a parity to ensure equal footing. 

Income received by funds from the portfolio companies to be free of TDS

This is a good move as funds by themselves have been declared to be tax pass through. Thus it reduces an administrative hassle of accounting for TDS and claiming it later. 

Pass through for CAT 1& II fundsNo pass through for capital loss to investors, it needs to be utilized by the fund
This has been one of the most important reform moves as far as the Industry is concerned. The Industry has made quite a few representation over the years and finally they have been heard. This introduces parity between domestic and offshore funds at a practical level. Such pass through facility existed only for venture capital firms earlier and based on approval from the Income Tax department. This will be an auto pass through facility. 

However the pass through facility has been diluted to some extent by a withholding tax. There is a school of thought that the withholding tax however can be claimed as credit during the filing of returns by the investor. An important point to be noted is that losses cannot be allocated to investors. Thus investors with long term capital gains in their personal portfolio cannot aim to offset it from the allocation of long term capital loss from the fund/AIF.

No distribution tax on distributions made by the fund, however there is a withholding tax 

This is a very significant move as, distributions made by the fund will not attract a DDT as applicable to corporate that distribute their surpluses. 

 • 10% Withholding tax on distributions made by funds to unit holders other than business income 

This clause in the finance bill has been certainly been a dilution to many positive moves. However considering that that it a withholding and entitled to credit at the hands of the investors while filing their returns may at the most be a timing difference and a administrative hassle. The 10 % withholding/TDS is applicable only to non business gains or income. Most of the funds do not indulge themselves in trade or commerce and thus it looks like they will be able to gain benefit for all of their distributions 

Business income is however not defined

This could lead to litigation's due to differing definitions between the revenue and the assess on income characterizations. This lack of clarity has been going on for a while and has not been resolved. The question is “What constitutes business income for a fund? Common knowledge points out to any income from trade or commerce. However authorities have taken a view earlier that the fund itself is in the business of investing and hence all income/ gains are business incomes. There is a potential that 10% withholding may be applicable to exempt incomes like dividends and capital gains from listed portfolios 

Safe Harbour norms for offshore fund managers established to prevent a permanent establishment.

However the conditions stated to be exempt from permanent establishment do not seem to be practical given how offshore funds work. It however seems that funds that have only capital gains as return on investment, may be able to take advantage of the status by having fund managers located in India. Clarity is needed and there will be a wait until the fine print emerges. A discussion with players in the Industry does not seem to suggest that there will be a rush to relocate fund managers to India. The reform while being brilliant in its intention to get fund managers into the country, has many riders like “connected persons” which may make implementation tough. 

Deferment of GAAR to 2017

This is welcome step and has been discussed for many years now. However a lot of clarity will need to emerge on actual rules on the ground. 

Tax on Indirect transfers

They have been very clearly clarified to prevent unnecessary litigation. This brings in immense relief. For tax on Indirect transfer the Indian assets should form more than 50% of the total assets of the offshore entity and value of Indian assets should be more than Rs 10 Cr. Further small shareholders in offshore funds owning less than 5% of the offshore fund or 5 % of the underlying fund that holds the Indian assets will be exempted from the definition of indirect transfer. There are also stringent reporting requirements on the Indian portfolio company that has a offshore fund/entity as its investor to report any change in shareholding of its offshore investors/entity without any reference to minimum threshold. 

MAT on FPI long term capital gains removed.

However there is MAT on short term gains and income. It however seems that there is still a MAT on offshore entities/funds and the exemption is only for FPI’s.

Sesh A.V. is a member of the Institute of Chartered Accountants of India and the MD of Basiz Fund Service Pvt Ltd, a $13.6 bn in assets under administration fund administrator that services PEVC funds, hedge funds, family offices & foundations globally and in India. His Contact Information:

Sesh A.V ACA
Managing Director
Basiz Fund Services Pvt. Ltd
M: +918286008554