Hurdles for PE and VC industry in India how it is affect ecosystem
With private equity (PE) and venture capital (VC) investment inflows being at an all-time high in the last quarter of the decade, the industry had expected that this Budget would announce certain tax changes to address certain irritant road-blocks faced by them.
While PE investing gives an impetus to manufacturing and employment generation, VC investing on the other hand gives an impetus to innovation and technological development. All four are strong pillars required to build the nation and are a complete package for the all round development of the economy.
Recognizing the boost to economic activity and growth this industry has provided, It is commendable that this Government had announced a number of sops- lowering the capital gains tax for non-resident investors to 10 percent, providing a tax pass through to Category I and II AIFs, allowing for direct investment by foreign investors into a Category I and II AIF without Governmental approval, and so on.
Like every developing industry there were some more holes which needed to be plugged in the taxing framework for which the industry had made a number of representations and had hoped that this Budget would have cleared the mist around those looming questions.
The first amongst these misses is that currently the 10 percent withholding tax on distributions to a resident investor by a Category I and II AIF, applies to every stream of income, including tax exempt income. It cannot be the intention of the legislature that on the one hand dividends and long term capital gains tax on listed securities is exempt (at least as of now), while on the other hand, a tax of 10 percent is levied if the same income is distributed by an AIF.
It was genuinely hoped that this miss would be clarified. Another miss related to Category I and II AIFs was the fix on the availability of carry forward of tax losses to their investors. Though a complete pass through is provided for income earned by an AIF, losses incurred by an AIF on its investment are blocked from being passed on to an investor. This is an absurd situation as on the one hand if income is being passed on to investors, losses should also be passed on in the corollary. Else, it would lead to a loss of the capital losses at the AIF level resulting in a higher tax pay out by the investors. This needed a correction in the Budget.
Category III AIFs which are most catered towards investing in complex strategies including hedge funds, prayed for some certainty on their tax position similar to their fellow Category I and II AIFs. Currently managers to Category III AIFs are in the dark on the characterization of income earned by the AIF, i.e. business income or capital gains, whether tax is to be paid by the investor or the Category III AIF itself, whether expenses can be claimed as a deduction, etc. No resolution has been provided to Category III AIFs, which would lead to a stifle in the growth to this breed of investing.
With the Government announcement of facilitating foreign investment into a Category I and II AIF, without Government approval, it was hoped that foreign investors would get direct market access rather than investing through offshore pooling vehicles. However, direct investing would envisage such foreign investors having to file tax returns in India, leading to increased compliances, which essentially discouraged them from investing directly into such AIFs. The industry had hoped that since the tax law provides for the complete tax to be deducted prior to a distribution to a non-resident investor, the Budget would do away with the requirement of filing an income tax return for such non-resident investors. However this hope was left in despair
On the other hand, AIFs (as well as Real Estate Investment Trusts and Infrastructure Investment Trusts) have been placed under additional scrutiny by amendments proposed to the SEBI Act. It is proposed that a penalty be leviable for non-compliance with the SEBI regulations / directions relating to AIFs, InvITs and REITs. Such penalty would range from a minimum of Rs 0.1 Million and will be subject to a maximum of Rs 10 Million or three times the gains made due to such failure, whichever is higher. Further, a penalty of Rs 0.1 Million per day, subject to a maximum penalty of INR 10 Million is proposed to be levied on investment advisers or research analysts who fail to comply with the relevant regulations or directions.
It is surprising to see that where on the one hand a lot of regulatory onus is cast on AIFs and its advisers, investors and the AIFs themselves are not being rewarded for the investments being generated through their efforts. Recognizing the critical role that this industry plays in the development of the Indian economy, it is hoped that the pleas of the PE and VC industries would be addressed so as to lead to a greater participation of this industry in economic growth.
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