PE & VC Funds To Be Treated As Separate Class Of Investors

The government is considering classifying private equity (PE) and venture capital (VC) funds as a separate class of investors so that the many difficulties and concerns that these increasingly important investors face may be addressed comprehensively.

Several PE and VC funds have raised concerns about taxation, regulation, and processes, which have resulted in lawsuits before several tribunals.

“We are setting up an expert committee in a month or two to look at terms of regulation and processes, and related issues. The idea behind it is that those funds in (unlisted space) and are setting up offices in India require a paradigm shift (in taxation and other regulations), looking at the significant amount they are investing here” says Ajay Seth, secretary at the Department of Economic Affairs.

In addition, the tribunal determined that wages paid to fund managers should be subject to indirect taxes. Carry fees are currently subject to an 18 percent GST

He went on to say that the PE-VC industry has asked for an organised conversation on the subject.

Rather than providing a remedy to one or two issues, the government wants to learn about their expectations and worries and then come up with a holistic plan, according to Seth.

"Scaling up this investment requires a holistic examination of regulatory and other frictions. An expert committee will be set up to examine and suggest appropriate measures," she stated.

According to sources familiar with the matter, the committee will consider all of the issues and determine whether PE and VC funds should be classed as a separate class of investors from international portfolio investors (FPIs). The Securities and Exchange Board of India regulates FPIs, who invest in the listed market.

Representatives from regulators, the tax department, and industry stakeholders are likely to be on the expert group. According to a source familiar with the idea, it would look into how firms treat employee stock options and carry costs. Carry fees are a percentage of a fund manager's earnings or investment.

“Of late, there have been multiple challenges both on income tax as well as GST fronts for PE-VC funds and the fund managers, with open litigations on many fronts. Easing out these challenges will allow for faster growth of this sector” PwC partner Bhavin Shah stated.

In a July 2021 judgement, the Bengaluru based Customs, Excise & Service Tax Appellate Tribunal found that service taxes were still applicable to expenses spent by PE-VC funds despite the trust structure. As a result, carry fees, legal costs, and salaries paid by a fund housed in a trust structure are subject to service tax.

Many venture capital firms, private equity funds, and other alternative investment funds (AIFs), including mutual funds located in India, invest through trust structures.

In addition, the tribunal determined that wages paid to fund managers should be subject to indirect taxes. Carry fees are currently subject to an 18 percent GST.

“Some of the aspects which the government could look at include creating a framework to encourage domestic listings of target companies and discouraging inversion of Indian companies to foreign jurisdictions, tax parity to PE/VCs in line with treatment of FPIs, regulatory and tax simplification for startups, tax simplification for performance fees extending tax exemption for infrastructure investments, simplification of AIFs regulations and registration procedures” says Rajesh Gandhi, partner, Deloitte India.