Budget 2020: How it affects PE/VC funds, other dealmakers and investors
Anil Talreja, Madhvi Jajoo and Dinesh Rajesth

Private equity and venture capital (PE/VC) funds play a pivotal role in defining India’s economic growth by providing risk capital to emerging businesses. These funds reportedly invested about $37 billion in 2019 alone.

India aims to become a $5 trillion economy by 2024-25. To achieve this goal, India will require PE/VC investments of above $100 billion. This makes it imperative for the government to focus on tax issues impacting this industry.

While the intention of the government appears to address the concerns of dealmakers and PE/VC investors, the journey has had a limited start as seen from the budget.

Dividend in a multi-layered structure

Budget 2020 addressed the long-awaited ask of PE/VC investors to abolish the Dividend Distribution Tax (DDT). Although dividend income will now be taxable in the hands of shareholders, considering the availability of tax treaty benefits, it would likely restrict the tax rate to 10% or 15%.

Further, unlike the DDT, foreign tax credit (FTC) in respect of Withholding Tax (WHT) paid on dividend would be available to a PE/VC investor. Additionally, the domestic company will be eligible for a set-off of dividend received vis-à-vis dividend paid out, so that multi-layered entities are not impacted on receipt of dividends unless they are not paid out. However, no such concessional tax regime has been offered for foreign-sourced dividend income. 

Further, abolition of the DDT should also put the issue relating to taxation of expenditure incurred to earn exempt income, to rest. Additionally, cash repatriation simply by dividend payouts may result in a better option for PE/VC funds than a buy back taxable at 20% (plus applicable surcharge and cess), though a lot would be fact-specific.  

FPI investors

Another significant consequence of shifting the incidence of the DDT on recipients is that the tax outflow could rise for foreign portfolio investors (FPIs) structured as trusts. FPIs, structured as trusts, would have to incur higher surcharge of up to 37% plus 4% cess, on the applicable tax rate of 20%, while corporate houses availing treaty benefits could restrict the tax rate to 10% or 15% with no surcharge and cess.

InvITs and REITs

In contrast to the above, the proposal for levying tax on unit holders on the dividends received from business Trusts could adversely impact the prospects of Infrastructure Investment Trusts (InVIT) and Real Estate Investment Trusts (REIT).

Currently, there were no taxes on distribution of dividend income (DDT) by the special purpose vehicle (wholly owned) to the business trust and on subsequent distribution by the business trust to the unit holder.

Prior to the budget proposal, business trusts in India had a single level of tax payable by SPVs on their stream of incomes such as rents and tolls and it was with the intent of providing tax stability for long-term infrastructure investors.

The proposal to abolish the DDT and therefore introduction of tax in hands of the unit holders could be detrimental to the interests of unit holders since the dividend income, which was not earlier taxable, will now become taxable subject to withholding as per the rates in force or as per applicable tax treaty.

All in all, the tax exposure for unit holders could increase substantially since business trusts are mandatorily required to distribute 90% of their cash flows.

Exemption for sovereign funds

In response to the recent show of interest from overseas investors, in the case of sovereign wealth funds including those from no-tax jurisdictions, Budget 2020 proposes to provide specific tax exemptions on investments in developing, operating and/or maintaining an infrastructure facility in India provided the investments are made on or before March 31, 2024 with a minimum tenure of three years.

The exemption is proposed on all income streams including dividend, interest and capital gains on investments in the infrastructure sector across road, highway projects, bridges, rail system, water supply projects, ports and airports. This is expected to generate significant capital investments for crucial infrastructure development.

This announcement will encourage similar funds of other countries to get in line to be included in such a concession. 

Startups

Startups with revenue of up to Rs 100 crore (as against Rs 25 crore earlier) will be eligible to claim a deduction of 100% of the profits earned for a period of three consecutive assessment years out of 10 years (which was previously seven years) beginning from the year in which it was incorporated. 

This is a welcome move. The increase in the turnover limit would bring more such ventures into its stride. Further, an extension to the period for claiming deduction would give more impetus for investments in startups as it becomes viable to claim the benefit in projects or businesses with longer gestation periods.

Fund managers

In another welcome move concerning offshore funds with a fund manager based in India, the criteria with respect to the period for maintaining corpus has been rationalised in specific cases, to 12 months from establishment as against six months earlier. In addition, the contribution of the resident manager, up to Rs 25 crore, during the first three years, is now proposed to be excluded in determining investments in the fund.

The finance minister has rightfully considered the hardship that existed and ironed out challenges for offshore funds that considering setting up during the latter part of the year, and for resident fund managers commercially required to invest in the fund, for fostering investor confidence.

To summarise, the budget attempts to address the problems of PE/VC investors and dealmakers with the objective to maintain India as an attractive destination that symbolizes the mantra ‘Ease of Transactions’.

Anil Talreja is a partner, Madhvi Jajoo is a senior manager and Dinesh Rajesth is a manager with Deloitte Haskins and Sells LLP.

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