Over the past few years, the VC/PE industry has garnered finance ministers’ attention. It started with the reduction in the capital gains tax on long-term assets. Specific tax regimes also have been introduced in the context of Alterative Investment Funds (AIF), business trusts (REIT/InvIT), offshore funds, etc.
While the introduction of these regimes has been a step in the right direction, some of them have not yet taken off in view of several commercial and tax considerations. In this Budget, the finance minister has tried to ease doing business in India and rationalise some tax provisions affecting the VC/PE industry.
Taxation of business trusts
Taxation of business trusts comprising Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvIT), regulated by SEBI, is governed by a specific regime under the Income-tax Act. The existing tax regime provides that, where the special purpose vehicle (SPV) is a company, it is first required to pay corporate tax and when such SPV distributes its surplus income to business trusts (being a shareholder), it needs to pay a dividend distribution tax. Thereafter, the income is exempt both in the hands of business trusts and investors.
Stakeholders had concerns that the levy of the dividend distribution tax (DDT) at the level of SPV when it distributes its income to the business trust makes the structure tax inefficient and adversely impacts the internal rate of return (IRR) for the investor. This was due to the fact that SEBI regulations require both the SPV and business trust to distribute 90 per cent of their operating income to the investors.
To rationalise the taxation regime for business trusts and their investors, it is proposed to provide an exemption from levy of DDT on distributions made by SPV to the business trust. DDT in any case would not have been applicable if SPV were to be formed as a ‘Trust’. As a result, dividend received by the business trust and its investors shall not be taxable. This exemption is conditional and would be applicable in cases where the business trust holds 100 per cent of the share capital of the SPV.
The Finance Act 2015 had introduced a special regime in respect of offshore funds. It provided that an eligible investment fund shall not be said to be resident in India merely because the eligible fund manager undertaking fund management activities on its behalf is located in India. However, this benefit was subject to satisfaction of certain conditions including corpus size, investor base, residence of fund, remuneration to fund manager, etc.
Residency of funds
In respect of the residence of the fund, the condition is that the fund has to be resident of a country or territory with which India has entered into a Double Taxation Avoidance Agreement (DTAA) or Tax Information Exchange Agreement (TIEA). In respect of activities of a fund, there is a restriction that the fund shall not carry on or control and manage, directly or indirectly, any business in India or from India and shall neither engage in any activity which constitutes a business connection in India (other than the activities undertaken by the eligible fund manager on its behalf).