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).
To rationalise the regime and to address the concerns of the industry, it is proposed that the eligible investment fund shall mean a fund established or incorporated or registered outside India in a country or a specified territory notified by the central government in this behalf. It is also proposed to provide that the condition of fund not controlling and managing any business in India or from India shall be restricted only in the context of activities in India.
The above rationalisation has been done by considering the fact that certain funds may not qualify as a tax resident of a country on account of domestic tax laws or legal framework of the country. Given that India would still be able to collect information regarding fund under the applicable DTAA or TIEA as under the agreements with many countries, information can be exchanged in respect of persons who may not be resident of the country.
Further, conditions relating to restriction on fund carrying on business or controlling fund managing business in India or from India restricts the flexibility of operation for funds and hence the focus should be on nature of activities undertaken in India.
Withholding tax on income paid by investment funds
As per the existing law, any income credited or paid by the investment fund (Category-I AIF and Category-II AIF) to its investor is subject to withholding (by the investment fund) tax at the rate of 10 per cent of the income. The non-resident investor is not able to claim benefit of lower or nil rate of taxation, which is available to him under the relevant DTAA, and deduction of tax at 10 per cent is to be undertaken mandatorily even if under DTAA the income is not taxable in India. This is in view of the fact that there is no provision under which an investor can approach the tax officer for seeking lower or nil rate.
Accordingly, it is now proposed to amend the specific provisions pursuant to which the non-resident investor can approach the tax officer and seek lower withholding certificate based on his facts.
While all the expectations from the industry may not have been met, some of the proposed changes including those explained above would go a long way in improving tax efficiency and overall IRR for the investors.
Anil Talreja is a partner and Vishal Hakani a director at Deloitte Haskins & Sells LLP.