Budget 2013: Not enough reason for PE/VC community to smile

Over the last year, the private equity world has seen through various tax and regulatory reforms/changes. These include introduction of tax on indirect transfer of shares and General Anti Avoidance Rules (GAAR), followed by the recommendations of the Shome Committee thereon, tax pass-through status to investment by venture capital investors and subsequent introduction of the alternative investment fund regulations. Over the past few months, the PE/VC community had been keeping their fingers crossed in anticipation of crucial changes that were required to allay fears of their investors which were shying away to make investments in India-dedicated funds due to the tax and regulatory uncertainties.

However, the tax proposals affecting the Private Equity / Venture capital investor group seem to be offering hardly any relief. The expectations of the investor community from the budget to revive the investment sentiment may not be seen to be coming through. While there are reforms encouraging investment, especially for manufacturing sector, these reforms are far and few to create an immediate revival for PE/VCF investments. We have discussed a few key proposals relevant to PE/VC sectors.

One of the most critical demand of fund managers managing domestic funds was to extend the tax pass-through status to all categories of Alternate Investment Funds (AIF). The Budget proposals provide for tax pass-through only to funds which are registered as Category I – AIF under the sub-category of Venture Capital Funds (subject to fulfilment of certain conditions). Accordingly, tax uncertainties relating to income earned and distribution made by funds registered as other categories of AIF would continue.

For investments made by Category I –AIF registered under the sub-category of venture capital funds (which are considered as angel investments), the investee company would not be subject to tax on the difference between fair value of shares and consideration received.

An additional tax of 20 per cent is proposed to be introduced on distributions made by domestic unlisted companies to its shareholders in the form of buy back of shares – a corresponding exemption is granted to investors receiving proceeds of buyback. Since the investee company is proposed to be taxed, treaty benefits (to the extent available) would be of no remedy to the investors.

Last year’s budget documentations laid down the intention that in order to claim treaty benefits by non-residents, tax residency certificate would be a necessary but not sufficient condition. However, the same did not find mention in last year’s Finance Bill. The law is now proposed to be amended to include the same.

Some of the recommendations of the Shome Committee on GAAR, which was mentioned by the Finance Minister as being accepted, are proposed to be included in the law. The GAAR is now proposed to be deferred for implementation from financial year 2015-16. While some relief is proposed to be provided to the investors for cases where GAAR can be invoked, the only remedy made available in case where GAAR is invoked is to refer the matter to the Approving Panel. The directions of the Approving Panel would be considered as binding on both the tax authorities and the assesses.

Further, the Budget has also not dealt with some of the tax expectations of the investors. The recommendations of the Shome Committee on taxation of indirect transfer of shares do not find any mention in the Bill. The present ambiguity on whether the concessional rate of tax (10 per cent) is applicable on long term capital gains on transfer of unlisted shares has also not been clarified.

In a nut shell, with introduction of tax on buy back and no update on taxation of indirect transfer of shares, the fact remains that Budget 2013 does not provide enough reason to the investor community to smile. The saving grace is that certain recommendations made by the Shome Committee with respect to GAAR including deferment of GAAR’s implementation have been incorporated in the proposed amendments.

(The article has been authored by Anish Sanghvi - Associate Director and Alka Mohta - Manager, PWC)

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