Tax Provisions for Venture Capital Funds
Venture Capital firms, generally known as VCs are benefited by manner of tax exemptions. Internationally, VC Funds are treated as pass through vehicles which helps to eliminate income tax at the pool level. A pass through status is desirable for all funds because their IRR will be higher as the sale proceeds can be passed on to the investors without payment of any taxes. The final recipient needs to pay income tax and the intermediary body is exempted. This is to avoid double taxation of the same stream of income and make such investment fall under single taxation.
In India, venture capital funds which are registered with market regulator SEBI are eligible to a tax pass through status. This exemption is given under section 10 (23FB) of the Income Tax Act, 1961 to avoid double taxation. The investor needs to pay for the taxes on the income earned through the venture capital investments. The SEBI (Alternative Investment Funds) Regulations, 2012 (AIF regulations) have replaced the SEBI (Venture Capital Fund) Regulations, 1996 (VCF regulations) from 21st May, 2012. This amendment will take effect from 1st April, 2013 and will apply in relation to assessment year 2013-14 and the subsequent assessment years.
These regulations govern onshore funds that have been set up in India to raise capital for the purposes of investment in India. The following points are to be noted while claiming such exemptions.
- Funds should be perceived to have positive spillover effects on economy.
- Funds should be of a minimum size of Rs.20 crore, and that each investor should have pooled a minimum of Rs.1 crore in the venture capital fund.
- Investors will be directly responsible for payment of taxes depending on their tax status.
This regulation governs all funds which invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable. It includes venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds. It also includes angel venture funds.
Generally, it is perceived that venture funded enterprises have created more wealth and consequent tax revenues and more job opportunities. Venture capital funding helps in the growth of industrial activity, which would indirectly add to the tax payers’ base. It is certainly believed that in India there will be a large number of successful enterprises which would add to the national wealth creation and also pay higher taxes. India is gearing up its security laws and is aiming at providing investors with a more secure and regulated environment.
Fund Managers and investors need to recognize this opportunity while setting up fund. By following changing tax environment Fund Managers will be able to provide investors with a better return on their capital rather than combating tax litigation at different levels.