Budget 2016: A mixed bag for private equity/venture capital sector
Given the objective of the Government to attract substantial capital investments from offshore and domestic investors for its various flagship initiatives including Make in India, Start-up India, Stand-up India and Digital India, the Private Equity / Venture Capital (PEVC) sector was expecting Budget 2016 to incentivise investments, address several anomalies and uncertainties affecting the PEVC sector.

While Budget 2016 lays down the pillars for India’s transformation and provides signs of optimism for the economy generally, several demands of the PEVC sector have gone unattended. Some of the proposals of the Finance Bill, 2016 that are relevant for the PEVC sector are discussed in this article.

With an intention to make tax pass-through provision work effectively in the case of SEBI registered Category I & II Alternative Investment Funds (AIFs), the tax withholding (TDS) at 10% by AIFs will now only apply to Indian residents; for non-residents, the tax withholding will be at the applicable domestic law or tax treaty (DTAA)rates.

The proposal aligns the tax withholding to the final taxability of the foreign investor in an AIF i.e. if income of the foreign investor is not taxable in India due to a favourable DTAA provision, the AIF is not required to withhold any tax. Coupled with recent relaxation in foreign investment policy for AIFs, this amendment should enable AIFs to attract foreign investors. The rationalisation of TDS for resident investors sought by the sector has not been accepted, however, an enabling framework for seeking a certificate for TDS at a lower or Nil rate has been introduced.

The deferral of POEM by one year to financial year 2016-17 comes as a welcome relief given that the final guidelines are still awaited. It would be critical for the said guidelines to be released incorporating the comments of the stakeholders so as to enable tax payers to make suitable structural changes, if required.

The safe harbour provisions for onshore management of offshore funds in India were a critical tax reform measure introduced in the last year’s Budget announcements. Several recommendations have been made to the Government to relax the requirements in the provisions relating to investor diversification, investment concentration and certainty in benefits for the life of fund, without which relocation of fund managers to India is unlikely. The Budget has addressed only a couple of these recommendations.

Firstly, the requirement that the fund should be a resident of a country or territory with which India has entered into a DTAA or Tax Information Exchange Agreement has been relaxed. Secondly, the ability of the fund to make investments in countries other than India so as to take control of the investee company has been introduced. Unless, the other recommendations are notified separately, the proposed safe harbour shall not benefit the PEVC sector.

In line with the tax benefits announced in the ‘Start-up India: Action Plan’, it is proposed to provide tax exemption to start-ups for three years, to provide capital gains exemption for persons who re-invest their capital gains in start-up ‘fund of funds’ recognized by the Government, to consider investment in ‘computer or computer software’ by start-ups as purchase of ‘new assets’ and other measures to kick start India’s ‘Start-up movement’.

The tax rate on long term capital gains of non-residents from transfer of private limited company shares has been reduced to 10%; this would align taxation of unlisted public and private limited companies.

This has been a long pending demand of the PEVC sector. Further, the budget speech also proposes to reduce the period of holding securities of an unlisted company for qualifying as long term capital gains from 3 years to 2 years (perhaps unintentionally the text of the Finance Bill, 2016 does not propose amendments to the law).
The reiteration of the Government’s commitment to implement General Anti-Avoidance Rules (GAAR) which target impermissible avoidance arrangements now makes it absolutely clear that GAAR will take effect from 1 April 2017. Hopefully, the Government will release practical guidance for implementation of GAAR to provide certainty in its application.
While the announcements lay down a roadmap to transform India amidst global and domestic headwinds, the PEVC sector expected more action on tax policies impacting investments.