The alternative investment fund (AIF) and the startup industry was largely left disappointed with the proposed Finance Bill 2023, which left out most of key demands made, including those on tax treatment and legal framework.
Instead, startups were unnerved by an ‘angel tax’ for non-residents.
“Startups were shocked to hear that ‘Angel Tax’ – the tax payable by a company for issuing shares at a premium above its fair market value, would now apply to investments from non-residents as well. Previously, it only applied to investments from residents. Foreign capital is the largest source of funding for Indian startups and this measure will push many investors to turn hesitant in funding Indian startups. It will also push Indian entrepreneurs to move overseas,” said Siddharth Pai, Co-Founder 3one4 Capital & Co-Chair, Regulatory Affairs Committee, Indian Venture Capital Association (IVCA).
Investors were expecting to find mention in the Union Budget 2023 of the suggestions made by Expert Committee on private equity and venture capital (PE/VC) investments. The Committee had tabled its report in December 2022.
“Yes, there was a lot of expectation from the VC/PE investor community to see rationalization in capital gains tax to boost capital flows to a space that attracted over $100 billion in investments over the last 6 years. It is a disappointment to have this request denied this year as well,” said Anirudh A Damani, Managing Partner at Artha Venture Fund.
"I strongly advocate for a tax regime to attract foreign capital directly into Indian startups," he added.
Anil Talreja, Partner at Deloitte India said the fund managers of AIFs (including REITs, Invits) had expected parity on tax rates applicable on interest income distributed by the funds and period of holding to determine long term/short term capital gains.
“They were also expecting clarity on taxation on carried interest as well as ‘pass through’ status for CAT III. The proposals to tax potential repayment of debt in the hands of the investors will dampen their spirits and may take them back to the drawing board to structure leverage,” he added.
AIFs have been seeking tax parity between listed and unlisted entities and recognition of AIF operations under Indian Tax law, especially GST. Under the existing tax framework for Mutual Funds, Portfolio Management Services (PMS), REITs/InvITs, the income is taxed in the hands of investors on a “pass through” basis, at tax rates applicable to such investment funds.
However, for AIFs, particularly those making public market investments, do not enjoy the pass-through status and gains are taxable at the hands of individual investors. In other words, there is no taxation at the fund level. Funds, therefore, need to rely on other avenues available under the tax laws which are prone to litigation.
“Having parity in treatment of securities will increase the capital allocated to investments in new asset creation that generate jobs and boost the economy, said Gopal Srinivasan, Chairman and Managing Director of TVS Capital Funds.
"In the AIF business model, carried interest and management fee requires right recognition and treatment across laws/regulations… we are opposed to holding our securities at a lower cost, even though carried interest is treated as Capital Gains by the industry and there is no clear directive or order instructing the tax assessment officer. So, there is a need to bring in certainty to this aspect to avoid friction across agencies/regulators. The pass-through character permitted to AIFs should be across incomes, losses and expenses instead of restricting it to only incomes/losses, he added.
The industry also hoped for extending the ESOP (employee stock option plan) tax changes from the last budget to all the Department for Promotion of Industry and Internal Trade (DPIIT)-registered startups and allowing for an objective M&A framework as opposed to going through NCLT or National Company Law Tribunal approval, which is for the large corporates.
"Ease of doing business I think is the only headline (in the Budget) which will indirectly help the investment community," Srinivasan added.