Budget wish list-Venture Capitalists ask for Tax Exemption

The Indian Venture Capital Association (IVCA) has asked the 

finance ministry to extend the benefit of tax pass-through on

investments across sectors in the upcoming Union Budget. 

Currently, under the Finance Act, 2007, tax pass-through

benefit has been allowed to investments in only nine sectors 

— information technology, biotechnology,

nanotechnology, poultry, 

dairy, bio-fuels, hotels 

and hospitality centres, 

seed research and chemical 

research & development.

In taxation parlance, 

a pass-through means

an exemption from 

paying taxes by the exempted group. The tax payable by the group

is passed on to the end beneficiary, in this case, the investors 

or limited partners in these VC funds. Funds investing into

non-specified sectors (sectors that do not fall inside the 

exempted bracket) will have to pay tax (on gains) at every exit.

Through its representation, IVCA has asked the government 

to do away with sectoral specification and restore tax pass-through 

benefits across sectors for venture capital funds. 

The industry body has asked the ministry to treat VCFs

(venture capital funds) at par with mutual funds, which are 

automatically exempted from paying taxes at the pool level.

“Non-availability of tax pass-through status could lead to 

higher taxation of income and, therefore, lower returns

for the investors,” said Pranay Bhatia, partner, Economic Laws Practice.

“If tax pass-through benefit is allowed across sectors, as is proposed

under the draft Direct Tax Code, it will alleviate tax interpretation 

challenges which are currently faced by domestic venture capital funds,”

Mr. Bhatia added.

According to IVCA, tax pass-through for select sectors is causing 

tremendous hardships to VCFs in terms of uncertain interpretations 

and operational ambiguity. Moreover, most VCFs are set up in 

the form of trusts. With pass-through unavailable in sectors other than 

those specified, these trusts (or VCFs) will be governed by

the provisions of trust taxation.

Trust laws — according to IVCA — are archaic

and hold good only for private trusts; the provisions

of trust laws are difficult to apply in the context of 

contributory trusts or pooling vehicles (like VCFs),

the industry body said.

“Pass-through basis of taxation without sectoral restrictions 

will resolve several of the current issues in the taxation of 

VCFs. Such a provision will allow the investors in VCFs to 

be taxed on income directly without any revenue loss to the government,” 

said Hiresh Wadhwani, partner, financial services, Ernst & Young.

Venture capital experts are asking the government to maintain parity 

with foreign venture capital funds which are exempted from paying 

tax in India. Currently, there are 137 SEBI-registered domestic VC funds

and 135 foreign venture funds