Budget 2023-24: Will Government push the pedal for PE / VC investments?

India has moved expeditiously over the path of capitalism over the past decade.  It would not be incorrect to say that amidst global recessionary trends and rising interest rates, India is still in a better spot today compared to its peers due to the capitalist measures taken by this Government.  India registered its highest ever annual Foreign Direct Investment (FDI) inflow of USD 84.84 billion in 2021-22, a substantial part of which came from investments of foreign PE / VC investors.  On the domestic front, over 1,000 AIFs have been launched till now, contributing to the domestic pool of investment.

This Government has not been insensitive to the needs of Private Equity (PE) / Venture Capital (VC) Industry.  Thanks to its active listening and setting-up an expert committee for PE/ VC in the last year’s budget.  All eyes in this budget would be on the Government’s reaction to the recommendations given by this committee.  

Some important asks of the PE / VC industry include:

Rationalising capital gains regime: India is a country of diversity and so are the current Indian capital gains tax rates, surcharges and holding periods for various forms of investments.  Expectation is that the Government can come up with proposals to standardise holding periods and bring parity in tax rates applicable to domestic / foreign investment and across various forms of investments (equity, debt, listed or unlisted).

‘Ease of making investment’ in India: This Government has introduced several measures for the ease of doing business in India and now is the time for bringing ‘ease of making investment’ in India.  Expectation from the finance minister would be to simplify the tax and regulatory regime, reduce compliances and timelines for private investments in India, domestic or foreign.

GST exemption on investment management services to foreign investors: GST is levied on the investment management fees payable by the AIF to the Fund manager and charged and recovered from its investors (whether domestic or foreign).  In all practicalities, management fees are more of an agreement between the investors and the Fund manager.  Without any credit/refund eligibility, levy of GST increases the cost of investment for foreign investors making it less attractive. It has been a very long standing ask that any investment management services provided to foreign investors should be regarded as deemed export of services and GST should not be levied on the same, which has till now remained unaddressed. It will be important to see whether the Government, which is promoting GIFT city in Gujarat, which already exempts GST on Fund managers, would agree to this ask or continue to encourage fund managers to move their shop to GIFT city.

Tax break for fund management fees: The Fund management fees paid by the AIF (and charged to Investors) is revenue in nature and hence, subject to tax in the hands of Fund manager at full applicable rates.  However, the Fund manager is unable to pass on any tax break of such Fund management fees to its investors with full certainty and investors generally end up paying tax on the gross investment income from the AIF.  Expectation from the Government is that the investors of AIF should be able to get a tax break of such fees against the investment income earned from the AIF.

One level taxation for Category III AIFs: This has been a very long ask from the PE / VC industry.  Category III AIFs which have not been accorded a tax pass-through status under the Income-tax Act, are governed by antiquated trust taxation provisions, and have no separate taxation regime like its peers – Category I and Category II AIFs.  With potential double taxation risk for Category III AIFs and its investors under the existing regime, expectation from the Government is that a separate regime for taxation of Category III AIFs is introduced.  

The expectations of the PE / VC industry seem to be modest if one sees the measures already implemented by developed capitalist economies.  The good part is that Government realizes that “what got India here, won’t get it there” (credit to the saying of Marshall Goldsmith) and that it will need to take bold steps to create new opportunities and attract investment.  

(Authored by Vivek Gupta, Partner and National Head, M&A and PE Tax, KPMG in India and Tanuruh Gupta, Chartered Accountant)