ETtech Budget Watch: PEs, VC firms call for tax parity in upcoming budget

This comes amid a 30% drop in venture funding for startups to nearly $24 billion in calendar year 2022, after a record year for fundraising in 2021.

Currently, listed stocks attract a capital gains tax of 15% on short-term gains, or those held for less than 12 months, while unlisted shares attract short-term capital gains tax as per the slab of the investor.

Similarly, gains from listed stocks sold after being held for more than a year attract 10% tax if the capital gains exceed Rs 1 lakh during a financial year, but that on unlisted securities attracts 20% tax. The minimum holding period for unlisted shares to be considered long-term assets is 24 months.
“Essentially, we’re saying, a lot of investment in emerging sectors is still run by foreign capital, and we have not seen a dramatic shift in base,” Karthik Reddy, co-founder, Blume Ventures and chairperson of the Indian Venture and Alternate Capital Association (IVCA) told ET.

“This asset class (alternative investments) is very foundational in terms of the nature of capital as it’s creating new enterprises, new entrepreneurs, new jobs, and is allowing us to compete on a global stage. It is also very different from public markets capital, where money is changing hands but isn’t fundamentally economy-forming,” Reddy said.

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To accelerate public markets, benefits were given to investors 10-15 years ago, and “we’re just saying normalise them,” he added.

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Internet industry body IndiaTech, which represents a clutch of startups and VC investors, also said that the longer holding period for unlisted securities to be considered long-term assets means angel investors have to pay up to four times more tax if they sell a stake in an unlisted company after holding it for 18 months.

“While it is understandable that the longer hold period is designed to encourage more long-term activity, this treatment (and the tax rate itself) may well be impeding the activities that it is meant to encourage,” it said in a submission to the government.

The PE and VC industry has also raised these issues with the finance ministry.

These recommendations assume significance given that in last year’s budget, finance minister Nirmala Sitharaman indicated the need for scaling up investments by these entities and announced the setting up of an expert committee to suggest measures.

In September last year, the Department of Economic Affairs constituted the committee led by former Securities and Exchange Board of India (Sebi) chairman M Damodaran. The committee submitted its report to the government in November.

“Venture capital and private equity invested more than Rs 5.5 lakh crore last year, facilitating one of the largest startup and growth ecosystem. Scaling up this investment requires a holistic examination of regulatory and other frictions,” Sitharaman said in her budget speech for 2022-23.

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In addition to the tax parity issue, the IVCA has sought allowing for pass through of expenses incurred by Alternative Investment Funds (AIF), which would effectively bring down their taxable income.

Currently, income and losses are treated as pass-throughs for tax calculation purposes. This means that tax is calculated on income after deducting capital losses, but not on expenses incurred to run the fund.

The IVCA has said that the tax pass-through status has only been given to hedge funds and listed market funds. This has pushed fund managers to set up shop in Singapore or Mauritius as opposed to in India, especially in places such as the GIFT International Financial Services Centre (IFSC) in Gujarat.

Also read | Budget 2023 may take up GIFT City AIFs’ tax snags

“For the last decade, the tax pass-through on income and losses has been well understood and appreciated but expenses are not considered pass through. Around 15-20% of the capital is being spent to run the fund, how can there be no pass through on that,” Reddy of IVCA said.

“Today, there is no tax benefit for that. Apples to apples — between a domestic and a foreign investor who has invested the same amount of capital in the same entities, the return in rupees is surpassed in the Indian fund because there is no pass through,” he added.