5.1 Internationally, VCFs being dedicated pools of capital, operate in fiscal neutrality and are treated as pass through vehicles. In any case, the investors of VCFs and VCUs are subject to income tax. Through a series of changes in the Tax Laws, a distinct fiscal frame work has already been created over the last decade, for taxation of Mutual Funds. The fiscal regime for mutual funds quite simply eliminated the tax at the pool level while maintaining taxation at the investor level. Thereby it avoided double taxation of the same stream of income of an unincorporated pool and concomitantly maintained single tax at investor level. The objective behind is to provide fiscal neutrality as the income is taxed in the hands of final recipient and intermediary body is considered a pass through entity. Drawing the same analogy, a Venture Capital Fund is also a pool of funds of investors and income of the fund should be taxed in the hands of the investor and the fund should be considered a pass through entity and exempt under the income tax. Under the present regime, income of a VCF is taxable at fund level, (except for the exemption provided under section 10(23 FA) of the Income tax act for the income by the way of dividend and capital gains) and also taxable in the hands of investors when distributed by VCF. Pre-empting dual level (pool, as well as investor level) taxation has been a hallmark of Indian Income Tax Legislation for decades. It is therefore recommended that the present Section 10(23FA) be reenacted such that it provides complete exemption from income tax at fund level on the basis of SEBI Registration (like in the case of mutual funds). Exempting the VCF from income tax does not necessarily cause the loss of revenue as these are pass through entities and income distributed by VCF would be taxed in the hand of investors. Further, such pass through income would not just include dividends only, but also capital gains and interest income. In most of the cases, the bulk of income pass through would be in the nature of capital gains which attract tax in contrast to the income passed through as dividend. This would therefore increase the country's tax base without any negative effect on the revenues.

5.2 In addition, venture capital activities aid to the growth of industrial activity, which would indirectly add to the tax payers base. Global experience shows that venture funded enterprises have created more wealth and consequent tax revenues. It is certainly believed that in India also, with the active venture capital funding, there would be a very large number of successful enterprises which would add to the national wealth creation including the tax revenues.


In the above background, following recommendations are proposed :

  1. The existing section 10(23FA) of Income Tax Act needs to be re-enacted to provide for automatic income tax exemption to VCFs registered with SEBI (like in the case of mutual funds) which will eliminate the taxation at the pool level while maintaining the same at investor level. The new Income tax Section 10(23FA) would then read as under :

"Any income of a registered venture capital fund under the Securities and Exchange Board of India Act 1992 or Regulations made thereunder".


Consequently, no separate rules as in 2D would be needed.