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5.0. TAX
PASS THROUGH FOR VENTURE CAPITAL FUNDS
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.
5.3
RECOMMENDATIONS
In the
above background, following recommendations are proposed :
- 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.
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