4.0 MULTIPLICITY OF REGULATIONS - NEED FOR HARMONISATION AND A NODAL REGULATOR

4.1 At present, the Venture Capital activity in India comes under the purview of different sets of regulations namely :

1. The SEBI (Venture Capital Funds) Regulation, 1996[Regulations] lays down the overall regulatory framework for registration and operations of venture capital funds in India.
2. Overseas venture capital investments are subject to the Government of India Guidelines for Overseas Venture Capital Investment in India dated September 20, 1995.
3. For tax exemptions purposes venture capital funds also needs to comply with the Income Tax Rules made under Section 10(23FA) of the Income Tax Act.

4.2 In addition to the above, offshore funds also require FIPB/RBI approval for investment in domestic funds as well as in Venture Capital Undertakings(VCU). Domestic funds with offshore contributions also require RBI approval for the pricing of securities to be purchased in VCU likewise, at the time of disinvestment, RBI approval is required for the pricing of the securities.

4.3 The multiple set of Guidelines and other requirements have created inconsistencies and detract from the overall objectives of development of Venture Capital industry in India. All the three set of regulations prescribe different investment criteria for VCFs as under :

• SEBI regulations permit investment by venture capital funds in equity or equity related instruments of unlisted companies and also in financially weak and sick industries whose shares are listed or unlisted. The Government of India Guidelines and the Income Tax Rules restrict the investment by venture capital funds only in the equity of unlisted companies.
• SEBI Regulations provide that atleast 80% of the funds should be invested in venture capital companies and no other limits are prescribed. The Income Tax Rule until now provided that VCF shall invest only upto 40% of the paid-up capital of VCU and also not beyond 20% of the corpus of the VCF. The Government of India guidelines also prescribe similar restriction. Now the Income Tax Rules have been amended and provides that VCF shall invest only upto 25% of the corpus of the venture capital fund in a single company.
• SEBI Regulations do not provide for any sectoral restrictions for investment except investment in companies engaged in financial services. The Government of India Guidelines also do not provide for any sectoral restriction, however, there are sectoral restrictions under the Income Tax Guidelines which provide that a VCF can make investment only in companies engaged in the business of software, information technology, production of basic drugs in pharmaceutical sector, bio-technology, agriculture and allied sector and such other sectors as notified by the Central Government in India and for production or manufacture of articles or substance for which patent has been granted by National Research Laboratory or any other scientific research institution approved by the Department of Science and Technology, if the VCF intends to claim Income Tax exemption. Infact, erstwhile Section 10(23F) of Income Tax Act was much wider in its scope and permitted VCFs to invest in VCUs engaged in various manufacture and production activities also. It was only after SEBI recommended to CBDT that atleast in certain sectors as specified in SEBI's recommendations, the need for dual registration / approval of VCF should be dispensed with, CBDT instead of dispensing with the dual requirement, restricted investment to these sectors only. This has further curtailed the investment flexibility.

4.4 The Income Tax Act provides tax exemptions to the VCFs under Section 10(23FA) subject to compliance with Income Tax Rules. The Income Tax Rules inter alia provide that to avail the exemption under Section 10(23FA), VCFs need to make an application to the Director of Income Tax (Exemptions) for approval. One of the conditions of approval is that the fund should be registered with SEBI. Rule 2D also lays down conditions for investments and section 10(23FA) lays down sectors in which VCF can make investment in order to avail tax exemptions. Once a VCF is registered with SEBI, there should be no separate requirement of approval under the Income Tax Act for availing tax exemptions. This is already in practice in the case of mutual funds.

4.5 The concurrent prevalence of multiple sets of guidelines / requirements of different organisations has created inconsistencies and also the negative perception about the regulatory environment in India. Since SEBI is responsible for overall regulation and registration of venture capital funds, the need is to harmonise and consolidate within the framework of SEBI Regulation to provide for uniform, hassle free, one window clearance. A functional and successful pattern is already available in this regard in the case of mutual funds which are regulated through one set of regulations under SEBI Mutual Fund Regulations. Once a mutual fund is registered with SEBI, it automatically enjoys tax exemption entitlement. Similarly, in the case of FIIs tax benefits and foreign inflow/ outflow are automatically available once these entities are registered with SEBI.

4.6 It is therefore necessary that there is a single regulatory framework under SEBI Act for registration and regulation of VCFs in India. It may be mentioned that Government of India Guidelines were framed on September 20, 1995 and SEBI regulations were framed in 1996 pursuant to the amendment in the SEBI Act in 1995 giving SEBI the mandate to frame regulations for venture capital funds. After the notification of SEBI regulations, separate GOI Guidelines for venture investments should have been repealed. Further, once a VCF including the fund having contribution from off shore investors, is registered with SEBI, the inflows and outflows of funds should be under transparent automatic route and there should be no need for separate FIPB / RBI approvals in the matters of investments, entry / exit pricing. Likewise, VCF once registered with SEBI should be entitled for automatic tax exemptions as in the case of mutual funds. Such single regulatory requirement would provide much needed investment and operational flexibility, make the perception of foreign investors positive and create the required environment for increased flow of funds and growth of the venture capital industry in India.

4.7 SEBI regulations provides flexibility in selection of investment to the VCF, however, in the event of subscription to the fund by an overseas investor or the fund choosing to seek income tax exemptions, the investment flexibility is curtailed to a great extent. It is worth mentioning that one of the condition for grant of approval under the Income Tax Rules for seeking exemption under the Income Tax Act is that the fund should be registered with SEBI which make it obligatory on the venture capital fund not only to follow Income Tax Rules but also the SEBI Regulations. Further, a VCF has to seek separate registration under the SEBI Act and approval under the Rules of Income Tax apart from seeking approval from FIPB / RBI in the event of subscription to the fund by an overseas investor.

4.8 RECOMMENDATIONS

In the above background, following recommendations are proposed:

1. Since SEBI is responsible for registration and regulation of venture capital funds, the need is to harmonise and consolidate multiple regulatory requirements within the framework of SEBI regulations to provide for uniform, hassle free, single window clearance with SEBI as a nodal regulator.
2. In view of the (a) above, Government of India may consider repealing the Government of India � MoF(DEA) Guidelines for Overseas Venture Capital Investment in India dated September 20, 1995
3. The Foreign Venture Capital Investor (FVCI) should registered under the SEBI Regulations under the pattern of FIIs.
4. For SEBI registered VCF, requirement of separate rules under the Income Tax Act should be dispensed with on the pattern of mutual funds.