Sebi panel headed by NR Narayana Murthy proposes easier norms for VC, PE funds

MUMBAI: A Sebi panel has recommended sweeping changes in rules governing venture capital and private equity funds in India to bring the norms in line with global practices and help attract capital flows, streamline tax collections and widen the participation of domestic and overseas investors. The Securities & Exchange Board of India’s committee on Alternative Investment Funds (AIFs), headed by Infosys founder NR Narayana Murthy, has proposed creating a favourable tax environment for investors, tweaking of safe harbour rules, unlocking domestic pools of capital, enabling onshore fund management in India and reforming the AIF regulatory regime.

AIFs, which include venture capital, private equity, debt funds and infrastructure funds, can attract large capital flows that can potentially reach as much as 2% of GDP (gross domestic product) if regulatory issues are streamlined, according to the committee.

As part of the tax proposals, the committee recommended introducing the securities transaction tax (STT) for private equity and venture capital investments.

The 21-member panel was set up to ensure rules are in step with India’s rapidly evolving startup ecosystem.

Members of the panel include Sanjay Nayar, chief executive officer for Kohlberg Kravis Roberts & Co in India, Manish Chokhani, chairman of TPG Growth India, Gautam Mehra, a partner with PricewaterhouseCoopers India.

Also on the panel are KEC Raja Kumar, CEO of Ascent Capital Advisors, Ajay Piramal, chairman of Piramal Group, Manish Kejriwal, managing partner of Kedaara Capital, and Arvind Mathur, president of Indian Private Equity & Venture Capital Association.
“The star businesses of today, were once startups…The digital age has created a fertile new environment for startups… Accordingly, reforming the AIF regulatory framework for venture capital, private equity and angel capital will play a key role in making a success of the startup policy,” the panel noted in its report submitted to Sebi recently.

The government on Saturday announced its Start Up India initiative and a 19-point action plan aimed at building a strong ecosystem for nurturing innovation and startups that will drive sustainable economic growth and help create jobs.

Between 2001 and 2015, venture capital and private equity firms invested over $103 billion in more than 3,100 Indian companies across 12 major sectors, ranging from startups to mature, mid-size companies, according to the panel’s report.

The regulator has already taken up the tax-related proposals with the government as the Budget is scheduled to be presented on February 29, a Sebi official said. The report will soon be put out for public comments, the official said.

The committee, set up in March 2015, has met four times. It focused on four key areas — taxation reforms, development of domestic capital pools, attracting overseas managers onshore to India and categorisation of AIFs in Sebi’s regulatory regime.
CHEQUERED HISTORY
The tax treatment of venture capital and private equity funds has seen a chequered history. Until 2007, Sebi-registered venture capital funds enjoyed a blanket passthrough on all income. Subsequently, a restricted passthrough was implemented and recently, the Finance Act, 2015, was amended to make withholding tax applicable.

“In the case of mutual funds, real estate investment trusts, full pass-through is provided in the Income Tax Act, whereas in the case of AIFs, funds are subjected to tax on certain heads of income and 10% withholding tax. In view of this, both funds and the investors are subjected to tax compliance burden. So, the industry has been asking for full pass-through, like in the case of mutual funds and REITs (real estate investment trusts),” said a member of the panel, asking not to be identified since the report hasn’t been made public.

The committee proposed the introduction of STT at an appropriate rate on all distributions (gross) of AIFs, investments, short-term gains and other income and elimination of any withholding of tax. After STT, income from AIFs should be tax-free to investors, the panel said.

The STT approach could pave the way for direct participation of overseas investors (limited partners) in Indian AIFs and increased involvement of domestic investors.