Budget 2020-21: Currently, compared to domestic investors, long term capital gains earned by foreign investors in private companies gives a concessional tax rate of 10 per cent.By Rajat Tandon
Union Budget 2020 India: Private equity and venture capital (PE/VC) funds are playing a key role in defining India’s economic growth. In the last 15 years, the PE/VC Industry has provided risk capital of over $200 billion investing in 4,000 odd companies. In 2019 alone, the industry invested $37 billion in the businesses. These investments resulted in the creation of 30 per cent more employment and 90 per cent more taxes compared to non-funded firms. With 27 Unicorns as a part of the ecosystem, together the start-ups have created nearly US$90 billion in value for the economy.
$178 billion has been raised across venture capital, private equity, real estate and social venture capital fund from Jan ‘13 to Sept ‘19, whereas, in the same time period, the SEBI registered alternative investment funds (AIFs) have raised $13.4 billion, which is approximately 15.6 per cent of the total.
The government has set an ambitious target of making India a $5 trillion economy by 2024-25. For that, PE/VC investments to the tune of approximately $123 billion would be required. PE/VC industry is committed to helping the government reach these targets but it requires an additional source of funding for capital generation. The industry has identified key areas to generate funds. The below mentioned topmost industry recommendations if allowed by the government, will not only give a major boost in FDIs but will also help in building the domestic pools of capital for the PE/VC asset class, which in turn will lead to the growth of the economy.
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Tax parity for listed and unlisted shares
Currently, compared to domestic investors, long term capital gains earned by foreign investors in private companies gives a concessional tax rate of 10 per cent. Public market investments are also taxed at a concessional tax rate of 10 per cent. Further, capital gains on listed shares are exempted from the enhanced surcharge rate of 37 per cent. On the other hand, domestic PE/VC players are taxed at 20 per cent for LTCG and pay an enhanced surcharge of 37 per cent. As a result, there is a considerable advantage for domestic players to invest in listed shares in comparison to the unlisted shares. There is a need for complete tax parity for listed and unlisted shares for the domestic players. We strongly recommend that tax rate on LTCG for unlisted shares (invested by AIFs that are regulated by SEBI) should be reduced to 10 per cent and enhanced surcharge be rolled back.
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Unlisted ESOPs taxed only at time of sale
In the case of employee stock ownership plans (ESOP) granted to employees, taxes are withheld by the employer upfront on the allotment. It leads to an immediate tax outflow even if the employee has not actually earned any profit which could be as high as 42.47 per cent on the salary income. To make matters more worrisome, if the sale price of ESOPs is less than the fair market value (FMV), it can lead to capital loss with no provision for refund of the excess taxes paid on the FMV at the time of exercise of ESOPs which discourages employees to exercise the options till the time they intend to sell their shares. Hence, it becomes important to tax ESOPs only at the time of sale of shares rather than at the time of allotment.
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Allowing CAT I AIFs to invest in NBFC
Financial technology is one of the most attractive sectors in the Indian startup ecosystem. It has grown by 300 per cent – from $593 million in 2016 to $2.34 billion in 2018. A number of the fintech companies register themselves as the Non-Banking Financial Companies (NBFC). However, there are certain regulations that prevent India’s VC funds (Category I AIFs) to invest in NBFCs. Due to their exclusion, Category I AIFs cannot fully participate and invest in these start-ups, that brings down their attractiveness as an asset class for Indian and foreign investors. To ensure that VC funds remain an attractive option for the investors, SEBI should allow them to invest in firms registered as NBFCs.
The government has always extended its support to the industry in the past. With budget 2020 right here, the industry has high hopes that the government’s support for the PE/VC and startups, will be continued in this fiscal year as well.
Rajat Tandon is the President of Indian Private Equity and Venture Capital Association. Views expressed are the author’s own.
