The Finance Bill, 2007 proposes to restrict the pass through status for Venture Capital Funds (‘VCFs’)/ Venture Capital Companies (‘VCCs’) to only income from investment in domestic unlisted company engaged in certain specified businesses such as IT, bio-tech etc (‘VCU’).

Currently, VCFs/ VCCs enjoy complete pass-through status under Section 10(23FB), irrespective of nature of income.  Instead, the income is taxed in the hands of its investors at the time of distribution under Section 115U, on a pass-through basis.

The proposed amendment raises several issues in respect of income of VCF from non-VCUs.

Firstly, being in the nature of a Trust vehicle, the taxation of VCFs would now be guided by the complex principles relating to trust taxation. Whilst this taxation regime for Trusts also aims at one-level taxation, the implications could be manifold ranging from complex trust taxation provisions, issues relating to characterization as business income or capital gains, taxation on accrual basis rather than on distribution to investors, tax implications for foreign investor in VCF (availability of treaty benefit), etc.

Further, in case of VCCs, the proposed amendment would result in two levels of taxation – ie tax in the hands of VCC and on distribution of income to the investors. It is also doubtful as to whether the DDT provisions would apply to VCCs having mixed investments.

Also, the existing non-VCU investments that have already been made by VCFs would be governed by the proposed provisions. It would be unjust to subject these investments to the proposed regime considering that the investments were made based on the complete pass-through status which was made available to VCFs.

To conclude, with the proposed amendment, the Government has discouraged venture capital from making long term investments in India in key sectors such as Infrastructure/ real estate development.

By:-

Tushar Sachade, Partner - RSM & Sheetal Nagle, Manager- RSM