Tax pass-through ought to be restored

Tax pass-through ought to be restored
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First Published: Tue, Feb 19 2008. 01 27 AM IST

Snigdha Sengupta
Snigdha Sengupta
Updated: Tue, Feb 19 2008. 01 27 AM IST
Snigdha Sengupta
Budget 2008-09 comes up next week and domestic venture capital funds—funds (venture capital and private equity) registered with the Securities and Exchanges Board of India (Sebi)—hope that the tax pass-through benefit earlier available to them will be restored. Till February 2007, domestic venture capital funds (VCF) enjoyed 100% tax exemption on income from exits (sale of investments).
This was amended in the last budget to limit the pass-through only to VCFs focused on certain sectors, notably nanotechnology, biotech, hotels and dairy farming—the full list is available at http://indiabudget.nic.in/ub2007-08/bs/speecha.htm.
Why finance minister P.Chidambaram deemed only these sectors as “truly deserving” over others continues to baffle most folks in the industry. The Indian Venture Capital Association (Ivca), in a letter to the minister shortly after the budget, pointed out; “The Budget’s notable exclusions are some of the fastest growing and innovation driven areas such as KPO/BPO, telecom, wireless value-added services, media and entertainment and health care…”
Now, it is true that none of the sectors that have been excluded from the pass-through have actually suffered in terms of attracting investors.
In fact, investments in sectors such as wireless value-added services, telecom and KPO have grown quite significantly in the last 12 months. That is so because the majority of investors are foreign funds (not registered with Sebi), which work out of “tax-neutral jurisdictions” such as Mauritius and enjoy exemptions under double tax avoidance agreements. As long as confidence in the Indian economy is strong, and it is likely to remain so for a while, such foreign investors will keep most sectors well funded.
But, consider for a moment the scenario that existed between 2001 and 2004. This was a time when investor interest in India was at an all-time low, driven by factors such as the Internet bust and recession in the US, which alone accounted for 90% of direct venture capital investments in India.
The absence of a local, self-sustaining venture capital industry was sorely felt at the time. Total investments during this period languished at significantly less than $1 billion (Rs3,970 crore at current exchange rates). And, while mature businesses still managed to scrape together some investors, early-stage businesses all but perished.
After 2005, the scenario changed and one of the most welcome changes was the growing number of domestic VCFs. These funds are still backed by foreign institutional money, but for all practical purposes operate as local entities. As a result, investments have gone wider and deeper into sectors that earlier did not come under the radar of venture capital.
A big incentive for the emergence of such funds was the tax pass-through. It was assumed that over time, such funds would come to be backed by domestic institutional investors and lead to a truly self-sustaining industry.
The finance minister’s intentions last year were no doubt noble—it is a fact that sectors such as nanotechnology and biotech required an extra push. Venture capitalists are still not rushing in to fund companies in these sectors but it was necessary to bring them into focus.
But, as Ivca puts it, “We need to leave it to entrepreneurs and investors to decide on what are the promising and potential growth areas of the future. No one can predict what these are and that is why no government in the world even attempts to do so.” Let’s hope the finance minister is listening.
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First Published: Tue, Feb 19 2008. 01 27 AM IST