You can claim long-term capital gains tax exemption for unlisted firms after 2 years
In what could come as relief to private equity investors and alternate investment funds (AIF) that invest in unlisted companies and wish to exit soon, Budget 2016 has reduced the threshold to claim long-term capital gains tax to two years, down from three years before. This provision may not help you directly if you invest through mutual funds (MF) or in listed equities, but is relevant for ultra high net worth investors who invest in private equity funds and AIFs that invest largely in unlisted companies and startups.
AIFs are of three types. Category-1 AIFs include venture funds, social venture funds and infrastructure funds, among others. Category-II includes private equity funds and debt funds. Category-III includes hedge funds and usually come with strategies to make short-term returns. The minimum investment in AIFs is Rs.1 crore. These funds cannot have more than 1,000 investors and each scheme must have a corpus of at least Rs.20 crore. But as far as this budget announcement is concerned, industry experts see this as an additional feature but not really a game changer.
WHAT IS IT?
Investments where returns are not assured and depend on the capital or principal going up or down are subject to capital gains tax at the time of withdrawal. Typically, short-term capital gains tax is higher than the long-term capital gains tax to encourage investors to stay invested. Unlike an MF, where you or the MF doesn’t pay tax on sale of underlying securities, with AIFs, the investor will pay the tax when the fund sells the underlying securities. Since AIFs are a pooled account (where they collect money from several investors), they will give you a tax statement at the end of the fiscal, telling you your share of taxes that you are liable to pay when you file your annual tax returns.
If your AIF sells a listed security within a year (the threshold for short-term capital gains tax for a listed security), a short-term capital gains tax of 15% (excluding surcharge and cess) needs to be paid. If it’s an unlisted security, the tax rate is 30% (excluding surcharge and cess). To claim long-term capital gains in an unlisted security, the threshold limit is three years (while this was mentioned in the Budget speech, the change in law is yet to happen). If the AIF sells a listed security after one year, the long-term capital gains is nil. But if it’s an unlisted security (same threshold as stated above), the tax is 20% for residents and 10% for non-residents (excluding surcharge and cess).
Experts in private wealth firms and tax firms we spoke to said that the reduction of capital gains threshold could benefit investments made in AIF categories I and II that can be exited between two and three years. But since most of the investments made into, and also by AIFs are generally for more than three years, the budget proposal would have limited appeal.