Mumbai: Venture capital funds waiting to enter the Indian real-estate sector are exploring alternative routes, now that they are no longer exempt from tax on profits they could earn by buying and selling real estate on behalf of their investors. Future Group company Kshitij Investment Advisory, which has raised nearly Rs2,000 crore for investments into real estate, has already engaged one of the top four accounting firms to assess various options.
“The Budget announcement has just killed the industry,” said Vishal Kampani, director of JM Financial, which manages Rs2,500 crore worth of real-estate funds. “The investors put money in our funds because of the pass-through benefit. Now it has just disappeared. This is not the right message to foreign investors coming into India.”
Finance minister P. Chidambaram proposed removing the “pass-through” status for venture capital investments in Budget 2007, which exempted the investment vehicle from tax; only the investor had to pay tax on profits. Now only certain sectors would retain this status, and within the domain of real estate, the exemption would be only for investments in an unlisted Indian company that builds and operates hotels-cum-convention centres with a seating capacity of more than 3,000 people.
In response, new real estate investment funds are looking for favourable tax structures such as foreign direct investment (FDI) and trusts.
Despite the concern over the tax implication, the vast majority of fund managers and tax experts agreed that total flows of foreign investment into India’s booming real-estate market would not be impacted.
Foreign funds to the tune of $1-1.5 billion (Rs4,400-6,600 crore) have already been invested in Indian real estate, while another $10 billion or so are in various stages of entry into the country through the numerous venture funds.
At February-end, Citigroup Property Investors closed a $1.29 billion fund to invest in real estate and real estate-related assets in Asia Pacific, focusing on India and China.
Kampani’s two funds—a Rs1,500 crore venture capital fund and another Rs1,000 crore private equity fund—have already collected their planned corpus. But going forward, he said, the new tax would stop real-estate funds registering as VCs. “They would now have to look for new avenues to bring in the fund,” Kampani said.
The new tax would apply to any divestment after 1 April, so previous investments that were based on the “pass-through” status would be subject to the tax.
Unless there is a clarification on the provision that changes this point, companies would focus on how to plan the tax for future investment schemes.
Funds coming in from overseas had the choice of becoming a domestic venture capital fund or investing directly—the latter option is likely to become the preferred choice now.
“The venture fund route is now as good as closed. The investors would now have to think of other ways like foreign direct investment,” said Balaji Rao, managing director of Starwood Capital India Advisors Pvt. Ltd, an international real estate investment management firm that had set up its India office last year.
Other companies are hoping for new options. Rashesh Shah, chief executive officer of financial services firm Edelweiss Capital Ltd, said funds might still be able to maintain a tax benefit as a venture fund if they adopt a limited partnership structure, which is likely to be approved in the new Companies Act that may be finalised in 2007. He has one real-estate fund with Rs150 crore tied up and is in the process of adding another fund with the same amount.
Real estate funds that want to continue as a registered venture capital fund would now need to be sure they are in a trust structure, and new entrants would want to steer clear of being in a company structure that will now be subject to the maximum tax rate. “We have engaged one of the top four accounting firms to explore all possibilities, including provisions in the Trusts Act, on the taxation front,” said Sanjeev Dasgupta, chief financial officer and head of investments at Kshitij Investment Advisory.
Trust structures offer favourable tax treatment, but it was not always the best option under the old regime because it does not offer the status of a qualified institutional investor (QIB) that a fund would get when it registered with market regulator, the Securities and Exchange Board of India (Sebi), as a venture fund.
The QIB status allows incentives for investing in the capital markets, but Sebi did have some terms that funds would likely not miss like reporting requirements and restrictions on investing in listed companies.
Girish Vanvari, executive director at audit firm KPMG India, said that venture funds going forward would likely want to promote new schemes under unregistered trust structures.
Vanvari said companies need to decide: “Is the QIB status worth losing?”
Yet, Hiresh Wadhwani, partner (financial services) at audit firm Ernst & Young India, pointed out that Sebi could decide to amend its regulations and no longer offer registration for certain sectors.
But Vanvari was sceptical about all new funds coming in under FDI.