Bangalore: Venture capital funds, which have been largely able to avoid paying tax when they sell shares in start-up companies, will soon see this benefit restricted to investments in just 10 select sectors.
The funds have benefitted from what is known as “pass-through” tax treatment, meaning profits earned on exit from unlisted firms are not taxed, while individual investors are taxed when they receive distribution from the fund.
Under the Union budget, starting 1 April 2008, the tax benefit will be extended toinvestments in technology-intensive sectors such as software and hardware development and nano-technology; development of new drugmolecules; dairy and poultry industries; biotechnology, seed research, and bio-fuel production.
Funds investing in business tourism outfits that build hotels and convention centres will also be eligible.
Caught off guard by the announcement, venture capitalists call the change an exercise in futility. In the 10 select sectors, the individual investors will be taxed; in other sectors, the fund will be. “Pass through tax is not an incentive, the finance minister has only confused the issue” said Nishith Desai, founder of a legal and tax firm that focuses on the venture capital industry.
Observers and investors alike expect the 88 domestic venture capital funds, such as UTI Venture, Gujarat Venture Fund, and SIDBI Venture, will be hit the hardest, as they are governed by Indian tax laws. At present, 66 foreign venture capital firms are registered with the Securities and Exchange Board of India, and some benefit from foreign tax treaties.
Other industry advocates questioned if technology sectors, such as animation and BPO, would be eligible.
“The VC industry cannot be restricted to certain sectors, risk capital must flow to any start-up that has promise,” said Vishnu Varshney, the managing director of the Gujarat Venture Fund.
In 2006, of the 302 private equity and venture capital deals that brought in investments of Rs33,300 crore, close to 99 deals were in engineering, construction, food and beverages, media, textiles and pharmaceuticals—all sectors no longer eligible for the pass-through benefit.
In contrast, the software and IT-enabled sectors saw a total of 87 venture investments. Healthcare had 30 transactions, manufacturing 54 and the banking and financial services closed 30 deals.
Sectors such as realty have attracted private equity interest in the last year, which industry watchers say has reduced risk capital into R&D. They say that since India has not adopted real-estate investment trusts as an investment vehicle, options are limited.
Rana Rosen, Yassir A. Pitalwalla and Pankaj Mishra contributed to this story.