A Parliamentary panel has batted for the abolition of long-term capital gains (LTCG) tax for all investments in startups which are made through collective investment vehicles such as angel funds, alternate investment funds and investment Limited Liability Partnerships.
The former minister of state for finance Jayant Sinha headed Standing Committee on Finance in its report tabled on Tuesday said the tax should be removed at least for the next two years to encourage investments amid the pandemic.
It also recommended that the exemption for income on investments made before March 31, 2024, subject to the investment being held for a period of at least 36 months as incentivised in the Finance Act, 2020, should be provided to long-term and patient capital invested across all sectors.
Noting that businesses are stressed for liquidity and valuations of businesses have softened due to the Covid-19 pandemic, it also said the pricing guidelines prescribed under the various laws and regulations by SEBI, Income Tax Act, Companies Act, FEMA should be made more consistent to provide a certain, coherent and simple framework for facilitating large-scale investments in India.
“The Committee would like to strongly recommend that tax on Long Term Capital Gains be abolished for all investments in startup companies (as designated by DPIIT) which are made through collective investment vehicles (CIVs) such as angel funds, AIFs, and investment LLPs,” the committee said in its report “Financing The Startup Ecosystem”.
India’s startup sector welcome the recommendation of abolishing long term capital gains (LTCG) in startup investments. Industry leaders said that the move would open the floodgates for Rupee (domestic) capital to flow into the sector, which has been sorely lacking.
“These reforms would open the floodgates of domestic capital going into start-ups like never before, as long as the eligibility criteria of the tax benefits is not too narrow, enabling the widest set of startup investors and companies to benefit for a long enough period of time,” said Kunal Bhal, cofounder and CEO at Snapdeal.
Others pointed out that removing LTCG or bringing it at par with taxation of gains made through listed securities on the secondary market, has been one of the most long standing asks of the industry.
“The Parliamentary Panel has given voice to a longstanding ask of the Indian startup ecosystem. Investments into startups are in the form of primary investments into the company, which in turn generates new assets, economic growth and jobs. These measures, if adopted, will help accelerate the Indian startup ecosystem and allow them to meet the PM’s goal of startups contributing 20% of India $5 trillion GDP by 2025,” said Siddarth Pai, founding partner at 3one4 Capital & co-chair Regulatory Affairs Committee at IVCA.
The panel recommended that after this two year period, the Securities Transaction Tax (STT) may be applied to CIVs so that revenue neutrality is maintained.
Investments by CIVs are transparently done and have to be done at fair market value, the Standing Committee said, adding that it is easy to calculate the STT associated with these investments.
“This can be done in lieu of imposing LTCG on these CIVs and to make the taxation system fairer, less cumbersome, and transparent. This will also ensure that investments in unlisted securities are on par with investments in listed securities,” it said.
At present, LTCG earned by foreign investors in private companies attracts taxation at concessional rate of 10%, in comparison to the domestic VC/PE investments being taxed at 20% (for LTCG) with an enhanced surcharge of 37%. The panel also proposed that the sectors in which Foreign Venture Capital Investor (FVCIs) are allowed to invest should be expanded to include all sectors where Foreign Direct Investment (FDI) is permitted, as this route provides a flexible investment framework and hence will be able to attract significant capital in the economy.
“There is now a need to allow issuance of hybrid securities, which bear characteristics of both debt and equity under the FDI route, at least for a limited period to enhance the fund-raising capabilities of the companies to raise capital at commercially suitable terms in this difficult time,” it said.
The committee also recommended that the exemption for income on investments made before March 31, 2024, subject to the investment being held for a period of at least 36 months as incentivised in the Finance Act, 2020, should be provided to long-term and patient capital invested across all sectors.
It also said that there is a need for AIFs to be allowed to be listed on capital markets, thereby creating permanent source of capital for the startup ecosystem besides creating more domestic Development Financial Institutions (DFIs) on the lines of International Finance Corporation (IFC) and The German Investment and Development Company (DEG).
Self-reliance, fund mobilisation
The committee said that India needs to reduce the startups’ dependence on foreign funds as capital going into India’s unicorns comes mainly from foreign sources such as the US and China. Currently more than 80% of capital going into India’s unicorns comes from foreign sources. China has investment of over Rs 30,000 crore in India’s growth companies and currently invested in 18 of 30 unicorns.
It said India needs to become self-reliant by having several large domestic growth funds powered by domestic capital to support India’s unicorns and suggested that Small Industries Development Bank of India (SIDBI) Fund-of-Funds vehicle should be expanded and fully operationalised/utilised to play an anchor investment role.
The panel said domestic risk capital should not be punished at any level while observing that the current tax disparity was proving advantageous to foreign capital through low tax jurisdictions and low taxes for fund management services.
As per the panel, such a move will establish a level playing field for domestic investments in comparison to foreign investments and domestic listed in comparison to unlisted securities.
The committee recommended that CIV capital gains should always be taxed at the same rate as listed securities to encourage domestic investments in unlisted debt and equity securities.
As per the report, large financial institutions in India should be encouraged to channelise a proportion of their investible surplus into domestic to bring in “much-needed” additional domestic capital for startup investments.
The panel suggested that Pension Fund Regulatory and Development Authority and National Pension Scheme be encouraged to invite bids from professional fund managers for running a fund-of-funds programme on which SIDBI would be eligible to participate while major banks should join hands to float a fund-of-funds.
For insurance companies (both life and non-life), it said, they must be given latitude to invest in fund-of-funds by IRDAI as well as directly in VC/PE funds along with a higher exposure cap and that investments by insurance companies in AIFs must be carved out under a separate category while calculating the applicable exposure limits and not clubbed with other investments under ‘unapproved investments’.
Foreign Development Finance Institutions may also be encouraged to participate with local asset management companies to set up fund-of-funds structure or direct VC/PE funds, particularly in social impact, healthcare and venture/startup sectors.