PE/VC investors press for tax code on profits

MUMBAI/BENGALURU : Private investors will lobby the recently-empaneled private equity and venture capital expert committee to formalize a tax code on private equity profits later this month, even as there are calls to make fund management fees a deductible expense under capital gains, senior industry executives said .

Typically, PE and venture capital firms charge their investors a 2% annual management fee, and take a 20% share of fund profits after a basic return threshold is met. This share in fund profits, which is paid to fund managers as an incentive, is defined as ‘carry’, and has emerged as a bone of contention between fund managers and the tax department.

“There should be a definition on ‘carry’ somewhere in the tax code. Right now, there is no definition, and that leaves room for discretion,” said Gopal Srinivasan, senior board member of industry body IVCA (Indian Private Equity and Venture Capital Association), and founder and chairperson of PE firm TVS Capital.

Currently, fund managers end up paying tax either as capital gains or as a service tax under the goods and services tax (GST) regime, depending on how the assessment is done by tax officers.

Investors expect that the issue of carry, along with other demands, will be taken up by the expert committee headed by former Sebi chairman M. Damodaran. The committee, which was first announced in the budget earlier this year, will identify ways to accelerate the growth of the PE/VC ecosystem, the finance ministry said last Tuesday.

“There are several aspects of the tax framework applicable to funds that could be clarified. Taxation (both direct and indirect) on carried interest is one of the major issues that will have a bearing on fundraising in India-domiciled vehicles. Several fund managers are currently dealing with inquiries in this regard,” said Subramaniam Krishnan, Partner, EY.

Tax notices to PE and VC firms gained pace especially after July 2021, when the Bangalore bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) said levy of service tax on carried interest distributed by PE and VC funds was justified. This was a case involving ICICI Venture’s ICICI Econet and Internet Technology Fund, which is now under appeal. Investors are seeking two other changes around the tax levied over the 2% annual management fee charged by fund managers. Currently, there is a GST levied on the management fee paid to the fund for managing foreign capital. Fund managers want this to be waived.

“The rationale is if advisory services would have been provided to overseas investors directly, then it is likely to have qualified as ‘export of service’ and not liable to GST,” said Kunal Shah, partner, PwC.

Secondly, investors want the management fee to be allowed as a tax deductible from capital gains.

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