Budget 2020 expectations: Alternative investment industry’s wishlist

New Delhi | February 01, 2020 7:20 AM

India Budget 2020 expectations: While many of the income-tax related issues faced by the private equity/venture capital investors have already been addressed in a series of steps taken, the following few issues are yet to be addressed by the government:

india budget 2020, india budget 2020 expectations, union budget 2020 expectations, India Budget 2020: In case of preferential allotment of shares in listed companies, the pricing is governed by the preferential allotment guidelines under the SEBI Issue of Capital and Disclosure Requirements Regulations (ICDR Regulations)

Budget 2020 expectations: Foreign investment is a major monetary source for economic development in India. India attracted an estimated USD49 billion of FDI (Foreign Direct Investment) in 2019, which was a 16 per cent increase from USD42 billion in 2018. Approximately 77 per cent of this FDI was funded by private equity investors. The Government aims to make India a USD5 trillion worth economy by 2025. In order to stimulate economic development, it has initiated a flurry of initiatives, such as:

corporate tax reduction through the Tax Laws (Amendment) Bill, 2019;
financial sector restructuring;
efforts to resolve angel tax issues;
reforms in FDI policy;
increase fund allocation to infrastructure sector;
interest rate reductions.
Further, our Prime Minister and Finance Minister are constantly interacting with business leaders, entrepreneurs on how to address industry-specific issues.

WATCH- Budget 2020: Your income tax burden may come down – Top 5 Expectations

While many of the income-tax related issues faced by the private equity/venture capital investors have already been addressed in a series of steps taken, the following few issues are yet to be addressed by the government:

· An Alternative Investment Fund (AIF) usually incurs expenses such as fees payable to the investment manager, bankers, advisers, lawyers, and other service providers. Neither the AIF nor their investors can offset these expenses against income/gains that eventually result from the investment. A suitable amendment should be brought under the Income-tax Act, 1961 (the Act) allowing investors to claim the expenses incurred by the AIF, from the date of the investment to the date of its divestment, as cost of improvement while computing capital gains on sale of AIF units.

· Typically, when an AIF invests in the debt instruments of a stressed company, the interest income from such instruments is taxable on accrual basis in hands of investors of the AIF. In an event the portfolio entity is unable to pay the interest, the AIF is still required to withhold tax on such interest that is accrued in its books, if the AIF follows mercantile system of accounting. This could result in cashout for the AIF which may not ultimately receive the interest income. A suitable amendment should be brought under the Act to provide that interest income from stressed company should be taxable on receipt basis in the hands of the investors of the AIF.

· There are certain practical difficulties which arise due to deemed gift tax provisions provided under section 56(2)(x) of the Act, where a recipient receives shares for an inadequate consideration (i.e. lower than the Fair Market Value as per prescribed method). Even in a scenario where there is no tax evasion envisaged, the gift tax provisions get triggered resulting in artificial tax costs. The Finance Act 2019 stated that the class of persons to which the provisions of gift tax would not apply would be notified. However, as of now only a very specific case has been notified and such genuine cases are yet to be notified. Genuine cases of transfer of shares (especially typical private equity transactions and acquisition of shares of a company under the Insolvency and Bankruptcy Code, 2016) should be covered under the class of persons exempted from the gift tax provisions and be notified in the upcoming budget.

· In case of preferential allotment of shares in listed companies, the pricing is governed by the preferential allotment guidelines under the SEBI Issue of Capital and Disclosure Requirements Regulations (ICDR Regulations) i.e. the pricing cannot be lower than the prescribed floor price on the relevant date. This price could be different from the valuation price prescribed under the Act (i.e. the lowest traded price on the recognised stock exchange on the date of the transaction). In case the allotment price as per the SEBI ICDR Regulations is lower than the valuation price as per the Act the gift tax liability would be triggered. Accordingly, it would be appropriate that the relevant rule under the Indian tax regulations be amended to provide that the fair market value of quoted shares and securities would be the price determined in accordance with the applicable SEBI regulations.

· Unlike Category I and II AIF, the tax pass-through status has not been accorded to Category III AIFs under the provisions of section 115UB of the Act. Category III AIFs are therefore governed by complex trust taxation provisions under the Act. There is no specific tax regime or guidance on the taxation of Category III AIF and their investors. Therefore, a separate tax regime should be implemented for investors of Category III AIF thereby bringing clarity and certainty on taxation of income from Category III AIF.

· The government has specifically exempted investors of Category I and Category II FPI and AIF entities from applicability of indirect transfer provisions. However, it should further be clarified that the indirect transfer provisions shall not be applicable to the following cases:

(a) transfer/redemption is directly or indirectly in consequence of transfer of capital assets situated in India; or

(b) transfer/redemption of share or interest does not alter the ownership of the transferor in the transferee (this would help in restructuring exercises done within the same group).

The above expectations, if acceded in the Union Budget 2020 can further the agenda of current government to facilitate ease of doing business, reduce tax litigations, bring clarity and certainty in laws, stimulate investor confidence and regain the investment momentum during 2020.

(Authored by Kalpesh Desai, Partner, M&A and Private Equity, Tax, KPMG in India and Shital Gharge, Director, Private Equity Tax, KPMG in India. Views expressed are personal)

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