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Budget 2020: What’s next for Private Equity and Venture Capital industry


By Padmanabh Sinha

Private Equity & Venture Capital (PE & VC) investors have become a vital part of India’s growth story. Companies backed by PE & VC funds have consistently shown better performance vis-a-vis other companies, in terms of high-quality performance and growth, job creation and tax revenues. In the last 15 years, PE & VC industry has invested more than $200 bn in the Indian economy. In 2019 alone, the industry invested more than $30 bn.

PE & VC flows have become the largest component of FDI investment into India and even larger than all other sources of FDI put together. Various independent studies have confirmed that PE & VC funded companies create significantly more employment and pay more taxes than comparable non-funded firms. Nearly $2.3 billion was paid as corporate tax by about 700 Unlisted PE-VC backed companies in FY18. PE & VC flows have also become a steadier and often a larger source of capital than even IPO markets.

The Indian government has helped create a conducive environment for the industry to grow. In 2019, some of the key recommendations of the industry such as extension of tax exemptions in IFSCs to Alternate Investment Funds (AIFs, which is what PE &VC firms incorporated in India are called); pass-through of end of fund losses for AIFs to their investors; and exemption from the purview of Angel Tax (Sec 56) were accepted by the government. These persistent efforts by various stakeholders have also helped India emerging as the third largest startup ecosystem in the world.

There has been a significant increase in direct jobs due to an increasing pool of both fresh graduates and lateral recruits joining the startup wave with the creation of more than 1.5 million jobs over the past decade. Indirect job creation can be added to that.

What the PE & VC Industry hopes for from the Budget

While the industry is making progress a lot more needs to be done to unleash its full potential. I have summarised below the two most important changes which could help realise this – the first relating to local investors and the second relating to foreign investors into AIFs.

The first relates to increasing the domestic pools of capital in the country. Just like domestic flows have begun to play an important role in capital markets alongside FPI flows, it is important to create an experienced base of domestic investors into AIFs. In countries like Korea and China, over 50% of the capital for VC & PE are from domestic sources.

In India, domestic flows into AIFs have been hampered by a significantly higher long-term capital gains (LTCG) taxation on the sale of unlisted securities (compared to listed securities). The effective tax rates for certain classes of domestic investors is more than 2X the rate when they trade in the public markets. This significant friction cost distorts flows towards passive trading in the markets, rather than investing through AIFs to build startups and provide critical growth & expansion capital to emerging national champions.

Most large and sophisticated economies in the world have the same rates applicable to the sale of unlisted and listed securities. We believe that applying consistent tax rates to investors (when their AIFs sell their underlying unlisted portfolio company holdings when compared to the rates applicable when selling public market shares) would allow more efficient and fair channelization of investments.

Another important contributor to increasing the domestic capital flows is through the participation of local pension funds and insurance industry, something commonly seen in other economies. There is a need to make regulatory changes to the EPFO/NPS investment norms to permit them investing into AIFs. The long term nature of these savings is also well suited to the long term investment profile of PE & VC funds.

The second relates to onshoring of offshore capital pools with significant second and third-order related benefits to the Indian economy. The 18% GST currently levied on management fees paid by AIFs to onshore fund managers (even when the contributors of capital are overseas and the fund management services are thus really genuine exports!) acts as a deterrent for overseas funds to situate in India for their operations in India.

As salaries constitute a major part of their expenses, domestically domiciled PE & VC do not get adequate input tax credits to offset their GST levies. Most countries waive or commute GST on overseas funds pooled onshore as it ultimately leads to the government earning incremental revenues from local ecosystem employment in banking, consulting, finance and law firms. If even 30% of offshore PE & VC pools move to India as a result of this change, we believe the government will generate significant incremental tax revenues. A robust local fund ecosystem is a ‘no- brainer’ for high-value additive job creation, exports of services, and is tax accretive as well. Waiver or refund of GST on overseas funds pooled and managed locally (as there are legitimate exports just being routed through a local entity used for pooling the funds) would be a huge catalyst for growth.

The PE & VC industry is set to play a significant role in upping India’s growth trajectory and quality through their role in making long term investments, job creation, innovation and better governance and professionalisation of Indian companies. We hope that Budget 2020 will include these recommendations and the government will continue to provide its support to the industry. These two recommendations if implemented could be a game-changer.

(
The writer is the Chairperson, Indian Private Equity and Venture Capital Association (IVCA).)





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