Budget and private equity: A missed opportunity?

India’s recent general elections gave the country its first single party government in 30 years with the Bharatiya Janata Party (BJP) obtaining a simple majority in the Lok Sabha. The overwhelming mandate coupled with the economically reformist outlook promised by the BJP and the new prime minister, Narendra Modi, during the election campaign had led to expectations in the business community, including the private equity (PE) industry, of sweeping economic and fiscal reforms being introduced in the 2014-15 budget. The proposals in the budget passed into law as the Finance (No. 2) Act, 2014 (Finance Act), however, turned out to be a mixed bag for the PE industry.

Alternative investment funds

From a fund manager’s perspective, the biggest expectation from the budget was in terms of obtaining clarity on the taxation of alternative investment funds (AIFs) set up as trusts and registered with the Securities and Exchange Board of India (SEBI) under the SEBI (AIF) Regulations, 2012. The Income Tax Act, 1961 (ITA), currently provides pass-through status for only one sub-category of category I AIFs, namely venture capital funds. The taxation of other sub-categories of category I AIFs, as well as category II and category III AIFs, is governed by the general principles of trust taxation. This position has led to considerable ambiguity and the industry expectation was that the budget would at least extend pass-through status to other sub-categories of category I AIFs.

However, the budget was silent on this point and the ambiguity was further compounded by a circular on AIF taxation issued by the Central Board of Direct Taxes on 28 July 2014. The circular states that the trustees of AIFs which are not considered to be determinate (i.e. whose trust deeds do not specify the names and beneficial interests of the investors) would be required to pay tax at the maximum marginal rate (MMR) on the entire income of the AIF as a “representative assessee”. The circular further stated the trustees of AIFs which are determinate and are considered as business trusts would be required to pay tax at MMR on the entire income of the AIF as a “representative assessee”. The circular is silent on the tax treatment of AIFs set up as determinate trusts which are not business trusts.

Bijal Ajinkya is a partner and Rohit Jayaraman is an associate at Khaitan & Co. Views of the authors are personal and should not be considered as those of the firm.