India deals tax blow to PE

Private funds in India face the possibility of losing their “pass-through” tax status under updated tax rules. With pass-through treatment, income generated by the fund is taxed at the investor level, not the fund level, to avoid double taxation.

The reforms force GPs to name all their investors in a fund before it’s launch date – a requirement that runs against the grain of industry practice – or pay a 30 percent tax on any fund income.

Industry trade body the Indian Private Equity & Venture Capital Association (IVCA) reacted strongly against the reforms, calling them “unexpected” and acting against the interests of fund managers who raise long-term capital conducive to economic growth.

India’s securities regulator is reportedly being lobbied by industry tax and legal experts for relief. Stakeholders are asking the Securities and Exchange Board of India to provide a six to one year time window for GPs to market their funds without facing the 30 percent tax. Under the request, GPs would submit the names of any investors who committed after the grace period ended for final approval.

It is unclear what options a fund manager may have if the grace period ended without reaching a final close, however some GPs may simply avoid realizing investments until a final close is reached to avoid the tax.

Confusion around pass-through tax status is nothing new in India. Last June India introduced fund regulations that only provided pass-through tax status to early stage ventures, social ventures or infrastructure funds. Consequently some private equity managers organized their investment vehicles as trusts to preserve investors’ tax pass-through status. However, the trust structure GPs used to get around the previous pass-through issue will be caught under the new tax changes.