India's budget leaves PE tax issue open

India's recently released federal budget for 2013 leaves many unanswered questions about taxation issues that impact private equity, according to a recent BMR Advisors analysis. 

India’s finance minister stressed the need for foreign investment in the coming year, but Mahesh Kumar, international tax partner at Indian law firm Nishith Desai, believes the new budget actually does very little to attract it.

“This was an opportunity for the government to address all the issues pertinent to private equity, especially after saying that they need foreign inflow,” said Kumar. “It’s a case of missed opportunity.”

One of the biggest ambiguities in India’s private equity industry for the past year has been the tax question – how funds will be taxed, and how exits will be taxed. In 2012, India introduced a much more aggressive tax regime that could be applied to assets offshore, in the General Anti-Avoidance Rule (GAAR).

A major problem, however, was the vague language that made it difficult to determine exactly when it applied and when it didn’t. “Everyone hoped that this [new budget] would clarify the ambiguity – it has not,” Kumar said.

He added that he was most disappointed because the government has been receiving detailed recommendations from consultants and professionals in the private equity industry, but the new budget largely does not reflect their input. 

Vivek Gupta, a BMR Advisors partner, is more positive about the budget. Given the current economic conditions in India, it could have been a lot worse, he said, and the government has been clear that it is headed in the same general direction.

The language of the new budget tells him that the deferrals of tax laws like the GAAR are just that – deferrals, and the government will continue to move towards the implementation of the same laws, not revoke them.

“For private equity [taxation], the writing on the wall has been clear for some time,” Gupta said.

He believes the move toward substance-based taxation is continuing. Economic substance of a fund, which refers to issues such as the location of the office and employees, rather than the legal structure, will determine the fund’s domicile and any applicable treaty benefits in India. 

“Private equity funds will thus have to plan over the next few years how to prove substance,” he said.