NEW DELHI/MUMBAI: The finance ministry is set to halve the tax burden to keep alive the interest of private equity (PE) players, who constitute the biggest foreign direct investor group in India.
The ministry is prepared to lower long-term capital gains tax on unlisted stocks to 10% for PEs, government sources told ET, since equity infusion by PEs helps startups and mid-sized firms to grow.
The proposed change will put PEs at par with foreign institutional investors, who currently enjoy a concessional long-term capital gains tax rate of 10% on gains from unlisted or off-market share transfers. (For listed securities, there is no tax on long-term capital gains for transactions taking place on stock exchanges.)
A senior government official said the revenue department, which vets taxation proposals, has been taken on board and if it passes muster, the change in tax rate will feature in the official amendments to the Finance Bill, 2012.
This will also soften the tax blow for PE investors who fail to comply with the General Anti-Avoidance Rules, or GAAR, proposed in the Union Budget.
The sweeping changes proposed in tax laws in the budget have unsettled the PE fraternity as they are long-term investors, putting a large part of their money in unlisted stocks. If the Finance Bill is passed unchanged, PE investors who come in through tax havens such as Mauritius, but fail to comply with GAAR, will have to pay a long-term capital gains tax as high as 20% when they sell the shares of these closely held companies. GAAR is aimed at curbing aggressive tax avoidance through sophisticated financial structures.
The proposed tax cut would thus lighten the burden for many private equity funds that are looking to exit. Since most companies where PEs had invested could not come out with public equity offerings, a lower tax on unlisted shares will also support the return that PEs generate and help them raise fresh money from investors across the world.
Most PEs invest through Mauritius, and till now they were not required to pay any tax on sale of Indian share, listed or unlisted, long-term or short-term, by virtue of the Indo-Mauritius tax treaty. That will change with GAAR.
Typically, PEs formed the funds in tax havens such as Cayman Islands or Jersey, and then set up special purpose vehicles in Mauritius to invest in Indian companies.
The new rule, when enforced, will enable Indian tax authorities to charge tax on profits from long-term stock gains made by private equity firms that fail to demonstrate ‘substantial presence’ in Mauritius. Simply put, GAAR will override the tax treaty that India has with the island nation.
Representatives of the PE industry, who met up with top finance ministry officials recently, requested for reducing the long-term capital gains tax. The other major demand was not to make GAAR applicable on exits from investments made over the past 10 years.
If the government accepts this demand, better known as ‘grandfathering’ in tax parlance, it would mean that GAAR would be applicable only on exits from investments made on and after April this year. However, senior revenue department officials clarified this week that GAAR would apply if past investments came from tax havens through a post office box type-arrangement.
PEs are said to have invested nearly $20 billion in 2006 and 2007 in various closely held Indian firms and many of them are now in talks to sell their holdings. It’s perceived that a lower tax (of 10%) will still enable them to generate a decent return for investors (or limited partners) contributing to their funds.
Without this, most PEs stepping out to sell the India story will find it difficult to attract limited partners for their next round of investments, a possibility that may adversely impact FDI and something the government is keen to avoid.