Union Budget : Impact on the Private Equity investments in India. Grant Thornton India LLP. All rights reserved.

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1 Union Budget : Impact on the Private Equity investments in India Grant Thornton India LLP. All rights reserved.

2 Union Budget Impact on the Private Equity investments 2 Contents 03 An overview 04 Key policy initiatives 05 Key incentives to capital markets 06 Direct tax proposals 11 Our offices

3 Union Budget Impact on the Private Equity investments 3 An overview The finance minister while presenting his budget speech laid emphasis on "higher growth leading to inclusive and sustainable development" citing growth to be the mool mantra for the government. The finance minister stressed that the key to growth driver is to attract more investment both from domestic and foreign investors. He further stressed that "doing business in India" should be seen as easy, friendly and mutually beneficial. The proposed budget focuses on increased expenditure in all sectors of the economy with special focus on infrastructure. The budget disappointed the PE industry by not according the pass through status to all funds registered under the AIF regulations and confining the pass through status only for a sub-section of Category I AIF ignoring SME funds, social venture funds and infrastructure funds. Further, the finance minister has failed to give any clarity on the governments stand relating to indirect transfers, retrospective amendments and clarity on the term "substantial". One of the major amendments in the budget is change of taxability in relation to buy-back of shares. The liability to pay 20% on the consideration paid for buy-back of unlisted shares in excess of the issue price of such shares will now be of the company. As anticipated, the deferment of GAAR to AY and other relevant changes in the GAAR provisions in line with the announcement made by the government on 14 January 2013 have been incorporated. Increase of withholding rate to 25% in relation to royalty or fees for technical services paid to a non resident. For claiming DTAA benefits, it is proposed to clarify that production of TRC is necessary but not sufficient condition. The much anticipated higher tax on high income earners has come by way of surcharge of 10% on all non-corporate persons having total income exceeding Rs 1 Crores and Corporates having taxable income in excess of Rs 10 Crores. We are pleased to provide our analysis of the major provisions of the tax proposals which could directly impact PE investors in India.

4 Union Budget Impact on the Private Equity investments 4 Key policy initiatives total expenditures budgeted at Rs 16,65,297 Crores and 30% hike in plan expenditure at Rs 555,322 Crores for FY to allocate Rs 2,03,672 Crores for defence sector out of which 86,741 Crores towards capital expenditure investment of Rs 55,00,000 Crores projected during the 12th Five Year Plan in infrastructure government to encourage Infrastructure Debt Fund and allow institutions to issue tax free bonds up to Rs 50,000 Crores credit enhancement offered by India Infrastructure Finance Corporation Limited in partnership with the Asian development Bank to infrastructure companies to access the bond market

5 Union Budget Impact on the Private Equity investments 5 Key incentives to the capital markets SEBI to simplify the procedures and prescribe uniform registration and other norms for entry of foreign portfolio investors. SEBI will converge the different KYC norms and adopt a risk-based approach to KYC to make it easier for foreign investors such as central banks, sovereign wealth funds, university funds, pension funds etc. to invest in India Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) have been defined by classifying investments with a stake of 10% or less in a company to be treated as FII and investment over more than 10% stake to be treated as FDI FIIs to be allowed to participate in the exchange traded currency derivative segment to the extent of their Indian rupee exposure in India FIIs to be permitted to make investment in corporate bonds and Government securities as collateral to meet their margin requirements angel investor pools to be categorised as Category I AIF venture capital funds. SEBI to come out with policy guidelines in this respect small and medium enterprises, including start-up companies, to be permitted to list on the SME exchange without being required to make an initial public offer (IPO) in addition to the existing SME platform in which listing can be done through an IPO with the object of developing the debt market, stock exchanges will be allowed to introduce a dedicated debt segment on the exchange. Banks and primary dealers will be the proprietary trading members. In order to create a complete market, insurance companies, provident funds and pension funds will be permitted to trade directly in the debt segment with the approval of the sectoral regulator mutual fund distributors will be allowed to become members in the Mutual Fund segment of stock exchanges so that they can leverage the stock exchange network to improve their reach and distribution the list of eligible securities in which Pension Funds and Provident Funds may invest to be enlarged to include exchange traded funds, debt mutual funds and asset backed securities

6 Union Budget Impact on the Private Equity investments 6 Direct tax proposals Special provisions relating to tax on distributed income of domestic company for buy back of shares under the existing provisions of the Income Tax Act, 1961 (IT Act), income arising to shareholders on account of buy-back of shares is taxable as capital gains in their hands. Further more, consideration for buy-back has been excluded from the definition of dividend, even under the deeming provisions under section 2(22) of the IT Act and is accordingly not subject to any dividend distribution tax in hands of the company with a view to shift the incidence of tax on the company, Finance Bill 2013 proposes a levy a 20% on distribution of income by an unlisted company to its shareholders through buy back of shares the tax paid under this chapter would be a final tax further, such income received from the company would be exempt in the hands of the shareholders under section 10(34A) of the IT Act the proposed amendment would take effect from 1 June 2013 The rationale for this amendment is that unlisted companies have been seen to be resorting to buy-back of shares instead of payment of dividend in order to avoid incidence of dividend distribution tax, particularly where capital gains to shareholders on account of such buy back are either not chargeable to tax, like in case of investments from Mauritius, or are taxable at a lower rate. This provision is targeted to plug this loophole. 'Pass through' status to Venture Capital Funds (VCF) registered under the AIF Regulations Section 115U of the IT Act provides that income accruing or arising or received by a person out of investment made in a Venture Capital Company (VCC) or VCF shall be taxable in the same manner as if the person had made direct investment in the Venture Capital Undertaking (VCU), thereby providing a tax pass through status to VCC/VCFs. In view of the above, the existing provisions contained in Section 10(23FB) of the IT Act provides that any income of venture capital company or venture capital fund set up to raise funds for investment in a venture capital company shall be exempt from tax provided the conditions specified in SEBI (Venture Capital Fund) Regulations, 1996 (VCF regulations) is fulfilled. The SEBI (Alternative Investment Funds) Regulations, 2012 (AIF regulations) have replaced the SEBI VCF Regulations from 21 May In order to extend the pass through benefit to similar venture capital funds registered under the AIF regulations there has been a change in the definition of VCU, VCF and VCC to include those registered under the new regulations. The amended definitions shall take effect retrospectively from FY

7 Union Budget Impact on the Private Equity investments 7 Direct tax proposals General Anti-Avoidance Rule (GAAR) existing GAAR provisions (under Chapter X-A of the IT Act) are proposed to be amended to give effect to the major recommendations by Expert Committee headed by Dr. Parthasarathi Shome salient features of the amended provisions are: GAAR provisions to take effect from 01 April 2016 impermissible avoidance arrangement to include only arrangements the main purpose of which is to obtain a tax benefit (subject to other prescribed conditions) as against the present provision which includes any arrangement the main purpose or one of the main purposes of which is to obtain a tax benefit as an impermissible avoidance arrangement following may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not: the period or time for which the arrangement (including operations therein) exists the fact of payment of taxes, directly or indirectly, under the arrangement the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement an arrangement shall be deemed to be lacking commercial substance, if it does not have a significant effect upon the business risks, or net cash flows of any party to the arrangement constitution of Approving Panel prescribed, to consist of 3 members Amendments proposed are a welcome move in light of the Expert Committee s recommendation. However, the following key recommendations have not been given effect: to ensure that the same income is not taxed twice in the hands of same tax payer in same/ different assessment years grandfathering of investments made before 30 August 2010 Fixation of monetary threshold of Rs 3 Crore of tax benefit in order to invoke GAAR GAAR to be restricted to the tax consequence of that part which is impermissible and not to the whole arrangement on one hand it is proposed that the directions of Approval Panel are binding both on assessee and the tax authorities, at the same time order passed in pursuance of GAAR has been appealable under made Section 253 of the IT Act the Appeal perhaps would lie on issues other than the direction of Approval Panel, otherwise this would lead to conflicting situation. However, further clarification on this is desired

8 Union Budget Impact on the Private Equity investments 8 Direct tax proposals Increase in rate of withholding tax for payments of royalty or fees for technical services (FTS) Tax rate for a non-resident taxpayer with respect to income by way of royalty or FTS proposed to be increased from 10% to 25%. Currently, India has tax treaties with 84 countries, majority of which provide for withholding tax on royalty or FTS at rates ranging from 10% to 25%, whereas the tax rate under the IT Act is 10%. This resulted in taxation at a lower rate of 10% in some cases, even where the tax treaty provided for a higher rate. Tax residency certificate (TRC) under the existing provisions of the IT Act, a non resident person / a foreign company is required to obtain a TRC from the tax authorities in their country of residence/incorporation so as to avail the benefits of the double taxation avoidance agreements (DTAA) entered into by India with other countries the Finance Bill 2013 proposes to amend Section 90 and 90A to provide that submission of TRC containing prescribed particulars is a necessary but not a sufficient condition for claiming the benefits of the DTAA the proposed amendment will take effect retrospectively from AY (FY ) The proposed increase in tax rate for royalty or FTS is expected to correct this irregularity in the IT Act. This would result in additional withholding of 5% to 10% in cases where the existing tax treaties provide for rates higher than 10% (e.g. USA, UK, Denmark, Australia, Canada etc.).

9 Union Budget Impact on the Private Equity investments A comprehensive suite of tax and regulatory services 9 The changes in the tax and regulatory environment constantly challenge large and growing businesses, particularly those operating internationally. How your business meets this challenge can have a significant impact on your bottom line. The more your business grows, the more complex tax requirements can become. Grant Thornton can help you minimise your tax exposure and highlight the risks presented by constantly evolving and increasingly complex legislation. Drawing on our knowledge and understanding of tax regimes in India and around the world, we offer timely information and independent advice. Through legitimate planning, we consider issues that arise within specific types of tax, as well as the tax implications of a new project, or a change to the business. We work with you to develop bespoke tax-planning strategies suitable for your specific business structure, and our solution-oriented approach is designed to help you understand and minimise the tax challenges your business faces. About Grant Thornton India LLP Grant Thornton India LLP is a member firm within Grant Thornton International Ltd. The firm is one of the oldest and most prestigious accountancy firms in the country. Today, it has grown to be one of the largest accountancy and advisory firms in India with over 1,200 professional staff in New Delhi, Bangalore, Chandigarh, Chennai, Gurgaon, Hyderabad, Kolkata, Mumbai and Pune, and affiliate arrangements in most of the major towns and cities across the country. As a member firm within Grant Thornton International, the firm has access to member and correspondent firms in over 120 countries, offering our clients specialist local knowledge supported by international expertise and methodologies.

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