20 October 2015 Indian Venture Capital/ Private Equity Industry – Introduction & Suggested Reform Measures Meeting with: Dr. Hasmukh Adhia Revenue Secretary, Ministry of Finance, Government of India

20 October 2015 Executive Summary  The Venture Capital/ Private Equity (VCPE) industry has contributed substantially to India’s growth story... –VCPE has invested more than USD100 billion (INR 6 lakh crores+ in today’s terms) since 2001 –VCPE is accepted by local businesses as long term patient capital and VCPE investors are viewed as partners instead of pure financing options –India allocations currently represent a very small proportion of fund allocations of global VCPE investors and there is scope for multiplying the investments over the next decade ... however there are a few challenges being faced by the VCPE industry. The reforms process which was initiated in the recent budget needs to be carried forward to realize the industry’s full potential and move towards making a greater impact –Complex web of tax laws resulting in uncertainty of taxes applicable to long term VCPE investors (key issues being safe harbour provisions, disadvantageous tax position vs. public market investments, residual issues in alternative investment funds (AIF) taxation, clarity on indirect transfers) –Fund Managers are currently shying away from operating in India which has resulted in fund managers operating from offshore jurisdictions such as Singapore and Mauritius –Certainty and consistency in tax laws has the potential of immediately switching substantial foreign investment commitment presently raised by funds domiciled in offshore jurisdictions as commitments to Indian VCFs/ AIFs thereby giving an immediate boost to the sector Now is an opportune time for giving a major reforms push to the VCPE industry to attract more investments in the country Slide No. 2

20 October 2015 VCPE investments over last 10 years India can attract significant VCPE capital (INR 1 lakh crores+) on an annual basis if reform measures for the industry are implemented  VCPE funds have invested over INR 4.9* Lakhs Cr in Indian companies in the past 10 years, averaging about INR 50,000 Cr investments a year;  It is a very important source of steady long-term risk capital for small, emerging and growing businesses in India.  In VCPE sector, investment made by foreign firms exceed that of domestic firms in the ratio of 4:1 * Excluding RE/Infra and Angel/Seed investments; Source: VCCEdge, TCF Analysis Slide No. 3

20 October 2015 Since 2001, VCPE has invested more than USD 103 bn in more than 3,100 companies in India Even during the 2008 downturn, capital inflows from VCPE were more reliable than those from other sources of equity funding, including foreign institutional investment and equity issuances. Stronger job creation record ► In the five years following initial investment, companies backed by private equity grew direct employment faster (~9% CAGR) than companies not backed by private equity in a comparable period (~3%) ► VCPE firms select companies with high growth potential and work with them to exercise and expand their corporate capabilities to exploit this potential Superior financial performance Assist in global foray & greater export earnings Better governance & higher tax collections ► In the two years following initial investment, revenues of private equity portfolio companies grew 28 per cent more than revenues of companies not backed by private equity in a comparable period. In addition, profits were stronger. ► 80 % of the companies in a McKinsey study participated in their first cross-border merger and acquisition (M&A) only after receiving private equity funding ► VCPE investors tend to bring their expertise in international markets to their portfolio companies and helps in easing access to foreign customers in an effort to drive export growth ► Companies backed by VCPE generally improve their corporate governance by, for example, introducing independent committees for audit and compensation and enhanced board oversight ► Private companies with revenues less than INR 7.5 billion linked to VCPE contributed about 18.8 % of the corporate tax receipts for all companies of a similar size, more than their 13.1 % share of total revenue within this group McKinsey Study Slide No. 4

20 October 2015 Budget 2015 was a path breaking initiative for VCPE and laid the intent to support reforms In a globalised world where multiple economies compete for inbound capital, the success of VCPE investments heavily depends on tax policy reforms/ measures taken to support the industry Several announcements made by the Government in the Union Budget provide an enormous fillip to offshore and domestic VCPE funds ► With suitable enhancements, the initiatives taken in Budget 2015 will provide a compelling vision that will encourage (i) the flow of domestic savings and overseas capital into VCPE assets and (ii) strengthen the onshore fund management industry ► The enhancements to the tax provisions, which can be introduced by way of notifications/ clarifications have been summarised in the next slide and detailed in the annexure Slide No. 5

20 October 2015 Ongoing reform initiatives  The Securities and Exchange Board of India (SEBI) has formed an ‘Alternative Investment Policy Advisory Committee’ (AIPAC) to advise on issues related to the further development of the alternative investment and start-up ecosystem in India  Extensive recommendations have been made by the sub-committees of AIPAC on various issues affecting the alternative investments  As a next step, the tax recommendations proposed to the AIPAC will be shared with the Central Board of Direct taxes (CBDT) during the course of workshop to be attended by CBDT and SEBI. IVCA has been at the forefront in representing the PE industry at various forums. Slide No. 6

20 October 2015 A few pending reform measures can help forge a resurgent path for the VCPE industry  Make taxation certain and consistent for ease of doing business without compromises on tax revenue While recent steps of the present government have remedied some of the key issues faced by such funds, it is important to address few other issues to bring complete “clarity”, “certainty”, “consistency” in the tax policies (3C’s) without any loss to the government treasury. Such clarifications will play a significant role in creation of conducive business environment which could lead to increased capital inflows in the economy. Based on the above principle, we recommend the following propositions: 1.Exempt income of AIFs and exempt investors in AIFs [under the Act or Double Tax Avoidance Agreement (DTAA)] should not be subject to tax withholding of 10% 2.Investment gains of AIFs should be deemed to be ‘capital gains’ 3.Losses incurred by AIF should be available for set-off to its investors 4.Tax pass-through rules applicable to ‘investment funds’ in the Act should be extended to close ended Category III AIFs 5.Exemption to AIFs on receipt of shares of closely held companies at a value lower than fair market value (FMV)/ Exemption to AIFs (other than VCFs) on issue of shares at a value higher than FMV 6.Indirect transfer provisions should be clarified to be not applicable to the distribution of the income by eligible investment funds (EIFs) and gains from transfer of share or interest of the holding companies above EIFs Slide No. 7

20 October 2015 A few pending reform measures can help forge a resurgent path for the VCPE industry  “PARITY” in the Indian tax policy for all types of investments Given the long term and stable nature of Private Equity & Venture Capital, the least that the Government can enunciate is parity in the taxation of unlisted Private Equity investments and investment in listed equity shares which investors can sell and exit at short notice. The capital inflows, invested in listed equity shares, from Foreign Portfolio Investors (FPI) are relatively volatile. Given the high risk and relatively illiquid nature of capital from the venture capital and private equity industry, it needs to be incentivised or atleast be taxed at par with public market investments. Based on the above principle, we recommend the following propositions:  Provide a tax neutral incentive rate to attract capital for Indian fund management -Given that the AIFs/ EIFs primarily undertake strategic investments, it is recommended to have a uniform tax treatment on capital gains from sale of the securities of the company irrespective of whether these securities are listed or unlisted -Further, it is recommended to reduce the holding period of investments in unlisted securities to 12 months for long-term characterisation Slide No. 8

20 October 2015 A few pending reform measures can help forge a resurgent path for the VCPE industry  Promoting onshore management for offshore funds A suitable safe harbour framework provides a significant opportunity to fund managers to relocate to India, make their life simple, easy, safe and sustainable apart from their contribution to enhancing the Indian financial ecosystem by generating employment and contributing to additional taxes. Currently, the safe harbour rules are defined keeping FPIs in perspective. Tweaking safe harbour norms focused on VCPE funds in the following areas could pave the way for gradual onshoring of offshore fund managers. Based on above principle, we recommend the following propositions: 1.Investor diversification related conditions should be diluted by providing the following clarifications: -The fund has minimum of 10 members who are directly or indirectly, not connected persons -Look through approach to be applied to determine number of members -Foreign Venture Capital Investors/ FPI should automatically qualify -Diversification conditions should be relaxed if majority of the investors are institutional investors -A simplified definition of “Broad Based Fund” to be incorporated as per the FPI Regulations into the safe harbour provisions itself. Any fund qualifying as a Broad Based Fund, should be eligible for the safe harbour provisions 2.The restriction on investing not more than 20% of a EIF’s corpus in any entity should be removed/ applicable only at the first instance and not to follow-on round 3.EIFs should not be regarded as carrying on business in India merely because of the activities they perform to protect their shareholding in investee entities 4.Time bound approval mechanism can be provided for specific funds to be notified as EIFs based on a qualitative review – this approval should be valid for the life of the fund 5.Arm’s length fund management compensation should not impact the fund’s qualification as an eligible investment fund Slide No. 9

20 October 2015 A few pending reform measures can help forge a resurgent path for the VCPE industry  India’s “NEXT PRACTICES” Besides the highlighted tax issues for VCPE industry till now, there are a set of tax issues along with the recommended reforms, which, if implemented, will help India carve its way to a ‘developed country’. Based on this principle, we recommend the following propositions:  In line with the global practice, it is proposed that the individuals who satisfy the following conditions should be recognised as accredited investors:  Capable of identifying the potential investments and its underlying risks  Possess sufficient financial sophistication to take on the risks associated with the investment offerings and  Have a sound financial track record i.e. reported total income (including exempt income) exceeding Rs 50 lacs annually in immediately three assessment years preceding the assessment year in which the investment is proposed to be made  The Act should provide a deduction for expenses incurred by AIFs/ EIFs subject to a reasonable cap (say 3% per annum) and adjustments for exempt income  The Act should expressly provide an exemption for conversion of preference shares into equity shares  In determining holding period of equity shares in the context of investment in convertible preference shares/ debentures, the tax law should provide for inclusion of period of holding of convertible preference shares/ debentures (pre-conversion)  Service tax on fees charged to an AIF, to the extent the investors are foreign investors, should be exempt from service tax Slide No. 10

20 October 2015 Discussion Pages Slide No. 11

20 October 2015 VCPE is a more stable source of equity capital VCPE capital inflows has been relatively less volatile across economic cycles VCPE provided about 2x the capital raised from IPO in the last 5 years Slide No. 12

20 October 2015 VCPE backed companies are creating employment at rapid pace VCPE backed companies (sample of 85) saw employment increase at 12.5% (from 217,500 to 398,000) in 5 years compared to non-PE backed peers Slide No. 13

20 October 2015 VCPE backed companies contribute a disproportionate share of direct taxes VCPE backed companies, which form 2.9% of registered companies, contributed about double (5.5%) of India’s total corporate tax in FY13 Slide No. 14

20 October 2015 Thank You Slide No. 15