1. 1 3 December 2015 Pre-budget representation on taxation

2. 2 1.Introduction to Venture Capital and Private Equity 2.Objectives 3.Investments over the last 10 years 4.Impact on the Indian economy 5.Budget 2015 – a path breaking initiative 6.Principles underlying the recommendations 7.Core recommendations  Clarity on taxation of domestic/ foreign funds  Taxation parity with investments in public equity markets  Simplify the safe harbour provision  Adopt globally “BEST PRACTICES” Index

3. 3 Introduction to Venture Capital and Private Equity  Venture Capital and Private equity (VCPE) in India as an asset class has evolved significantly over the past two decades. Starting in the late 1990s, VCPE provided an alternative source of financing for local businesses accustomed to limited credit options from banks or turning to public equity markets to underwrite their growth ambitions  Today, the asset class is accepted more readily by Indian entrepreneurs as a source of strategic capital that can play a transformational role in the growth of their businesses by providing valuable long term, illiquid risk capital for start-ups to stand-up, to grow, to list on exchanges and to turn-around in difficult times assisting in job creation, technology innovation, formation of sustainable and well governed companies, nation-building infrastructure and housing for rising India VCPE has invested more than USD 100 billion since 2001

4. 4 Objectives  Enhance capital inflows in the VCPE asset class from Indian and foreign sources in following manner Pooling of funds from domestic investors which would provide access to VCPE asset class' higher returns Attract foreign capital into India-focused foreign funds, to participate in Alternative Investment Funds (AIFs), by having investment managers domiciled in India  While the presentation includes a set of tax and issue-specific recommendations, they add up to an integrated blueprint for the future architecture of the Indian tax system, rather than a series of one-off tax policy measures India can attract INR 3 lakh crores of capital annually which is about 3X of today, and 2% of the GDP, if the recommendations are implemented

5. 5 VCPE investments over the last 10 years VCPE funds have invested over INR 4.9 lakh crores in Indian companies in the past 10 years, averaging investment of about INR 50,000 crores 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

6. 6 Impact on the Indian economy Stronger job creation record Superior financial performance  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  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. Source: McKinsey Report on Indian Private Equity: Route to Resurgence – June 2015 Even during the 2008 downturn, capital inflows from VCPE were more reliable than those from other sources of equity funding (including Foreign Institutional investors)

7. 7 Assist in global foray & greater export earnings Better governance & higher tax collections  80 % of the companies in a McKinsey study participated in their first cross-border merger and acquisition 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 Impact on the Indian economy

8. 8 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 2015-16 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 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 AIPAC on various issues affecting alternative investments Budget 2015 was a path breaking initiative for VCPE and laid the intent to support reforms

9. 9 1. Ease of doing business A simple, clear, consistent tax regime would play a significant role in creation of conducive business environment leading to increased capital inflows in the economy and facilitate businesses for VCPE funds and their investors 2. Tax neutrality The recommendations have been proposed keeping in mind that there is no revenue loss to the government. In certain cases, there could be an immediate revenue loss to the government but the multiplier effect on the economy would significantly outweigh the tax revenue loss 3. Clarity, certainty and consistency in tax policy for alternative investments A certain level of clarity, certainty and consistency in tax policy for alternative investments is critical for investors and in turn impacts the funds' ability to attract capital 4. Road map for Next Practice for establishing parity in tax policy between alternative investments and public markets investments The disparity in taxation of investment in public markets vs alternative investments coupled with other factors acts as a strong deterrent for capital allocation to alternatives 5. International best practices In a globalised world, the success of alternative investments in the medium to long-term heavily depends on India’s tax policy for alternative investments remaining globally competitive Principles underlying the recommendations

10. 10  Make the tax pass through system work flawlessly in a simple manner with complete “clarity”, “certainty” and “consistency”, provide exemption to AIFs from section 56(2)(viia) and 56(2)(viib) of the Income-tax Act, 1961 (the Act) and clarify indirect transfer provisions for funds/ investors  Attract large amount of foreign capital into India-focused foreign funds by  providing a safe harbour to onshore managers of offshore funds  make FDI in AIF work efficiently  Given the high risk and relatively illiquid nature of capital from VCPE sector, it needs to at least be treated at par with volatile, short-term public market investments for taxation. We recommend the government adopt roadmap for AIF taxation based on STT framework.  India should at least be the global best practice and be followed by the world for “NEXT PRACTICES” Core Recommendations

11. 11  Make the tax pass through system introduced work flawlessly in a simple manner with complete “clarity”, “certainty” and “consistency”, provide exemption to AIFs from section 56(2)(viia) and 56(2)(viib) of the Act and clarify indirect transfer provisions for funds/ investors It is important to make the Indian tax code simple with complete “clarity”, “certainty”, “consistency” without any loss to the government treasury. Such tax code will play a significant role in creation of conducive business environment which could lead to increased capital inflows in the economy. Based on this principle, we have discussed the following issues in detail in subsequent slides: 1. Make the concept of tax pass-through for AIFs effective − Withholding on income of AIFs − Characterisation of income of AIF/ eligible investment fund (EIFs) − Tax pass-through for losses of AIFs to the investors − Tax pass-through for income from Category III AIFs 2. Exemption from section 56(2)(viia) and 56(2)(viib) of the Act 3. Clarify indirect transfer provisions for funds/ investors Core Recommendations

12. 12  Attract large amount of foreign capital into India-focused foreign funds by providing a safe harbour to onshore managers of offshore funds A suitable safe harbour framework would encourage the fund managers to domicile in 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. Tweaking safe harbour norms in the following areas could pave the way for gradual onshoring of managers of offshore funds. Based on this principle, we have discussed the following issues in detail in subsequent slides: 1. Investor diversification conditions 2. Investment diversification condition 3. Conditions on control or management of any business in/ from India 4. Simplification of procedure to avail safe harbour 5. Condition on tax residence in India 6. Condition on remuneration of fund manager being at arm’s length 7. Annual reporting requirement Core Recommendations

13. 13  Given the high risk and relatively illiquid nature of capital from VCPE sector, it needs to at least be treated at par with volatile, short-term public market investments for taxation. A clear roadmap for tax parity with public market collective investments is critical Between 2001 and 2014, the VCPE sector has invested more than US$ 100 billion in India; majority of these investments have provided primary capital to Indian portfolio companies for their growth aspirations. The companies that have been backed by the industry have a differentiated track record on job creation, corporate governance, tax compliance, etc. In contrast, the capital inflows into public markets are relatively volatile. Therefore, the high risk and relatively illiquid nature of VCPE capital should at least be taxed at par with public market investments. Based on this principle, we have discussed an approach for a Securities Transaction Tax based taxation approach for AIFs Core Recommendations

14. 14  India should at least be the global best practice and be followed by the world for “NEXT PRACTICES” Besides the highlighted tax issues for VCPE sector 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’. These issues/ areas have been listed below and explained in detail in subsequent slides: 1. Deduction for investments in Angel funds/ social venture funds 2. Taxation rules for listed close-ended AIFs 3. Deduction/ allowance for AIF expenses 4. Taxation of gains from sale of shares obtained under an Employee Stock Option Plan (ESOPs) as salary or perquisite 5. Tax rate on long term capital gains on from transfer of shares of private limited companies 6. Taxation of convertible preference shares/ debentures 7. Investments by charitable and religious trusts in AIFs 8. Taxation on conversion/ transfer of Global Depository Receipts issued against permitted securities (other than listed shares) 9. Service tax in respect of capital raised by an AIF from overseas investors Core Recommendations

15. 15 Make the tax pass through system work flawlessly in a simple manner with complete “clarity”, “certainty” and “consistency”, provide exemption to AIFs from section 56(2)(viia) and 56(2)(viib) of the Act and clarify indirect transfer provisions for funds/ investors

16. 16 Issue 1 – Withholding on income of AIFs  Tax withholding (TDS) presently applies to distribution/ accrual of:  income exempt under the Act  income to exempt investors (pension funds, provident funds)  Income taxable at rates in force [includes rates as per applicable Double Tax Avoidance Agreement (DTAA)]  Given that foreign investments have been recently permitted in AIFs under the automatic route (subject to conditions), the need to clarify TDS treatment on income to non-residents is critical  TDS subjects investors in AIFs to needless compliance burden of claiming refund for taxes deducted (where their tax liability is minimal or ‘nil’)  Absence of mechanism to obtain nil or lower withholding tax certificate under section 197 of the Act Recommendation  Resident investors  No tax withholding on income exempt under the Act or income credited/ distributed to exempt investors (pension funds, provident funds)  Tax to be deducted in accordance with the provisions of Chapter XVII-B of the Act for the type of income credited/ distributed to the investors  Non-resident investors  Tax withholding only on the taxable portion of income  No tax return filing if the income has suffered withholding tax at the applicable rates  TDS on accrual/ distribution of income to non-resident investors to be in accordance with the tax rates under an applicable DTAA.  Subject to conditions in section 197, mechanism to obtain a NIL/ reduced tax withholding certificate under section 197 to be extended to section 194LBB. Make the concept of tax pass-through for AIFs effective

17. 17 Sr. NoParticulars Net income basis (INR in crores) 1Initial investment1000 2Total realisation after 6 years1700 3 Investment break up a) Investment in listed companies b) Investment in unlisted companies c) Investment in unlisted companies 400 300 300 4 Realisation on exits a) from listed exits of 3(a) b) from exits of 3(b) c) from exits of 3(c) d) Total 750 650 300 1700 5 Book Gains from exits a) from 3(a) b) from 3(b) c) from 3(c) d) Total 350 350 0 700 6 Tax withholding under section 194LBB @ 10 percent on 5(d)70 7 Capital Gains as per Act a) from 3(a) b) from 3(b) considering indexed cost 50% c) from 3(c) considering indexed cost 50% d) net taxable income Exempt 200 (150) 50 8 Actual tax as per Income Tax @20%10 9 Tax refund (6) – (8) being excess deduction60 Make the concept of tax pass-through for AIFs effective – An illustration

18. 18 Issue 2 - Characterisation of income of AIF/ EIFs*  The primary objective of an AIFs/ EIFs is to make investments and provide much needed capital to entrepreneurs. AIFs/ EIFs predominantly invest in unlisted investee entities with a medium to long-term investment horizon.  In case of AIFs, the ability to borrow funds is severely restricted under the SEBI (AIF) Regulations. Given the intent of SEBI (AIF) Regulations is not to allow carrying on of business, there is no need to provide for taxation of business income at AIF level Recommendation  The provisions relating to taxability of business income earned by AIF at the AIF level should be deleted  Income earned by AIFs/ EIFs should be taxable under the head ‘capital gains’ or ‘income from other sources’ and not ‘business income ’ *The expression “eligible investment fund” shall have the same meaning assigned to it in section 9A(3) of the Act Make the concept of tax pass-through for AIFs effective

19. 19 Issue 3 – Tax pass-through for losses of AIFs to the investors  Where an AIF incurs net losses on its investments towards the end of its lifecycle or has unabsorbed losses which cannot be utilised, such losses would lapse in the absence of an express provision  In such case, the investors end up paying tax on income higher than the “real” taxable income from their investment in the AIF making the AIF investment option unattractive Recommendation  As such, a tax pass-through regime should not distinguish between gains and losses  Therefore, similar to the tax pass-through for net income, net losses incurred by all the categories of AIFs under any head of income, should also be allowed to be passed on to the investors annually Make the concept of tax pass-through for AIFs effective

20. 20 Issue 4 - Tax pass-through for income from Category III AIFs  The Finance Act 2015 (FA 2015) introduced a special tax regime to provide a ‘pass-through’ tax status to Category I and II AIFs for the income earned (except for business income). However, the ‘pass-through’ tax status has not been accorded to Category III AIFs Recommendation  Extend the tax pass-through rules for investment funds in the Act to Category III AIFs  There would be no revenue loss as the investor would be taxed on income/gains in a like manner and same extent basis Make the concept of tax pass-through for AIFs effective

21. 21 Issue 5 – Exemption from section 56(2)(viia)* and 56(2)(viib)** of the Act  Since the SEBI (Venture Capital Funds) Regulations, 1996 have been superseded by the SEBI (AIF) Regulations, the exemption from section 56(2)(viib) to VCFs/ AIF (VCF sub-category) should be extended to Category I AIFs and Category II AIFs. Further, investments by such AIFs and also EIFs, being monitored by SEBI and RBI respectively should be exempt from the provisions of section 56(2)(viia) of the Act  AIFs/ EIFs, being institutional investors, hold a fiduciary responsibility to invest in investee companies on an arm’s length basis Recommendation  Category I and II AIFs, EIFs and their investee companies should be exempted from the rigor of sections 56(2)(viia) and 56(2)(viib) of the Act *Section 56(2)(viia) of the Act provides that where shares are purchased at a value lower than fair market value of a closely-held company, then the difference is taxed in the hands of the purchaser. **Section 56(2)(viib) of the Act provides that where a closely-held company issues shares at a consideration which exceeds the fair market value of such company, then the difference is taxed as income in the hands of the issuing company. Pricing for acquisition/ subscription of securities

22. 22 Issue 6 – Clarify indirect transfer provisions for funds/ investors  Gains from an offshore vehicle wherein the Indian assets represent at least 50% of the value of all the assets is subject to tax. India-centric offshore funds by design have more than 50% Indian assets and therefore are subject to ambiguity on taxation  In multi-layered structure, the gains can be subject to indirect transfer tax at multiple levels  Globally, there is a practice of providing liquidity to limited partnerships (LPs) by facilitating secondary transfers (for example - LP buying stake of other LP in a fund which has more than 50% Indian assets) Recommendation  Indirect transfer provisions should be clarified to be not applicable to gains from transfer of share or interest of the holding companies/entities above EIFs investing in India Indirect Transfer

23. 23 Attract significant flows of foreign capital into India-focused foreign funds by providing a safe harbour to onshore managers of those funds.

24. 24 Issue 1 – Investor diversification conditions  Benefits under the new safe harbour provisions are available only upon satisfying certain stringent conditions related to investor diversification which are impractical to comply  The following are illustrative situations of providing good case for management of EIFs in India, but where the diversification of investor base may not be relevant:  Investment in a Fund by a small set of investors with relatively large pools of capital  Global proprietary funds of development and other financial institutions  Diversification may be achieved over multiple fund closings but the asset management has to start immediately from the first closing  New fund managers looking at raising commitments may be able to achieve diversification once they have established a reasonable track record  Raising funds from investors in jurisdictions having regulatory restrictions in marketing and distribution of financial products Promoting onshore management for offshore funds

25. 25 Recommendations  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 Promoting onshore management for offshore funds

26. 26 Issue 2 - Investment related diversification condition  Investment related diversification conditions restrict the ability of the funds to make significant minority investments (say more than 20 per cent) or make controlled acquisitions  Furthermore, it restricts ability of the funds to set-up offshore subsidiaries which may be required to ring fence the investment risk of a specific investment in India or to get a co-investor for a specific investment Recommendation  The restriction on investing not more than 20% of a EIF’s corpus in any entity should be removed  Alternatively,  Investment by a fund in an entity should not exceed 20% of its corpus should apply only at the first instance and not to follow-on rounds  Corpus of a new fund should be determined 24 months from the date of launch of the fund  The term ‘corpus’ should be interpreted to mean ‘commitments raised’ rather than funds received and this definition should apply for the entire fund life including in its winding down phase Promoting onshore management for offshore funds

27. 27 Issue 3 – Conditions on control or management of any business in India or from India  At times, offshore private equity funds (especially buyout funds) acquire a controlling stake in the investee companies. In such cases, representatives of the fund shall be extensively involved in the oversight of the portfolio companies business  In other cases also, where the fund has acquired a minority stake, the fund may have minority interest protection rights which could be viewed as resulting in ‘control’ over the business of the investee company in India Recommendation  It should be clarified that the EIFs shall not be regarded as carrying on business in India merely because of the activities they perform to protect their shareholding in investee entities. Promoting onshore management for offshore funds

28. 28 Simplification of procedure to avail safe harbour  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  This will eliminate uncertainty of having to meet the eligibility criteria year on year and provide much needed comfort to fund managers Promoting onshore management for offshore funds

29. 29 Issue 4 – Condition on tax residence in India  There are many instances where a fund may not qualify as a tax resident of a country on account of domestic tax laws and hence do not avail tax treaty benefits  Removal of the trigger of ‘residence’ should not impact India’s ability to collect required information under the applicable tax treaty / information exchange agreements Recommendation  The requirement of the fund to be a “tax resident” of a foreign country should be changed to a requirement of fund being “established” or “set- up” or “incorporated” or “registered” of such country so long as India as a Tax Information Exchange agreement with such country Promoting onshore management for offshore funds

30. 30 Issue 5 – Condition on remuneration of fund manager being at arm’s length  Ordinarily where the fund and the fund manager are unrelated or unconnected, there is no reason to believe that the fund management fees will not be at arm’s length  In cases where they are related persons (associated enterprises), the payment of management fees to the fund manager has to be at arm’s length  Determination of fees at arm’s length will involve a lot of subjectivity (demand and supply, experience and track record of the fund manager, investment strategy and size of the fund) and that the tax authorities having a different view cannot be ruled out Recommendation  The condition of fund management fees to be at arm’s length should not impact the fund’s eligibility to avail benefit under the safe harbour norms and therefore, should be deleted Promoting onshore management for offshore funds

31. 31 Issue 6 – Annual reporting requirement  Every fund is required to furnish a statement containing information relating to the fulfilment of the safe harbour conditions and other relevant information, within 90 days from the end of the financial year  Further, failure to furnish the aforesaid statement within the above timeline would result in a penalty of Rs 500,000 Recommendation  It is important to clarify that non-compliance (i.e. if the statement is not furnished within 90 days) should not result in denial of the safe harbour Promoting onshore management for offshore funds

32. 32  The RBI notification permitting foreign investment in AIFs reflects the ‘Make in India’ initiative for the fund management industry  Substantial benefits have been offered for an AIF that is sponsored / managed by Indian resident citizen or entities under their control  Few minor tweaks could attract substantial capital through this investment route Recommendation  Permit Indian controlled and managed Limited Liability Partnerships (LLPs) to act as sponsors/ managers to AIFs  Manner of determining ownership/ control of LLPs has now been defined  Permit investment by Non resident Indians in AIFs on a non repatriation basis through appropriate amendments in the Foreign Exchange Management Act, 1999  TDS on accrual/ distribution of income to non-resident investors in AIFs to be in accordance with DTAA tax rates (refer earlier slide)  Relax Indian tax compliance obligations for non resident investors in AIFs where tax has been fully discharged through TDS FDI in AIFs

33. 33 Given the high risk and relatively illiquid nature of capital from VCPE sector, it needs to at least be treated at par with public market investments for taxation. We recommend the government adopt roadmap for AIF taxation based on STT framework.

34. 34  Securities Transaction Tax (STT) was introduced in 2004 to:  replace the long term capital gains tax on securities traded on the floor of the stock exchange  shore up revenue from stock transactions and to create a level playing field for all participants in the stock market  simplify the tax treatment on transaction in securities leading to a significant reduction in litigation  As a long-term approach to align taxation of AIFs and other forms of collective investment vehicles, an STT approach may be considered. This approach would  Eliminate tax arbitrage and hence, attract more capital in AIFs  Simplify tax administration of AIFs and reduce revenue compliance gaps  Ease of operations – pave the way for VCPE funds to domicile in India  Discourage ‘treaty shopping’ – development of local financial hubs Recommendation  Introduce STT at an appropriate rate on all distributions (gross) of AIFs, investment, short- term gains and other income and eliminate any withholding of tax. After STT, income from AIFs should be tax free to investors  VCPE funds have a complete audit trail. The audit trail and full information on investments/distributions to be provided to tax authorities Why STT approach for AIFs?

35. 35 Tax collected if STT was levied on VCPE investments (Projected taxes collected over a 15 year period) Assumptions: 1. USD 15 billion PEVC investments per year (same as in 2015) 2. The fund will hold the investment for 5 years and divest it after. 3. An average multiple of 1.7x on realization of exit 4. STT is levied both during investment and distribution 5. STT on short term gains is at 1.0% (gross); assumed 10% of total distributions STT on investment0.25% STT on distribution0.25% STT on short term capital gains1.00% Capital Invested per year(USD million) as per actuals for FY201515,000 Average Holding period for an Investment (years)5 Average Return on Investment170% (USD million)STT on InvestmentSTT on DistributionTotal Tax collected Year 13883120 Year 23883120 Year 33883120 Year 43883120 Year 53883120 Year 63883120 Year 73883120 Year 83883120 Year 93883120 Year 103883120 Year 113883120 Year 123883120 Year 133883120 Year 143883120 Year 153883120 Total tax1806 Illustration – Levy of STT on investments and distributions

36. 36  Currently no taxes are being paid by foreign investors on account of their investment through DTAA jurisdiction. Even when taxes are being paid, there is a limited amount being collected due to indexation, loss-setoffs and other exemptions being claimed. The current tax regime is also not very well understood by foreign investors and has led to numerous litigations with tax authorities.  To facilitate the pooling of foreign funds in India, foreign investors should be provided simple straight-forward tax laws that they are comfortable with.  If STT is implemented and Withholding Taxes are removed, tax authorities can directly collect a significant amount of taxes on the investments/distributions made by AIFs.  STT approach will reduce tax disputes and enable smooth collection of taxes.  Post STT, distributions are tax free to LPs.  India can significantly move up in World Bank Group rating on “Ease of Paying Taxes” (current ranking is 156 out of 189 economies). Impact – Levy of STT STT will be a game-changer towards facilitating pooling of capital in India

37. 37 India should at least be the global best practice and be followed by the world for “NEXT PRACTICES”

38. 38  Many start-ups require finance in the initial years to run the business and grow. Angel funds/ social venture funds not only provide finance but also mentor and nurture these businesses  Thus, recognition and promotion of early stage investors in Angel funds/ social venture funds and providing a conducive environment will encourage them to channelise more funds to the Indian entrepreneurs while delivering social impact to the world Recommendation  Investors in SEBI regulated angel funds/ social venture funds should be provided an incentive in form of a tax deduction of up to 50% of the investment amount Deduction for investment in Angel funds/social venture funds

39. 39 Issue 1 – Taxation of gains from sale of ESOPs as salary or perquisite  In the case of ESOPs, the employee is subject to tax at time of exercise of option – i.e. this tax is payable immediately even if the employee has not sold the share in that tax period. The magnitude of the tax is calculated on the notional gain between the acquisition price of the share (option strike price) and the fair market value (FMV) at the time of exercise.  Secondly, the nature of such gains is considered as salary or perquisite. This means that the employee may be payable for ordinary income tax [30% (excluding surcharge and education cess), calculated as per the marginal income tax rate] for the notional gains calculated above. Recommendation  Tax incidence should arise in the year of the sale of shares (not the year of exercise of the option)  Profit made on sale of shares should be treated as capital gains (vs. the treatment as a portion of the gains as salary or perquisite) Taxation of ESOPs

40. 40 Issue 2 – Tax rate on long term capital gains from transfer of shares of private limited companies  Section 112(1)(c) of the Act provides a concessional tax rate of 10% on long term capital gains earned from transfer of unlisted securities in the hands of the non- residents  However, the manner in which the term ‘unlisted securities’ has been defined in the Act leads to the unintentional consequence of the 10% concessional tax rate not being applicable to long-term gains on transfer of shares of private limited companies  Given that a significant portion of investments by VCPE funds in India are in private limited companies, the recommendation will ensure that the intended beneficiaries actually benefit from the tax provisions Recommendation  Amend the definition of the term ‘securities’ in Explanation (a) to section 112(1) of the Act to include shares of private limited companies Tax rate on long term capital gains

41. 41 Issue 3 – Taxation on convertible preference shares  Currently, there is no specific exemption for conversion of preference shares into equity shares from ‘transfer’ under the Act  Based on a Circular dated 12 May 1964 and the provision in tax law for considering cost of equity shares (post conversion) as cost of preference shares pre-conversion at the time of transfer of equity shares, conversion of preference shares to equity shares should not amount to ‘transfer’  The Act exempts any transfer by way of conversion of bonds or debenture of a company into shares from tax  The FA 2015 amended the definition of a short term capital asset to provide a higher holding period of more than 36 months for unlisted securities from the earlier 12 month period leading to investor discomfort Recommendation  To provide certainty and mitigate litigation risk, it is recommended to 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 preference shares, the tax law should provide for inclusion of period of holding of preference shares (pre-conversion) Taxation on convertible preference shares

42. 42 Issue 4  Charitable and religious trusts have been in existence in India for many decades. These are established for several purposes including building hospitals, educational institutions and the promotion of various social causes. These institutions are regulated under a variety of laws. Prudent cash flow and expenditure management of these organizations requires investing in a diversified set of assets.  Similar organizations in other countries invest a portion of their assets in VCPE industry. For example, the respected Yale Endowment has over a 30 per cent asset allocation to VCPE investments.  Charitable Trusts have long term funds for which AIFs are well matched. Recommendation  AIFs should be an eligible asset for investment by charitable and religious trusts.  Amend section 11(5) of the Act and Rule 17C of the Income-tax Rules, 1962 to permit charitable trusts to invest in AIFs.  Charitable trusts with INR 25 crores or more of assets under management (AUM) should have an investment committee, a chief investment officer and an appropriate compliance function.  Section 80G - charitable and religious trusts should be permitted to invest up to 10% of their AUM in AIFs Charitable and Religious Trusts

43. 43 Issue 5 – Taxation on conversion/ transfer of Global Depository Receipts (GDR) issued against permitted securities (other than listed shares)  GDRs are permitted to be held and transferred by both residents and non- residents. GDRs are liquid because the supply and demand can be regulated by creating or cancelling GDR shares  In this context, it would be relevant to note that the Sahoo Committee report, pursuant to which the New Scheme was issued, recommended that the issue and transfer of (all) permitted GDRs prior to conversion into local securities should not be taxable in India Recommendation  A specific regime for taxation of GDRs issued under the new scheme should be introduced  Transfer of GDRs from one non-resident to another non-resident should not be regarded as a taxable transfer  Transfer by way of conversion of GDR into the underlying security should not be regarded as a taxable transfer Taxation of Global Depositary Receipts

44. 44 Issue 6  Presently, services provided by a fund manager to a Fund located in India are taxable, irrespective of the location of its investors  In this regard, AIFs have an inherent disadvantage vis-a-vis foreign VCPE funds who are able to procure their services in a manner as to qualify as “export” under the applicable rules Recommendation  Service tax on fees charged to an AIF, to the extent the investors are foreign investors, should be exempt from service tax  A reduction/ abatement in the service tax law for an AIF to the extent it has foreign investors would provide AIF a level playing field and thus encourage onshoring of the fund management industry Service tax in respect of funds raised by an AIF from overseas investors

45. 45 Thank You