Tax Insights
from India Tax & Regulatory Services
www.pwc.in
VCF does not lose exemption under section 10(23FB), even if some
investments made in mutual fund units etc.
November 2, 2019
In brief
Recently,1 the Mumbai bench of the Income-tax Appellate Tribunal (Tribunal) granted exemption under section 10(23FB) of the Income-tax Act, 1961 (Act) to a venture capital fund (VCF) on income from investments in venture capital undertakings (VCUs), where the VCF had, inter alia, temporarily deployed funds in units of mutual funds (MFs) and had invested in convertible debenture application money. The Tribunal held that the taxpayer is permitted by its trust deed as well as by the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 (VCF Regulations) to temporarily deploy funds in units of MFs and invest in convertible debenture application money. The Tribunal observed that the Certificate of Registration as a VCF continued to subsist during the period under consideration, which contradicted the assertion of the revenue authorities of a violation of the VCF Regulations.
In detail
Facts
The taxpayer is a trust established under the Indian Trust Act, 1882, in terms of a trust deed.
The settlor of the trust had identified investment opportunities in various sectors in India, such as real estate. In order to pool the resources and obtain finance from institutions and other investors for funding such investment opportunities, the taxpayer was established as a VCF and had obtained
registration under the VCF Regulations.
1 ITA No. 7472/ Mum/ 2017
During the year under consideration, the taxpayer earned the following income from investments in VCUs:
a. Long-term capital gains;
b. Dividend income; and c. Interest income.
This income was claimed as exempt under section 10(23FB) of the Act.
Further, until the taxpayer could actually deploy the funds in the targeted VCUs, for a temporary period, the funds were deployed in MFs and in bank fixed deposits.
The taxpayer had also invested in convertible
debenture application money.
The tax officer (TO) denied exemption under sections 10(23FB) and 10(35) of the Act on income earned, for the following reasons:
a. The taxpayer’s investments in the units of MFs and in convertible debenture application money do not qualify as
investments in VCUs;
thus, they are in violation of the taxpayer’s trust deed.
b. The above-mentioned investments are also in
Tax Insights
2 pwc
violation of the VCF Regulations.
The Commissioner of Income- tax (Appeals) [CIT(A)] upheld the TO’s order.
Aggrieved, the taxpayer filed an appeal before the Tribunal.
Issue before the Tribunal
Whether exemption under section 10(23FB) of the Act is available to the taxpayer?
Whether the CIT(A) erred in exceeding his jurisdiction in alleging that the appellant has violated the VCF Regulations to disallow the claim for exemption
under section 10(23FB) of the Act?
Taxpayer’s contentions
The taxpayer qualifies to be a VCF as mandated by section 10(23FB) of the Act, as it fulfils the following three conditions:
a. It is operating under a trust deed.
b. The trust deed is registered under the provisions of Registration Act, 1908.
c. The certificate of
registration granted under the VCF Regulations continues to subsist.
The TO could not assume the violation of VCF Regulations as long as the certificate of registration granted by
Securities and Exchange Board of India (SEBI) is not
withdrawn. Reliance was placed on a Supreme Court2 decision.
The investments in money market instruments, units of money market liquid MFs or other similar debt instruments
2 Gestetner Duplicators Private Limited v.
CIT [1979] 117 ITR 1 (SC)
were temporary in nature, and were permissible by the taxpayer’s trust deed.
In the context of deployment of temporary funds by VCFs, the SEBI issued a
communication3 under the SEBI (Informal Guidance) Scheme, 2003. The SEBI opined that it is permissible for VCFs to invest any un- invested portion of their investable funds in liquid MFs or bank deposits or such similar liquid assets until the deployment of funds as per the objectives of the VCF.
Without prejudice to the above discussion, if the contentions of the taxpayer are not accepted:
a. The income should not again be taxable in the hands of the VCF, as the investors had included the income from the taxpayer in their individual returns on a pass-through basis;
b. Alternatively, the benefit of taxes paid by the investors on the same income should be given to the taxpayer.
Revenue’s contentions
The taxpayer’s investments in the units of MFs and in convertible debenture application money do not qualify to be investments in VCUs; thus, they are in violation of the provisions of its trust deed.
Every VCF is obligated to abide by the VCF Regulations and it should carry out no activity other than that of the VCF. Investing in MFs and earning interest on convertible debenture application money constitute activities in
3 Dated 10 June, 2017
violation of VCF Regulations.
Tribunal’s ruling
With regard to taxability under section 10(23FB) of the Act
It is undisputed that the taxpayer is registered as a VCF under the VCF Regulations.
Hence, the taxpayer is eligible to stake its claim for
exemption under section 10(23FB) of the Act.
A conjoint reading of sections 10(23BF) and 115U of the Act reveals the intention of the legislature to accord a pass- through status to SEBI registered VCFs.
Any income of a VCF earned from investments in VCUs is exempt in the hands of the VCF [subject to conditions prescribed in section 10(23BF) of the Act]. Further, such income is taxable in the hands of the investors of the VCF, based on the methodology laid down in the provisions.
With regard to violation of the trust deed
As per its trust deed, the taxpayer is empowered to invest the available contributions awaiting investment or realised funds awaiting distribution in temporary investments (which would include the investments in question).
It is an industry and trade practice, whereby VCFs retain certain amounts, pending regular investments in VCUs for certain purposes, such as disbursement of expenses, distribution to investors, etc.
Until such time the funds are not utilised for the main purposes, the VCF make temporary investments to earn money.
Tax Insights
PwC Page 3
With regard to violation of VCF Regulations
The Tribunal also considered the communication3 issued by SEBI under the SEBI
(Informal Guidance) Scheme, 2003, with regard to VCF Regulations, whereby the temporary deployment of funds by a VCF in liquid MFs or bank deposits or other liquid assets of high quality, such as treasury bills, etc., were permissible.
The Certificate of Registration as a VCF, issued by the SEBI, continues to subsist during the period under consideration, which clearly contradicts the assertion of the Revenue authorities of a violation of VCF Regulations. Further, the SEBI has not undertaken or contemplated any adverse action for the violation of any VCF Regulations.
The VCF Regulations envisage investments in convertible debenture application money as being investments which can be said to be linked to investment in equity shares.
Conclusion
The taxpayer is entitled to exemption under section 10(23FB) of the Act for the following reasons:
a. The taxpayer is a VCF operating in terms of a trust deed registered under the provisions of the Registration Act, 1908.
b. It has been granted a Certificate of Registration as VCF by the SEBI, which continues to subsist, and the SEBI has not undertaken or contemplated any adverse action for the violation of any VCF Regulations.
c. The targeted investment in VCUs is within the purview of the VCF Regulations.
d. The taxpayer is permitted by its trust deed as well as by the VCF Regulations to temporarily deploy funds in units of MFs and invest in convertible debenture
application money.
The takeaways
The ruling comes when the Revenue authorities—recently concluded assessment
proceedings—where they have denied exemption under section 10(23FB) of the Act to certain SEBI-registered VCFs.
One of the most common reasons for the denial of exemption was investments by VCFs in MFs not being in accordance with the trust deed and violating the VCF Regulations.
Thus, the ruling should provide respite to taxpayers facing this problem. The Tribunal’s observation that a VCF is
permitted by the VCF Regulations to temporarily deploy funds in MF units and bank fixed deposits should be specifically relevant in this context.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
Tax Insights
For private circulation only
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwCPL, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of PwCPL, this publication may not be quoted in whole or in part or otherwise referred to in any documents.
© 2019 PricewaterhouseCoopers Private Limited. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers Private Limited (a limited liability company in India having Corporate Identity Number or CIN : U74140WB1983PTC036093), which is a member firm of PricewaterhouseCoopers International Limited (PwCIL), each member firm of which is a separate legal entity.
About PwC
At PwC, our purpose is to build trust in society and solve important problems. We’re a network of firms in 158 countries with over 250,000 people who are committed to delivering quality in assurance, advisory and tax services.
Find out more and tell us what matters to you by visiting us at www.pwc.com.
In India, PwC has offices in these cities: Ahmedabad, Bengaluru, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai and Pune. For more information about PwC India’s service offerings, visit www.pwc.in
PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.
© 2019 PwC. All rights reserved
Follow us on:
Our Offices
Ahmedabad Bengaluru Chennai
1701, 17th Floor, Shapath V, Opp. Karnavati Club, S G Highway,
Ahmedabad – 380051 Gujarat
+91-79 3091 7000
6th Floor
Millenia Tower ‘D’
1 & 2, Murphy Road, Ulsoor, Bengaluru – 560 008 Karnataka
+91-80 4079 7000
8th Floor
Prestige Palladium Bayan 129-140 Greams Road Chennai – 600 006 Tamil Nadu
+91 44 4228 5000
Hyderabad Kolkata Mumbai
Plot no. 77/A, 8-2-624/A/1, 4th Floor, Road No. 10, Banjara Hills, Hyderabad – 500034,
Telangana
+91-40 44246000
56 & 57, Block DN.
Ground Floor, A- Wing Sector - V, Salt Lake Kolkata - 700 091 West Bengal
+91-033 2357 9101/
4400 1111
PwC House Plot No. 18A,
Guru Nanak Road(Station Road), Bandra (West), Mumbai – 400 050 Maharashtra
+91-22 6689 1000
Gurgaon Pune For more information
Building No. 10, Tower - C 17th & 18th Floor,
DLF Cyber City, Gurgaon – 122002 Haryana
+91-124 330 6000
7th Floor, Tower A - Wing 1, Business Bay, Airport Road, Yerwada, Pune – 411 006 Maharashtra
+91-20 4100 4444
Contact us at
