Union Budget 2023 brings mixed results for VC firms, but optimism remains  

As the Indian private capital industry eagerly awaited this year's Union Budget, hopes were high for resolutions to some of its persistent challenges. However, the outcome of the budget fell short of expectations for the majority of the industry. 

Venture capital (VC) and private equity (PE) investors were of the view that the country’s regulations have not kept up with the complexities of this industry and were demanding a meaningful intervention from the government to make private investments easier and friendly. 

“In 2022, PEs and VCs invested $23 billion in Indian start-ups, a 35 per cent fall from $35 billion in 2021. In the absence of any major announcements with respect to tax parity and favourable structures, the funding winter for start-ups is expected to continue,” Shravan Shetty, Managing Director, Primus Partners, said. 

Investors and funds are grappling with ambiguity related to taxation of carried interest, treatment of long-term capital gains (LTCG), restrictive foreign pricing rules and co-investment framework, use of convertible instruments, absence of hedging and leveraging options, downside protections, and lack of a single-window system to address the issues of the industry.

“There was a lot of expectation from the PE/VC investor community to see rationalization in capital gains tax to boost capital flows to a space that attracted over $100 billion in investments over the last 6 years. It is a disappointment to have this request denied this year as well,” Anirudh A Damani, Managing Partner, Artha Venture Fund. 

One of the primary asks from the PE/VC community is to find a solution to the taxation of ‘carried interest’ or ‘carry’, that is taxed under income tax as well as GST. Carry, in VC parlance, is the share of profit general partners of a VC fund receive in compensation for the management of a fund. 

Siddharth Pai, Co-Founder of 3one4 Capital and Co-Chair, Regulatory Affairs Committee of IVCA said rationalisation of capital gains taxation would have made this budget a game-changer for entrepreneurs and investors in the country. 

He said the announcement of a thorough review of all financial services regulations in the country through public consultation is a welcome step and demanded that the existing restrictions must be rationalised and modernized in order for Indian investors to become globally competitive.

The introduction of angel taxation for investments by foreign investors has caused a sense of anxiety across the investing community.

“While the intent is appreciated, the rules as prescribed could unintentionally impact genuine cases such as convertible rounds. On wish lists including easing ESOP taxation, rationalizing capital gains tax rates for unlisted shares etc., there remains optimism that these areas will be dealt with in due course as tax rules continue to evolve,” pointed out Pankaj Makkar, MD Bertelsmann India Investments. 

Yagnesh Sanghrajka, Co-Founder and CFO of 100X.VC added that the lack of intervention on GST rates for registered start-ups, ESOP taxation, tax parity in base rates for unlisted shares, and tax benefits for angel investors might adversely affect the start-ups growth.

Anil Joshi, Managing Partner at Unicorn India Ventures said the PE/VC industry was expecting the government to introduce initiatives to bring parity on capital gain in line with listed space.  

 “Risk Capital is the life blood for start-ups to thrive and we need more VCs to register with SEBI and the flow of capital to double in the next three years. So, we had hoped for some of the key asks of the VC industry to be addressed such as GST on management fees, fees to be set off against profits, etc. as they put us at a disadvantage versus other countries,” Saurabh Srivastava, Founder, IAN and Co-Founder & Past Chairman, NASSCOM, said. 

“We had also hoped that the inequity of LTCG for investments in start-ups being more adverse than for listed equities would be corrected. Investments in unlisted shares of start-ups is patient, long term capital which creates new jobs and carries much higher risk versus trading in listed stock Plus FPI can flow out at a moment's notice. All of these can increase the flow of capital to start-ups and accelerate the velocity of the start-up revolution," he added. 

During last year’s Budget, Finance Minister Nirmala Sitharaman had addressed this long-pending demand of the PE/VC industry by announcing that the government will set up a panel of experts to examine the issues concerning the investor ecosystem. Seven months later, a high-level panel headed by former Sebi chairman M. Damodaran was formed, and tasked with suggesting steps to scale up PE and VC investments in the country. The committee is tasked with suggesting reforms to improve the venture capital ecosystem and recommend ways to scale up PE/VC investments in India. 

Investors across the board appreciated government’s decision to delegating the powers under SEZ act to IFCSA.

“A big win for the investing community in this budget was the announcement related to GIFT IFSC – making IFSC the supreme authority for all SEZ compliances and boost India’s position as a fund management hub in the world. Plus, the relocation of the fund timeline extension to 2025 in the IFSC is well appreciated. The announcement related to the highest surcharge rate to reduce from 37 per cent to 25 per cent of the max tax rate to 39 per cent will greatly benefit as well,” Karthik Reddy, Co-Founder, Blume Ventures & Chairperson, IVCA, said. 

Prashanth Prakash, Partner at Accel said making GIFT IFSC as a singular point for all approvals and mitigating SEZ compliances, allowing acquisition financing and enabling arbitration will go a long way to make GIFT a fund management hub in the world. 

Also Read: Union Budget 2023: Income Tax changes to cost govt Rs 35,000 crore annually