House panel favours abolition of LTCG tax on investments in startups

The Standing Committee on Finance has recommended several measures to reduce the dependence on the US and China for funding startups and Unicorns in the country.

In a report titled "Financing the startup ecosystem" submitted to the Lok Sabha Speaker last week, the committee has strongly recommended that the tax on Long Term Capital Gains (LTCG) be abolished for all investments in startup companies (as designated by DPIIT) which are made through collective investment vehicles (CIVs) such as angel funds, AIFs, and investment LLPs. At a minimum, this should be done for at least the next 2 years to encourage investments during the pandemic period.

After this 2-year period, the Securities Transaction Tax (STT) may be applied to CIVs so that revenue neutrality is maintained. Investments by CIVs are transparently done and have to be done at fair market value. Thus, it is easy to calculate the STT associated with these investments. This can be done in lieu of imposing LTCG on these CIVs and to make the taxation system fairer, less cumbersome,and transparent. This will also ensure that investments in unlisted securities are on par with investments in listed securities, the report said.

The committee, headed by its chairperson Jayant Sinha, former minister of state for finance,has also recommended that Small Industries Development Bank of India’s (SIDBI) Fund of Funds vehicle should be expanded and fully operationalised/utilised to play an anchor investment role.

“SIDBI should play a pivotal role in disbursing more funds that would help startups and Unicorns to scale up significantly, enabling the nation to become more self-reliant and be in a better position to control its economic destiny,” the report said.It is further desired that these funds be managed by top quality professional management teams who specialise in different sectors such as healthcare,e-commerce, agritech, cyber security, etc.The Committee recommended that in line with the global practices, large financial institutions in India should be encouraged to channelise a proportion of their investible surplus into domestic funds which would bring in much-needed additional domestic capital for startup investments.

Towards this end, the Committee has recommended the following specific measures:

Pension Fund Regulatory and Development Authority (PFRDA) and National Pension Scheme (NPS) may be encouraged to invite bids from professional fund managers for running a fund-of-funds programme. SIDBI would be eligible to participate as well. Further,the removal of restrictions such as the minimum corpus of AIF being an eligibility criteria for pension fund investment and requirement to invest only in listed AIFs, would considerably ease roadblocks for investment by NPS in AIFs.

The Committee also recommended that pension funds can start by allocating a small percentage of their corpus into AIFs currently and then gradually increase it as they gain more experience. Major banks should join hands to float a fund-of-funds. Furthermore, the current exposure limits applicable to banks need to be enhanced and permission be granted to invest in Category-III AIFs also.

Insurance companies (both life and non-life) must be given latitude to invest in fund-of-funds by IRDAI as well as directly in VC/PE funds along with a higher exposure cap. Further, the Committee recommended that investments by insurance companies in AIFs must be carved out under a separate category while calculating the applicable exposure limits and must not be clubbed with other investments under ‘unapproved investments’. The Committee has also recommended that Securities and Exchange Board of India (SEBI) should allow Venture Capital funds to invest in Non-Banking Financial Companies (NBFCs) which would help enhance their capital base.

The Committee has noted that successful Initial Public Offerings (IPOs) of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trust (InvITs) have already shown that asset portfolios can be packaged together to attract specific investor type and thus would like to recommend that NBFCs also be allowed to list on stock exchanges to be able to draw in a larger investment pool.