In a bid to attract venture capital investments, particularly foreign direct
investment (FDI), the Indian government has further eased venture capital
guidelines. These relaxations include a mix of fiscal and procedural
norms -expanding the definition of ``infrastructure facility'' under the
venture capital guidelines, dispensing with the three-year lock-in
applicable on venture capital investments and freeing investment norms
stipulated for venture capital companies, in order to be eligible for tax
exemptions.
Currently, income by way of dividends or long-term capital gains of a
venture capital fund or a venture capital company from investments in the
equity of a venture capital undertaking are exempt from tax, provided these
companies and funds subscribe to several stringent investment norms.
These norms include a three-year lock-in on investments. Additionally, to
avail tax benefits, venture capital companies have to subscribe to a
mandatory investment pattern over the three years.
The investment pattern prescribed includes mandatory investment of 20 per
cent, 50 per cent and 80 per cent of the funds by the venture capital
company over a period of three years in a venture capital undertaking to be
eligible for tax shield. Both these norms, prescribed in Rule 2D under the
provisions of Section 10(23F) of the Income Tax Act, have now been removed.
The relaxations come into effect from April 1, 1999.
Additionally, the definition of the term `infrastructure facility' as
defined in Section 10(23F) of the Income Tax Act has been expanded. This
section deals with exemptions of venture capital earnings from taxation. The
definition has now been expanded to include roads, highways, bridge,
airport, port, rail system or any other public facility of a similar nature
as may be notified by the Central Board of Direct Taxes.
Currently, the sectors eligible for tax exemption include manufacturing,
power, telecom services, electricity and other infrastructure including
computer software. Section 10(23F) grants the CBDT powers to notify
additional sectors, based on which the current round of relaxation has taken
place.
The changes have been made primarily on the basis of demands from overseas
venture capital funds, which have been demanding a relaxation in the
stringent investment norms. For instance, if a venture capital company or
fund is unable to meet the tight investment norms, because the project
hasn't taken off, then it stands to loose the tax shield.
Additionally, if the venture capital fund were to invest in alternative
investments - say government securities - during the interim period when
there is a delay in the drawdown on funds, then earnings are subject to
capital gains. All these bottlenecks had ensured a lack of interest in
venture capital activities.
The relaxation in norms are expected to give a spurt to such an activity.
Globally, venture capital constitutes a focus area for attracting FDI and
for spearheading industrial growth.