Can an Indian start-up get a foreign investor? What condition to abide

113 votes

A foreigner looking to invest directly into India, who is a venture capitalist has two ways to invest in India – Foreign Direct Investment (FDI ) and Venture Capital( VC).

A venture capitalist would, of course, choose the route that is most profitable. Profitability is determined by the rate of taxation on the returns of the VC, the freedom which the VC has to choose its investing policies, and the limits (if any) imposed by law on the prices at which a VC can invest into and exit out of a company.

Investment limits of an Indian VC versus a Foreign VC

Note, a Foreign Venture Capital Investor can invest all of its funds in a venture capital undertaking. However, if it is a domestic Venture Capital Fund, it cannot invest more than twenty five percent of its aggregate commitments in any one undertaking.Taxation of income of Venture Capitalists

Indian Venture Capitalists

As a venture capitalist, you want to realize maximum profits from your investment, and you do not want your income to be heavily taxed. Fortunately, tax law offers some benefits, if your investment fulfils certain conditions. Before moving onto those, you must know the methods by which you can have income as a venture capitalist. There are two ways in which a venture capitalist can earn money:

1. Dividend from the company he has invested in (Investee Company)

2. Sale of shares in the investee company due to appreciation in value of the share, that is, through a complete or partial exit.

Now, under Indian tax law (Income Tax Act, 1961) income of a venture capitalist is exempt from tax under certain cases. Income from investment in a company is exempt if:

1. The venture capitalist must operate as a venture capital company or a venture capital fund.

2. A venture capital company is one which has been granted a certificate of registration under the SEBI Act and Regulations (SEBI is the stock market regulator in India, like the SEC in the United States).

3) It must fulfill certain conditions which SEBI has specified with the approval of the Central Government.

In the event the venture capitalist is operating as a venture capital fund, in addition to the above conditions 1 and 2, it must also operate under a trust deed, registered under the Registration Act or operate as a VC scheme made by the Unit Trust of India under the Unit Trust of India Act, 1963 (most VCs are likely to adopt the former route of having trust deeds and not under the Unit Trust of India scheme)

The income of the VC is from investment in a venture capital undertaking, that is, a domestic company which satisfies the following 2 conditions:

1. Its shares are not listed on a recognized stock exchange in India. So, it can be a private company or a public company, and

2. The company is engaged in certain specified sectors only, namely —

       Nanotechnology

       information technology relating to hardware and software development

      seed research and development

      bio-technology

      research and development of new chemical entities in the pharmaceutical sector

      production of bio-fuels

      building and operating composite hotel-cum-convention centre with seating capacity of more than three thousand

      developing or operating and maintaining or developing, operating and maintaining any infrastructure facility, such as a road, highway project, water supply project, port, airport, inland waterway, etc. (an exhaustive definition is present in Section 80-IA of the Act);

       Or if the company is engaged in the dairy or poultry industry.

If the VC invests in these sectors, its own income is exempt from tax. It is treated as a pass-through entity

Foreign Venture Capital Investors typically choose to route their investments through a base in Mauritius because of a bilateral treaty known as the Indo-Mauritius Double Taxation Avoidance Agreement (DTAA) which India has with Mauritius. As per the treaty, capital gains arising from selling shares are exempted from taxation in case of a Mauritius tax resident. This exemption will apply irrespective of the sector in which the FVCI invests.

Note that from April 1, 2012 India shall have a new tax law in force, known as the Direct Taxes Code (DTC). As per the DTC, it may be possible for tax authorities to levy tax even on Mauritian investors, if they are of the opinion that the Mauritius route has been undertaken simply for the purpose of lowering the applicable tax rate. Until then, the present exemption still applies.

Tax Treatment of Investors of a VC

A person investing into a VC fund or a VC company may want to know the taxability of his income. The VC should have an idea of this, so that when investors approach the VC, he is able to address their concerns on how their income will be taxed, at least at a basic conceptual level.

Under Indian law, income of the VC’s investors is taxable and the investor of the VC is treated as if he had directly invested in the venture capital undertaking. Therefore, the VC fund or company is treated as a pass-through entity.

LawRato LawRato

812 votes

This depends on the sector the startup is engaged in. Consult a lawyer who will evaluate the FDI policy and assess whether foreign funding is permitted. In some sectors, funding is also subject to some terms imposed by the government. So, one has to ensure that FDI regulations are understood and complied with.

Advocate Dhruv Suri LawRato