The Alternative Investment Funds Policy Advisory Committee (AIPAC) under chairmanship of N R Narayan Murthy, established by the market regulator SEBI is pushing for a more favourable tax environment to and development of alternative investment funds (AIFs).
The Securities and Exchange Board of India (SEBI), in January 2016, released its first report on AIPAC for comments from stakeholders.
AIFs, defined under Regulation 2(1) (b) of SEBI (Alternate Investment Fund) Regulations, refer to privately pooled investment fund in form of a trust or a company or a corporate.
The committee has recommended various measures to unlock domestic capital pools like pension funds, charitable trusts, insurance companies and NABARD.
In an interview with CNBC-TV18, Gopal Srinvasan, CMD, TVS Capital Funds & Vice Chairman of IVCA says that it is important unlock ways to get more fund managers to the country.
There are three main principles through which foreign investors are looked at. “Ease of doing business is the most important principle, certainty in taxation is most important, we should not only bring in the best practice from other countries but India should be bold and setup the next practice in terms of regulation,” he says.
KEC Raja Kumar, Founder & CEO, Ascent Capital says the committee has estimated capital rising to Rs 3,000 crore if the fund managers are brought to India.
Ease of doing business and certainity in taxation are essential issues, says Srinivasan adding that these are the basis to make foreign investors more comfortable in India.
NASSCOM co-founder Saurabh Srivastava believes that it is essential to increase the domestic capital, which will automatically be followed by foreign capital.
Below is the transcript of Gopal Srinivasan, Saurabh Srivastava and KEC Raja Kumar's interview with Latha Venkatesh, Anuj Singhal & Guest Editor Manish Chokhani on CNBC-TV18.
Latha: You understand alternative investments much better. Is this going to be the magic wand that makes make in India happen?
Chokhani: There is no magic wand in India because we are a great country and lots of things happen. There were 28 of us who served on the committee constituted by Sebi under the chairmanship of Narayana Murthy. We had representatives from Sebi, Reserve Bank of India (RBI), the ministry of finance, the tax authorities also came.
The mood was that how do we create an ecosystem which starts encouraging entrepreneurship in India, much in the way which NASSCOM did 25 years ago because time has come when it is a young India. We will have to create more jobs, more employment and more wealth in this country and how can we as an regulators create an environment conducive for that.
Manish: Lay the context and the contours of what we discussed in a committee, the recommendations which are now sitting in front of the government, some of which came out in the Startup India announcement by the Prime Minister and some will now come in the Budget?
Srinivasan: The first thing to note is that alternate investments - venture capital, private equity bring about USD 20 billion of long-term capital to India and along with a capital, they bring a style called capability capital, working very closely with companies.
Companies with venture capital partners (VCP) funding typically generate 15-18 percent more employment and also more taxation as evidence in the recent McKinsey study that was done by us, the IVCA last year. So, it is good that Sebi which I would call them as a listening regulator, essentially commissioned this study under the best possible leadership which is Narayana Murthy.
As Manish said what this study does is basically it looks at it from three or four angles. One, how do you get more capital to GPs or fund managers, how do you also get more fund managers to be comfortable in India.
Most of them are overseas, so 'Atithi Devo Bhava' how do you actually get them into India is also the issue and it also deals with very important issues of taxation and when put together this can give the results.
However, the last thing I want to say is it's been a breakthrough year. This policy where foreign direct investment (FDI) has been allowed in Alternative Investment Funds (AIF) and the ensuing downstream money does not get affected by FDI sector caps, is also another breakthrough the government has done. So this government has been listening also and acting. We hope on February 29 they will act in phenomenal power.
Manish: Pick on this whole theme of bringing fund managers onshore, which the sub-committee spend some time on as well.
Srinivasan: Out of the USD 21 billion, if you look at it.....
Manish: This is per annum. Last year, PE brought in USD 20 billion while foreign institutional investors (FIIs) were exiting and we should make the point that this is a stable long-term capital.
Srinivasan: Very simple number- 40 billion is total long-term capital that came to India Last year. 21 came from VCPE, balance came from strategic FDI and about 2 billion came from IPOs. So that is a total number. So this is the single most form, far more than IPOs.
Manish: Therefore, in a context when this market is selling off and there is fear that the FIIs are running away. I can speak from the foreign private equity investor's point of view and these guys are running local money. I think it is great time because you go and make investments now?
Srinivasan: The answer to your question, from our point of view out of 20 billion about 2 billion odd is rupee capital, about 20 percent about 4 billion is managed by Indian managers like ourselves or many others who have--the manager is domiciled in India but the balance 80 percent is by India based managers with offshore vehicles in Mauritius or Singapore because India is only country that gives zero tax status for foreign investors which is an amazing thing and like a dinosaur it will go away soon.
But, for them to feel comfortable to operate here, we need to give them something called safe harbour, which means they should not be assessed as having to pay Indian tax even though their vehicle is in Mauritius or Singapore.
Actually this kind of fears, Narayana Murthy has put very well, ease of doing business is the most important principle, certainty in taxation is most important, we should not only bring in the best practice from other countries but India should be bold and setup the next practice in terms of regulation. These are the three principles with which we have looked at foreign investors being comfortable to operate in India.
Manish: I will just toss over to Saurabh Srivastava, who is the father of the software industry in some form and we were so glad that entrepreneurship is getting recognized and rewarded in the Padma awards. Saurabh Srivastava did a lot of work in his sub-committee on how to unlock domestic pools of capital, so it could be pension funds, it could be banks, it could be family offices.
Srivastava: Gopal Srinivasan said that USD 20 billion came in, only USD 2 billion was domestic. 90 percent of it is foreign capital. It is very important for us to unlock domestic capital to go into this industry for many reasons.
One of the reasons is when you look at it globally, domestic capital is necessary if you want to fund start-ups early stage because it takes higher early stage risks. Foreign capital takes that but also prefers a lot of late stage risk and although we are survival in foreign capital, if market sentiments change, some of that capital could become scarce.
China started with the same scenario, 50 percent of their capital today is domestic capital. So we have domestic capital, you will have a lot more start-up investments and more foreign capital will follow the domestic capital. So this 20 billion annually can become 50 billion.
So for the start up regime that was launched and some of these suggestions that we had did find their place in there, it becomes very important because globally, studies that have been done in the US show that net new job growth is not done by just established large companies.
It is done by the newer companies that come up and are funded through private equity and venture capital. So it is very important for us to do it. If you look at it domestically then normally the people who invest in this asset class globally, pension funds, insurance companies, educational institutions, those kind of things, in India they are not enabled to do so.
What we have recommended in the committee is that the government should create enabling legislation which says pension funds for example should invest a small portion of the capital --3-5 percent in this asset class. For insurance companies this is exactly the right kind of risk, it is longer-term, banks, for example by saying that this is priority investment, the capital market exposure norms shouldn’t come into it.
So, we create a domestic asset class and we encourage family offices for example to also put money in these asset class. We would like HNIs to do this rather than buy the next farm house that puts property prices up, they should put money in here and governments around the world have done that. In the US, in the UK even till today Angel investing in the UK, you get 30-50 percent tax credits. We have section 56, which taxes that investment. So there is a lot of room for us.
Manish: in fact, capital may be treated as business income in the hands of the company. So that just leads me to Raja Kumar who in his previous avatar, spent time as a tax officer as well. So, he is very into the subject. He now runs asset capital which does a series of great investments. You want to take us through some of the recommendations we made around taxation which really is the bug-bear for most of the community?
Kumar: To present a big picture, macro view to the policy makers, the tax planning guys, our committee has done, analysed to figure out where is the tax potential in venture capital, private equity asset class. And we figured out there are three entities, the fund manager, the fund and the fund backed portfolio companies.
These are three entities where tax generated and we came out with estimates that about 85 percent of the tax is generated at the venture capital, private equity backed portfolio companies.
Only 5 percent of the tax potential exists at the fund level and about 10 percent potential, tax potential exists at the fund manager level. And, it is the fund backed portfolio companies which are robust tax generating entities. They generate tax annually, recurring taxes.
Now, typically, private equity funds, venture capital funds, they have losses, they have exempt income, they exit sometimes through public markets, and also they make capital gains typically once in 12 years or 10 years.
So, if there is only 5 percent in the tax potential at the fund level, why is that the taxation, the tax policies are so cumbersome for the alternative funds, especially SEBI registered alternative funds. So, this is particularly a reason why 90-95 percent of the funds have chosen to get located offshore. So, to bring them home, with a lot of good intentions, the current government has proposed safe harbour norms, but the details and conditionalities stipulated are very cumbersome and impractical to actually follow.
And our committee has recommended small tweaking, small changes in safe harbour norms so that we can bring the fund managers from the offshore to the onshore and it can give a new tax realisations. We estimated about Rs 3,000 crore per year is possible if fund managers can actually move to India.
Then also, I would like to say few things about the pass through which our industry has been asking for. Mutual funds, real estate investment trust or pooled investment vehicles, the regulated entities by SEBI, there is a clear one level taxation for the mutual funds.
In the case of our asset class, the most cumbersome tax laws have been put in place where the fund has to pay tax on certain heads of income, then it has to pay 10 percent withholding tax, then investors also have to pay tax.
Pass through is not a tax exemption at all. Pass through is something which is very much consistent with the Indian tax policy. Pass through will simplify taxation, will enable more addition of capital to Indian funds, will also create more pooling of capital from the domestic investors into Indian funds.
Also one more point to say here is that the category III alternative investment funds are also eligible for pass-through and there is logic or rationale or justification to deny pass through for category III funds.
We came out with another alternative approach of taxation that is called securities transaction tax (STT) approach. Every distribution made by alternative investment fund will be subjected to STT so that the income can be tax free in the hands of investors. STT is the same for both fund investors and also Indian investors.
Manish: What are your closing remarks?
Srivastava: I just wanted to make one last point at closing which is that what we are proposing on unlocking domestic capital is very key to the startup India launch. We announced a fund of funds so, Rs 10,000 crore.
However, this fund will actually take 15-20 percent of the corpus of funds that get created to invest in startups. Where will the 80 percent money come from? Unless we make more domestic capital available, so that Rs 10,000 crore will not be effective unless we make some of these changes.
Last one, I would just make is that today investing in private equity, venture capital in unlisted companies in particular is immensely more risky, is illiquid but it creates new jobs. However, we seem to treat this less favorably then investment in the stock market through foreign institutional investors (FIIs). We really should align the capital gains tax regime for both of these investments. If not make it better for this at least make it the same.