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`Curbs on tax benefits for venture capital funds to harm innovation'
March, 03rd 2007

The Government proposes to restrict the pass through to venture capital funds operating only in half a dozen areas specified by the Government.

The Indian Venture Capital Association (IVCA) has said that the Finance Minister's Budget proposal with regard to the tax pass through provision for venture capital funds will cause irreparable harm to innovation and entrepreneurship in the country. It will discourage the growth of venture capital, which is vital for the myriads of start-ups to achieve their full potential and enable the country's economy to continue its growth rate.

The provision is also unlikely to garner any significant tax revenues as all foreign venture funds will bypass the issue by investing through tax treaty-friendly companies, and the impact will only be on the fledgling domestic venture capital industry, which any way represents only a small fraction of the total investments, Mr Saurabh Srivastava, Chairman, IVCA, said.

Proposals flawed

The Government proposes to restrict the pass through to VC funds operating only in half a dozen areas specified by the Government. This measure is flawed on two counts, according to Mr Srivastava. "First, nowhere in the world does a government seek to be clairvoyant and direct in areas of innovation venture capital is allowed to operate.

This is an issue best left to entrepreneurs and people who are willing to invest in them.

"For example, if the Government had drawn up such a list two decades ago, computer software would not have been on it. This list has some obvious, inexplicable exclusion such as telecom, value-added services in the wireless arena, media, etc.

"But the main point is that no one, certainly not Government, is competent to draw up a list of what are the promising areas of tomorrow.

If the Government's intention was to exclude a specific sector, then that would have been better though not still a good, approach."

Double taxation

The second issue comes from the Government implying that the tax pass through represents some sort of incentive.

The fact is that the pass through only eliminates double taxation.

Worldwide, it is a standard practice that venture capital funds are not taxed twice and considered pass through vehicles, with the tax being paid in the hands of investors.

In fact, in most countries such pass through is routinely available to any pool or group of investors even if they do not represent a registered venture capital fund.

Even in India, any non-corporate vehicle, such as a partnership, is not taxed twice.

"We feel that the current proposals are regressive and retrograde and must be dropped," the IVCA said.

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