As an active player in the entrepreneurial ecosystem, we believe in advocacy. We make representations to the government and industry, with suggestions and requests, to ease the journey of an entrepreneur.
We believe in advocating, on behalf of, and at times to, all the stakeholders in this ecosystem. In recent past, we have approached the authorities multiple times. The aim of these representations has been –simplify the process of doing business in India.
Some of our representations are:
Being a part of the start-up ecosystem, where looking at the bright side is often the only ray of hope, let’s ask – what can our Government do for start-ups?
On a basic level, it translates into- what would I do if I were the Finance Minister? Since finance people like numbers, we begin with the fact that a start-up friendly policy environment can create over 10 million direct jobs for the Indian youth in 10 years.
Then we identify the bottlenecks in the growth of start-ups – starting, conducting and closing a business – and the lack of easily available risk capital for them.
The ground reality is that it is tough for a start-up to meet all the regulatory criteria to set-up, conduct and close a business because. How can the start-ups compete globally and efficiently, if the regulations suck their energy and enthusiasm? For ease of understanding let's limit the discussion to Small & Medium Company (SMC as defined in Dec'06 by the Ministry of Corporate Affairs.)
Given the number of compliances and the steps needed to operate, it is not surprising that India ranks 173rd globally on the index measuring ease of doing business in a country. The irony is that India is extremely friendly on the e-governance front, as many processes are online and thus easier. However, the number of steps, amount of time, and costs to navigate is a dampener. As a VC, it is shocking to see, that a start-up sometimes considers an incorporation certificate of their company a bigger feather in their cap than winning a customer order.
Years ago, an M&A expert told me, walk into partnerships only if you know the exit mechanism. The procedures for winding-up a SMC must be simplified with stringent timelines, given the high risk of failure for a start-up. Thus having simple processes with defined time-lines to close a company will encourage setting-up a company the moment an idea germinates. Moreover, start-ups must consider a formal corporate structure rather than the current way, of sole proprietorship or partnership firm,as the former is more transparent and accountable.
Not only exit, the formation of a company should be made easy too,with a single application taking care of multiple requirements – Name Search, Director Identification Number, Digital signatures, Incorporation certificate, and Permanent Account Number. When the start-up decides the place of operation allocate Tax Account Number, register it under Shop & Establishment Act and the MSME Act again in a single application. Only when the start-up reaches the minimum number of employees, a common application should be made for Professional Tax, EPFO, ESI and Gratuity.
An appeal on behalf of the entire start-up ecosystem would be – don't make our start-ups defaulters from the first day of operation. It is really difficult for a VC to find a SMC that is fully compliant in their initial days. Let me share an experience.A start-up normally makes payments to Google, Facebook, or Amazon via credit card, within a few days of starting operations. Unknowingly they become defaulters on Withholding Tax, Tax Deduction at Source (TDS), Foreign Exchange Regulation and even the Reverse Charge Mechanism to gross-up for deposit of service tax.
Can we provide some breathing time and concessions for a start-up so that they can standup and start walking before being dragged into such a complex compliance regime? Similarly, what is the need to mandate an internal audit or appoint an independent valuer for ESOP valuation for SMC's accounting? Instead of valuation, the last issue price per share should be good enough. We need to permit self-regulation and self-compliance for SMCs with stringent penalties for prevention of potential misuse. Steps in these directions can save valuable a start-up valuable time, better utilized for building their product that may go global.
Let us move to the issue of finding that critical risk capital. We as a nation have consistently failed to channelize the savings of our rich for creation of productive jobs for millions of poor. All our savings go into government securities, gold, fixed income securities and real estate. Productivity of a nation enhances only when savings are channelized into risk capital. I once asked a real estate developer – what is more valuable Rs.1 of sales or Rs.1 of equity contribution in your company. His instant response was equity infusion and the wonders it can achieve. Every day multiple full-page newspaper advertisement lures our rich to invest in property. In contrast, if, our regulator, SEBI, educates the rich to invest in Listed Equity, Equity Mutual Fund, Private Equity or Venture Capital, it may increase national productivity.
We have been encouraging our rich to invest in residential properties. The capital gains from one can be re-invested in another residential property and tax can be saved under Section 54 of the Income Tax Act. We need a similar provision for VCs so that capital gains are re-invested in venture capital funds. The risk takers have to be encouraged and rewarded.
The crux is that India has a supply side problem. We want investment-led growth for our economy. We should no longer be a pure domestic consumption story. That is more than 2 decades old. It is time to fund and invest in our future.
Our budding entrepreneurs are filled with ideas. Most of them are the first generation entrepreneurs. They have a dream. Equity or venture debt can take them on the path that realizes their dreams. Let us tap multiple sources of finance for our SMCs- global pension funds, provident funds, insurance, endowment funds, charitable and religious institutions, foundations, and the developmental institutions – that want to invest in Indian Venture Capital. Strangely, our own Indian institutions, except insurance and SIDBI, are not allowed to invest in Venture Funds.
At present all the savings largely go to Government securities. Nation building requires this capital for our private sector. Let me share a controversial example – I would like a factory labourer to be proud of being able to create a job for his or her own child. One who earns Rs.10,000 per month and saves Rs.500 in Pension can be made to allocate 3% – 5%, say Rs.25 per month, for venture capital or say start-up capital. Imagine the pride when he sees his savings leading to job creation. Let us all take some bold steps… invest in our savings in start-ups. We can not continue to lose out to start-up nations like Israel, Chile, Singapore, UK, US.
Before concluding, let me state another pain-point. It takes months to convince a NRI/PIO to invest in Indian Venture Capital Funds. Now our FDI policy, as per clause 3.2.3, requires DIPP & FIPB approvals for the NRI/PIO to invest via their NRO bank accounts in India in a Domestic Venture Capital Fund (DVCFs) or say local fund managers who invest in our start-ups. Despite months and years of struggle, approvals have not been granted to many such DVCF. The advice handed to these disgruntled fund managers is set-up a fund in Mauritius and channelize it to India. This is just not viable for a fund that plans to support start-ups. Second, these local managers help the Indian Government to earn the genuine 10% capital gains tax if a non-resident reaps capital gains from Indian ventures. Since, we are not able to discourage gold import nor hold back successful & large businesses from investing overseas… how and where do we go and find cash for our budding entrepreneurs!
Maybe some of these suggestions reach the ears of the powers that be and our start-ups have a chance to be a part of the growth story and create jobs that in turn give birth to more start-ups.
The department can help the entire ecosystem by intervening in the start-up process.
Ease regulations and processes for setting up, operating, and exiting a business.
Setting-up: The process of starting a business in India is online and becoming easier but it is still ranked 173 globally. The reason is, that for company formation a lot of steps, time, and cost is spent on each aspect such as name search, DIN, Digital signatures, Incorporation certificate, PAN, TAN, registration under shop & establishment act, VAT, Professional Tax, EPFO, ESI, Service Tax, Trade mark, ROC fees for initial authorized capital, stamping of company documents and share certificates.
Operating: Our policies and regulations do not provide time and concessions for a start-up business to stand-up and start walking. The compliances under the different regulations including but not limited to with holding tax requirements, profession tax, labour laws, etc. come into effect even before these businesses earn a penny in revenue. Even on a 6-month old business, a Venture Capital Fund has to conduct extensive due diligence and educate the entrepreneur on multiple non-compliances, that may amount to closure of a business.
Exiting: Majority of Start-ups and small businesses fail particularly when not mentored by a Venture Capital Fund, or an Angel Investor. Procedures for winding-up a private limited company are required to be reduced for the time and cost involved.
Facilitate investments by Venture Capital Funds (VCFs) – The risk of investing in Start-ups and small business is extremely high. While operating and exiting a start-up, our policies should offer adequate protection to such investors. May be a separate chapter dealing with SEBI approved VCFs is desired in the Act.
The risk taking can be encouraged for a young entrepreneur only if the entry and exit process are simple and easy to comply with.
By presenting a 5-point action plan to the finance ministry we hoped to trigger a process where in start-ups would contribute towards sustainable economic growth. A growth led by investments rather than consumption.
YourNest Angel Fund, is responsible for generating direct employment, since our launch in March '12, to over 100 people. Through our investments, in three companies so far, we build global companies amongst the first generation Indian entrepreneurs.
To provide an impetus to start-ups, we suggest the following actions points, in order of priority.
Encourage Indian fund managers to float and manage early stage Venture Funds from within India by allowing automatic route for NRI/PIO investment in these funds from the NRE/NRO account in the SEBI approved Funds on repatriation basis.
Permit pension funds, insurance funds and provident funds to invest a small part of their corpus in early-stage venture funds to improve access to long-term capital.
Offer Special incentives such as tax deduction to investors in early stage venture funds or incubators. MoF can replicate the provisions of Section 54 that encourage the HNIs / other entities to invest in the Domestic Early Stage Venture Fund (Category 1 Funds as per SEBI (AIF) Regulation'2012) to seek a deduction against capital gains. Additionally, to attract capital a general deduction in respect of investment into such funds could also be granted under Chapter VIA on the lines of section of section 80C, section 80CCB. To really incentivise capital flow into early stage ventures, it may be provided that any capital gains arising from sale of investment in venture capital undertaking, a securities transaction tax on the lines of transactions in listed companies and equity oriented mutual funds could be introduced.
MoF could also allow companies registered in India to make an initial public offer on exchanges outside India without or before listing in India, as was the case earlier. Indian start-ups require significant funding to scale themselves to serve global customers. Opening-up the doors of equity fund raising from across the globe will widen their scope. We do not want Indian Start-ups to have Head Quarters outside India to keep the option of global fund raising with them.
Ease regulations and processes for setting up, operating, and exiting a business. For example, as per Companies Act'1956 internal audit is mandatory if the paid up capital and reserves exceed more than Rs. 50 lakhs at the commencement of the concerned financial year. We as external investors do not need internal audit at such as early stage.
Decision Point – Encourage Indian fund manager to float and manage Venture Capital Funds (VCFs) or Alternative Investment Funds (AIFs) from within India by allowing automatic route for NRI/PIO investment in these funds from the NRE/NRO account in the SEBI approved VCF/AIF on repatriation basis.
Supporting Points – The proceeds from NRE / NRO account could be used to invest in mutual funds, whereas investments into VCF/AIFs are not explicitly permitted. Similarly if a VCF is set-up as a company the automatic route is allowed, whereas if VCF is set-up as a Trust NRI/PIO investment is subject to FIPB approval.
Additional Recommendation – To enable greater access to offshore capital, all non-resident investors meeting specified Know Your Client (KYC) requirements ought to be permitted to invest from the overseas bank account (Non NRE/NRO) into early stage venture capital funds set up as trusts and registered with the Securities and Exchange Board of India (SEBI) under the automatic route. Also, all repatriations by such funds to offshore investors especially in respect of capital must be permitted without prior approval from the Reserve Bank of India. Approvals at entry and exit create a regulatory risk for investors and therefore liberalisation on the above lines will greatly incentivise offshore investors to invest into domestic funds.
Amendment Required – In the Clause 3.2.3 under “3.2 ENTITIES INTO WHICH FDI CAN BE MADE” of the CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 10, 2012), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry.
Current Clause – “3.2.3 FDI in Venture Capital Fund (VCF): FVCIs are allowed to invest in Indian Venture Capital Undertakings (IVCUs) /Venture Capital Funds (VCFs) /other companies, as stated in paragraph 3.1.6 of this Circular. If a domestic VCF is set up as a trust, a person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF subject to approval of the FIPB. However, if a domestic VCF is set-up as an incorporated company under the Companies Act, 1956, then a person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF under the automatic route of FDI Scheme, subject to the pricing guidelines, reporting requirements, mode of payment, minimum capitalization norms, etc.”
Desired Clause – “3.2.3 FDI in Venture Capital Fund (VCF) or Alternative Investment Fund (AIF): FVCIs are allowed to invest in Indian Venture Capital Undertakings (IVCUs) /Venture Capital Funds (VCFs) /other companies, as stated in paragraph 3.1.6 of this Circular. If a domestic VCF or AIF either
is set up as a trust or as an incorporated company under the Companies Act, 1956 a NRI or PIO person resident outside India ( non-resident entity/individual including an NRI) can invest in such domestic VCF or AIF, on repatriation basis, subject to approval of the FIPB. However, if a domestic VCF is set-up as an incorporated company under the Companies Act, 1956, then a person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF under the automatic route of FDI Scheme, subject to the pricing guidelines, reporting requirements, and mode of payment , minimum capitalization norms, etc.
However, a person resident outside India (non-resident entity/individual excluding an NRI or PIO) can invest in such domestic VCF or AIF can invest in such domestic VCF under the automatic route of FDI Scheme, subject to the pricing guidelines, reporting requirements, mode of payment, minimum capitalization norms, etc.
For computation of sectorial cap in areas where FDI is restricted the proportionate shareholding of only the persons resident outside India be considered to be FDI in the VCU. For example, if a domestic VCF/AIF has 40% contribution coming from person resident outside India and it holds 30% stake in a VCU the FDI should be counted as 12% (40% of 30%).”
Positive Action that must Continue – We appreciate the business incubation support being extended by Department of Science and Technology (DST) along with Technology Development Board (TDB). DST program of business incubation has reward and supported 2400 Indian start-ups resulted in employment generation of nearly 20,000 employees, generating revenues of nearly Rs.7000 crore with minimal financial support. A continued and much higher support by MoF can enable them to incubate businesses at a much faster pace.
Decision Point – Encourage Insurance companies (both private & public), Provident Funds, Pension Funds, charitable or religious foundations, Banks to invest their long-term funds in building and supporting Indian Start-ups and small businesses. They can start funding the Venture Capital Funds (VCFs) or Alternative Investment Funds (AIFs) from the savings available within India. It can be limited to Category 1 AIFs that is Venture Capital Funds, SME Funds, Social Venture Funds, and Infrastructure Funds.
Supporting Points – Indian start-up need capital from within India. Until now the international pension fund and endowment funds are being rewarded for their proactive investments in Indian SMEs and Start-ups. The early stage business offers attractive return whereas the India’s own long-term funds are not participating in this asset class. These institutions have been encouraged to invest in listed equity market in recent times. It is time as the Indian start-ups and small businesses are also supported through SEBI registered Venture Fund for accessing long-term capital from these institutions. Some useful facts are –
The International Pension Funds, Superannuation Funds, Endowments Funds, Foundations are finding it highly lucrative to invest in the Venture Capital Funds focused at India. For example, following institutions hold investment in India focused funds –
- State of Delaware Pension Fund
- AT&T's Pension Fund
- Canada Pension Plan Investment Board
- Australian Post Superannuation Scheme
- Unilever Superannuation Trustees Limited
Stanford University, The University of Michigan, The University of Minnesota, Yale University, Princeton University, University of Chicago, University of Texas Investment Management Co.
Kauffman Foundation, The Ford Foundation, Aman Foundation, Dell Foundation, Niehaus Foundation, Sapling Foundation, Three Dogs Foundation, Alexander Family Foundation, Blood Family Foundation, dob Foundation, LF Foundation, Mahvash & Jahangir Siddiqui Foundation, Partridge Foundation, Peter & Devon Briger Foundation, Skoll Foundation, The James Irvine Foundation, Alfred IduPont Testamentary Trust, The Rockefeller Foundation, The William and Flora Hewlett Foundation, Adelson Family Foundation, Marc and Leigh Cohen Family Foundation.
In FY09, following investments were made by the following Funds–
- Employees' Provident Funds = Rs.29010 crores
- Employees' Pension Funds = Rs.14477 crores
- Employees' Deposit Linked Insurance Funds = Rs.877 crores
In FY13, fresh investments by these funds are estimated at approximately Rs.60,000 crores with cumulative investment portfolio of nearly Rs.500,000 crores.
Additional Recommendation – A beginning can be made in FY'13, with Provident Funds and Pension Funds allocating only 5% of the fresh investments going towards building a portfolio of equity assets. This will yield Rs.3000 crores towards the risk capital. Gradually, it can be increased to 5% of the total corpus of this funds that will bring additional assets of Rs.25000 crores into equity assets.
Endowment Funds or say Charitable and Religious Institutions (Approved under Sec 80 G of Income Tax Act) – In case of Charitable and Religious institutions or Foundation the Rule No. 17 C in relation to Section 11 (5) of the Income Tax Act, such foundation can invest in Mutual Funds, Incubated companies or National Skill Development Corporation (NSDC). The Rule must allow such institutions to invest in SEBI registered Category 1 AIF and Category 2 AIF. It requires amendment on similar lines as the last amendment carried out for NSDC for example
“Income-tax (Ninth Amendment) Rules, 2008 Notification No. 99 of 2008, dt. 22nd Oct., 2008 In exercise of the powers conferred by section 295 read with clause (xii) of sub-section (5) of section 11 of the Income-tax Act, 1961 (43 of 1961), the Central Board of Direct Taxes hereby makes the following rules further to amend the Income-tax Rules, 1962 namely:– 1. (1) These rules may be called the Income-tax (Ninth Amendment) Rules, 2008. (2) It shall be deemed to have come into force with effect from the 31st day of July, 2008. 2. In the Income-tax Rules, 1962, in rule 17C, after clause (vi), the following clause shall be inserted, namely:–“
(vii) investment by way of acquiring shares of National Skill Development Corporation”.“(viii) investment by way of acquiring units of a SEBI approved Venture Capital Fund or Alternative Investment Fund Category 1 or Category 2”.
Detailed Investment Guidelines for all Citizens under the New Pension System under PFRDA – The PR will manage 3 separate schemes, each investing in a different asset class, being:
- Asset Class E (equity market instruments) – The investment by a NPS participant in this asset class would be subject to a cap of 50%. The asset class will be invested in index funds that replicate the portfolio of either BSE sensitive index or NSE Nifty 50 index.
- Asset Class G (Government Securities) – This asset class will be invested in central government bonds, and state government bonds.
- Asset class C (Credit risk bearing fixed income instruments) – This asset will be invested in liquid funds of mutual funds, credit rated debt securities.
Regulation of Investment of the Insurance Regulatory and Development Authority (Investment) Regulations, 2000 has provided for “Approved Investment and Other Investments, subject to exposure or prudential norms. These Approved Investments and Other investment can specifically allow for investment in VCF or Category 1 AIF & Category 2 AIF.
On similar lines amendments can be introduced in –
- Employees' Provident Fund Scheme, 1952
- Employees' Deposit Linked Insurance Scheme, 1976
- Employees' Pension Scheme, 1995
- The Payment of Gratuity Act, 1972
Banks Investing in Shares or Units of Venture Capital Funds – Banks must also be encouraged to invest in Category 1 AIFs by treating such investment as “priority sector” funding without capital market exposure and provisioning norms being applied. The current “Prudential Guidelines on Bank’s Investment in Venture Capital Funds (VCF)” issued by RBI require amendment for the following clauses –
Risk Weight and capital charge for market risk f or exposures in VCFs – Shares and units of VCFs Investments in shares /units of VCFs may be assigned 150% risk weight for measuring the credit risk during first three years when these are held under HTM category. When these are held under or transferred to AFS, the capital charge for specific risk component of the market risk as required in terms of the present guidelines on computation of capital charge for market risk, maybe fixed at 13.5% to reflect the risk weight of 150%. The charge for general market risk component would be at 9% as in the case of other equities.
RBI approval for strategic investments in VCFs by banks – Banks should obtain prior approval of RBI for making strategic investment in VCFs i.e. investments equivalent to more than 10% of the equity/unit capital of a VCF.
Decision Point – Encourage Indian High Net-worth Individuals, family offices, Corporate, Firms, Institutions, Public Sector undertakings with investible surplus to invest in Category 1 AIF by extending fiscal incentives.
Supporting Points – The desired risk capital for India can come from within India. Today, Indian HNI deploy most of the investible surplus in Real Estate followed by debt and gold. It is time to get this surplus diverted to Category 1 AIF Funds. The economic multiplier impact of investment in equity is many-fold compared to investments currently flowing in the real estate or debt instruments.
Indian HNIs are risk averse to invest in Indian start-up or Venture Funds for the following reasons –
- Fund that have an investment lock-in of 8-10 years.
- No exit option exercisable by the investor.
- Returns are expected only on sale of shares of the start-up that ideally talks 4-6 years.
- Risk of loosing principal amount or inadequate return in case most of the start-ups in a funds portfolio fail.
- No involvement of the investor in deciding or identifying the start-up or businesses to invest-in, as the Fund Manager exercises the choice.
Recommendation – The provisions of Section 54 can be replicated to encourage the HNIs / other entities to invest in the Domestic Early Stage Venture Fund (Category 1 Funds as per SEBI (AIF) Regulation'2012) to seek a deduction upon investment against capital gains made on any asset category.
Additionally, to attract capital a general deduction in respect of investment into such funds could also be granted under Chapter VIA on the lines of section of section 80C, section 80CCB.
To really incentivize capital flow into early stage ventures, it may be provided that any capital gains arising from sale of investment in venture capital undertaking, a securities transaction tax on the lines of transactions in listed companies and equity-oriented mutual funds could be introduced.
Amendments Required (Point 1 & 2 or Point 3 only)
Long term capital gains may be invested in Category 1 AIF one-year prior to the date of capital gain or within 2-years of the date of Capital Gains for exemption from capital gains tax. On investment in the Units of Category 1 AIF, the Long Term Capital Gain will be exempt from the capital gains tax.
A general deduction under Chapter VI A to persons with a limit of say Rs.25 lacs per year for diverting their investment from Gold, Debt, and Real Estate to this highly risk asset class namely Category 1 AIF. As per SEBI an investment commitment by a person has to be minimum Rs.1 crore in an AIF.
Capital Gains arising from the sales of investments in Venture Capital Undertaking are exempted upon including sale of such investments under Securities Transaction Tax (STT).
Decision Point – MoF could also allow companies registered in India to make an initial public offer on exchanges outside India without or before listing in India, as was the case earlier.
Supporting Points – Indian start-ups require significant funding to scale themselves to serve global customers. Opening-up the doors of equity fund raising from across the globe will widen their scope. We do not want Indian Start-ups to have Head Quarters outside India to keep the option of raising funds globally with them.
Entrepreneurship in India, over the next decade, has the potential to create 2500 successful high growth ventures, with combined revenue of over Rs. 10 lakh crore (USD 180 billion), and to generate 10 million direct & 20-30 million indirect jobs. Consequently, powering India’s economic progress with –
- Inclusive economic development
- Innovative products/services for India’s young population
- India as a hub for frugal innovation
- Attracting investment flows and creating substantial wealth
This cycle has been set in motion over past few years with emergence of first generation entrepreneurs, increasing availability of capital, and strengthening of the ecosystem.
The Committee's recommendations include –
Facilitate investments: Recognition and promotion of early-stage investments and early stage investors such as angel investors, venture and seed funds, and attract investors through development of appropriate policy measures and fiscal incentives.
Enhance and scale-up venture incubation programs: Grow incubators from the current 120 number to over a 1000 by 2022, beyond IITs, IIMs etc. Enhance the limit of investing in an incubatee company from Rs.25 lacs to Rs.1 crores. Encourage Private Sector participation in incubation centers.
Ease entrepreneurial processes: Ease regulations and processes for setting up, operating, and exiting a business that are time consuming and complex. Governments and their agencies can at all levels – central, state, and local – reduce transaction time and costs. For example, permit self-regulation and self-compliance for businesses with turnover of less than Rs. 25 crore, and stringent penalties for prevention of potential misuse.
Ease exits for investors: Develop policy framework for easier exits to encourage early stage investments by Angels and others investors including appropriate fiscal incentive on capital gains. MoF could also allow companies registered in India to make an initial public offer on exchanges outside India without or before listing in India, as was the case earlier.
Remove regulatory hurdles that inhibit domestic investments: Permit pension funds, insurance funds and provident funds to invest a small part of their corpus in early-stage venture funds to improve capital flows. Special incentives such as tax credits could be provided to HNIs, corporates and institutions that invest in early stage venture funds or to incubators and to angel investors. Allow NRI investment in Venture Capital Fund through automatic route.
Government could establish a “fund-of-funds (FOF)” to seed other early stage venture funds: With a corpus of Rs. 5,000 crore, this FOF will invest as an anchor investor, in a number of Alternative Investment Funds.
Develop and scale-up debt offerings: Debt is critical to meeting working capital requirements. Traditional debt providers, however, do not lend without collateral. As such, early stage ventures cannot meet lender requirements. Therefore, expand the lender base by incentivizing banks to offer SIDBI-like schemes to early stage ventures. Banks to create capacity and capability for lending to such ventures.
Set up collaborative forums for mentorship and networking: Industry associations and chambers of commerce to set up mechanisms for mentoring relationships between established businesses and early stage ventures.
A. TAX UPDATES
1) Change in Corporate Tax Rates
- Corporate Tax Rate reduced to 25% for existing domestic companies with turnover or gross receipts in FY 2015-16 =< INR 50 crores;
2) Scope of Tax on Dividend in the hands of recipient
- Existing tax on dividend in excess of INR 10 lakhs under section 115BBDA to be on all residents except domestic company and certain funds, trusts, institutions, etc.;
3) Tax deduction to Start-ups Extended Period
- Existing deduction under section 80-IAC by eligible start-ups can be claimed for any 3 consecutive years out of 7 years (as against existing period of 5 years) beginning from the year in which such eligible start-up is incorporated;
4) Carry forward and set off of loss in case of Eligible Start-ups
In case of eligible start-ups, the loss incurred in any year prior to the previous year shall be carried forward and set off against the income of previous year, if all the shareholders of such company which held shares carrying voting power on the last day of the year or years in which the loss was incurred:
- continue to hold those shares on the last day of such previous year; and
- such loss incurred during the period of seven years beginning from the year in which such company is incorporated;
5) Carry forward of MAT and AMT credit – Extended period and restriction on carry forward
- Minimum Alternate Tax (‘MAT’) and Alternate Minimum Tax (‘AMT’) credit can be carried forward up to 15th assessment years immediately succeeding the assessment years in which such tax credit becomes allowable;
- MAT/ AMT credit not to be allowed to be carried forward to subsequent year to the extent such credit relates to the difference between the amount of foreign tax credit (FTC) allowed against MAT/ AMT and FTC allowable against the tax computed under regular provisions of Act other than the provisions relating to MAT/AMT.
6) Indirect transfer provisions- clarification
- Explanation 5 to section 9(1)(i) not apply to any asset or capital asset mentioned therein being investment held by non-resident, directly or indirectly, in a Foreign Institutional Investor registered as Category-I or Category II Foreign Portfolio Investor under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 made under the Securities and Exchange Board of India Act, 1992;
(effective from AY 2012-13 and subsequent years)
7) Fee on delay in filing of Return of Income (Section 234F – newly inserted)
For AY 2018-19 and onwards in case, return is not filed within the due dates as per Section 139(1), following fee shall be levied:
- INR 5,000 if return is furnished on or before 31st December of AY;
- INR 10,000 in other cases;
- Aforesaid fee restricted to INR 1,000 in case total income upto INR 5 Lakhs;
- Existing penalty under section 271 F for failure to furnish return dispensed with;
8 ) Exemption of long term capital gains tax u/s 10(38)
- Exemption for income arising on transfer of equity shares to be available only if the acquisition of share is chargeable to Securities Transactions Tax under Chapter VII of the Finance (No 2) Act, 2004;
- However, to protect the exemption for genuine cases, the aforesaid shall not apply on acquisitions of shares to be notified by Central Government in this behalf;
9) Fair Market Value deemed to be the consideration in certain cases
Where consideration for transfer of share of a company (other than quoted share) is less than the Fair Market Value (FMV) of such share determined in accordance with the prescribed manner, the FMV shall be deemed to be the full value of consideration for the purposes of computing capital gains income;
B. REGULATORY UPDATES
1) SEBI Board Meeting
On 23 November 2016, the SEBI held its Board Meeting wherein the following decisions were taken:
- Amend SEBI (Alternative Investment Funds) Regulations, 2012 with respect to ‘Angel Funds’ namely:
- Upper limit for number of angel investors increased from forty nine to two hundred
- Definition of start-up for Angel Funds investments be similar to definition of Department of Industrial Policy and Promotion (DIPP) as given in their startup policy
- Minimum investment in the venture capital undertaking reduced from fifty lakhs to twenty five lakhs
- Lock in requirements of investments reduced from three years to one year
- allowed to invest in overseas venture capital undertakings upto 25% of their investible corpus in line with other Alternative Investment Funds (AIF)
- Amend SEBI (FPI) Regulations, 2014 to allow FPIs to invest in unlisted non-convertible debentures and securitized debt instruments.
- between private equity funds and promoters, directors and key management personnel of listed companies to incentivize the latter.
2) External Commercial Borrowings (ECB) for Start-ups
On 4 October 2016, the Reserve Bank of India (‘RBI’) issued statement on developmental and regulatory policies whereby ECBs were permitted up to USD 3 million in start-ups. Guidelines on the same have been issued on 27 October 2016.
3) RBI Circular on Investment by FVCI
On 20 October 2016, RBI issued an A.P. (DIR Series) Circular in continuation to the FEMA Notification 363/2016 dated 28 April 2016. Two important clarifications in the A.P. (DIR Series) Circular are as follows:
- Downstream investments by a VCF or a Cat-I AIF, which has received investment from FVCI, shall have to comply with the provisions for downstream investment as laid down in Schedule 11 of the Principal Regulations.
- An entity receiving investment directly from a registered FVCI will be required to report the investment, in form FCGPR.
4) Notification of various sections under the Companies Act, 2013
The Ministry of Corporate Affairs has notified the much-awaited sections in the Companies Act, 2013 dealing with amalgamation, compromise, arrangement, liquidation and winding up. The notified sections will be effective from 15 December, 2016, and are likely to bring a paradigm shift in the manner in which these important restructurings are implemented. Going forward, the National Company Law Tribunal (NCLT) will have jurisdiction over these matters, which until now were within the jurisdiction of the High Court. NCLT has been setup as a specialised body to deal with Company Law matters.
A. TAX UPDATES
1) Central Board of Direct Taxes (CBDT) notifies final Buy Back Distribution tax rules
- The buy-back of shares (both equity / preference shares) by an unlisted company is subject to buy-back distribution tax (‘Buyback Tax’) at the rate of 23.072% in the hands of the said company which is calculated as difference between (i) the buy-back consideration and (ii) the amount received by the Company for issue of such shares.
- The manner of determining the “Amount received by the Company” under various possible scenarios has been prescribed by the Ministry of Finance by inserting Rule 40BB (‘the Rule’) vide Notification dated October 17, 2016 (attached as Annexure 2). The Rule is effective from 1 June 2016.
- In case of a buyback which involves tender of original shares as well as bonus shares by a shareholder (or buyback of shares subscribed to at different prices), the provisions of the IT Act read with the Rules are not explicit whether the Buyback Tax ought to be calculated qua each shareholder or qua each share. Say in a bonus situation, this issue becomes relevant where the buyback price is less than the original subscription price per share, thereby, buyback of original shares could result in a loss whereas buyback of bonus shares (cost deemed to be nil) will result in an income (in a case where Buyback Tax is to be computed on a per share basis, the loss on original shares cannot be set off against the positive difference on buyback of bonus shares).
- However, a good view appears to be that Buyback Tax ought to be calculated on the aggregate consideration qua each shareholder and not qua each share. Accordingly, it may be argued that Buyback Tax may be calculated on the difference between the aggregate buyback consideration on all shares and original subscription consideration (zero being cost of bonus shares).
2) Frequently Asked Questions (FAQs) on Goods and Services Tax (GST)
On 3 August 2016, Rajya Sabha, the Upper House of Indian Parliament passed the Constitution Amendment Bill paving the way for introduction of GST. Separately, the Government of India has released a set of FAQ on the GST.
3) Constitution Amendment Bill for Goods and Service Tax (GST Bill)
On 8 September 2016, the President of India has given his assent to the Goods and Services Tax (GST) Bill, paving the way for the formation of the GST Council. Thereafter on 12 September 2016, the Union Cabinet, under the chairmanship of the Prime Minister, approved the setting up of the GST Council and its secretariat.
B. REGULATORY UPDATES
1) FAQs on Alternative Investment Fund (AIF)
2) Scheme for grant of Permanent Residency Status (PRS) to foreign investors
On 31 August 2016, the Union Cabinet has approved the scheme for grant of PRS to foreign investors subject to specified conditions. PRS will serve as a multiple entry visa without any stay stipulation, and will provide exemption from the Foreigners Regional Registration Office (FRRO) registration.
3) Amendment to exchange control norms for foreign investment in financial service sector
On 9 September 2016, the Foreign Exchange Department issued a notification in the Official gazette of India to amend exchange control norms for foreign investment in financial service sector on the following key aspects:
- Purely from an exchange control standpoint, FDI upto 100% is allowed under the automatic route in financial services activities regulated by financial sector regulators viz. RBI, SEBI, IRDA, PFRDA, NHB or any other notified regulator [earlier, FDI under the automatic route, was permitted in 18 eligible FS activities enumerated in the FDI regulations – this list of 18 eligible activities is deleted].
- Minimum capitalisation norms as mandated under the FDI policy have been eliminated.
4) Consultation Paper for “Amendments/ clarifications to the SEBI (Investment Advisers) Regulations, 2013
SEBI notified the SEBI (Investment Advisers) Regulations, 2013 (“IA Regulations”) on January 21, 2013. Under IA Regulations, exemptions from registration as an investment adviser were granted to certain entities who were providing investment advice as an incidental activity to their primary activity.
In order to specify uniform standards and to address the gaps or overlaps in legal or regulatory standards governing all the intermediaries/persons engaged in providing investment advisory services, SEBI Board has approved bringing out a consultation paper proposing certain changes and clarifications in the IA Regulations.
5) Consolidated Foreign Direct Investment Policy Circular of 2016 dated June 07, 2016
Government of India issued consolidated FDI Policy of 2016. The present consolidation subsumes and supersedes all press notes/press releases/circulars issued by DIPP, which were in force as on June 06,2016 and reflect the FDI Policy as on June 07, 2016. Following amendments have been made in the consolidated FDI Policy Circular of 2016:i. Some definitions have been amended and some new definitions have been added to the FDI Policy of 2016. Amended and new definitions are as under:
a) Definition of “Capital” has been amended and warrants and partly paid shares have been included in definition of capital. In erstwhile Policy of 2015, warrants and partly paid shares could be issued only under government approval route. The revised definition is as under:
‘Capital’ means equity shares; fully, compulsorily & mandatorily convertible preference shares; fully, compulsorily &mandatorily convertible debentures and warrants.
Note: The equity shares issued in accordance with the provisions of the Companies Act, as applicable, shall include equity shares that have been partly paid. Preference shares and convertible debentures shall be required to be fully paid, and should be mandatorily and fully convertible. Further, ‘warrant’ includes Share Warrant issued by an Indian Company in accordance to provisions of the Companies Act, as applicable.
b) New definition of “Employees Stock Option” is included. It reads as under:
“Employees’ Stock Option” means the option given to the directors, officers or employees of a company or of its holding company or joint venture or wholly owned overseas subsidiary/ subsidiaries, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.
c) New definition of “Investment Vehicle” is included in FDI Policy of 2016. It reads as under: ‘Investment Vehicle’ shall mean an entity registered and regulated under relevant regulations framed by SEBI or any other authority designated for the purpose and shall include Real Estate Investment Trusts (REITs) governed by the SEBI (REITs) Regulations, 2014, Infrastructure Investment Trusts (InvIts) governed by the SEBI (InvIts) Regulations, 2014 and Alternative Investment Funds (AIFs) governed by the SEBI (AIFs) Regulations, 2012.
d) Definition of “Non-Resident Indian” is amended and the new definition reads as under:
‘Non-Resident Indian’ (NRI) means an individual resident outside India who is a citizen of India or is an ‘Overseas Citizen of India’ cardholder within the meaning of section 7 (A) of the Citizenship Act, 1955. ‘Person of Indian Origin’ cardholders registered as such under Notification No. 26011/4/98 F.I. dated 19.8.2002 issued by the Central Government are deemed to be ‘Overseas Citizen of India’ cardholders.
e) Definition of company “owned” by resident India citizens is amended and Limited Liability Partnership is also included in the amended definition. In terms of amended definition a Limited Liability Partnership will be considered as owned by resident Indian citizens if more than 50% of the investment in such an LLP is contributed by resident Indian citizens and/or entities which are ultimately ‘owned and controlled by resident Indian citizens’ and such resident Indian
f) New definition of “Sweat Equity Shares” is included in FDI Policy of 2016. It reads as under:
‘Sweat Equity Shares’ means such equity shares as issued by a company to its directors or employees at a discount or for consideration other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.
g) New definition of “unit” is included in FDI Policy of 2016. It reads as under:
‘Unit’ shall mean beneficial interest of an investor in the Investment Vehicle and shall include shares or partnership interests.
h) Definition of “Venture Capital Fund” is amended. The revised definition reads as under:
‘Venture Capital Fund’ (VCF) means an Alternative Investment Fund which invests primarily in unlisted securities of startups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model and shall include an angel fund as defined under Chapter III-A of SEBI (AIF) Regulations, 2012.
i) Following shall be treated as eligible investors:
- A company, trust and partnership firm incorporated outside India and owned and controlled by NRIs can invest in India with the special dispensation as available to NRIs under the FDI Policy.
- A Non-Resident Indian may subscribe to National Pension System governed and administered by Pension Fund Regulatory and Development Authority (PFRDA), provided such subscriptions are made through normal banking channels and the person is eligible to invest as per the provisions of the PFRDA.
A. TAX UPDATES
1) Finance Act, 2016
- Distribution of non-business income by an Alternative Investment Fund (‘AIF) to a non-resident would be subject to withholding tax as per rates in force (beneficial tax treaty rate should be available). Further, it has been clarified that no withholding shall be made in respect of income that is not chargeable to tax under the Income-tax Act, 1961 (‘the Act’) where the payee is a non-resident.
- Beneficial tax rate of 10% extended to long term capital gains arising to a non-resident on transfer of shares of private company.
- Minimum Alternate Tax (‘MAT’) not applicable to foreign companies (with retrospective effect from 1st April 2001) subject to conditions
- Period of holding to qualify as long term capital asset for unlisted shares reduced to 24 months from 36 months
- Tax incentives for eligible start-ups, as mentioned below:
- A startup shall have the benefit of lower rate of tax i.e. 25% of the total income if the following conditions are satisfied:
- the company has been set-up and registered on or after the 1st day of March, 2016
- the company is not engaged in any business other than the business of manufacture or production of any article or thing and research in relation to, or distribution of, such article or thing manufactured or produced by it; and
- the total income of the company has been computed without taking the benefit of profit linked deduction, without set-off and carry forward of losses of earlier years pertaining to these profit linked deductions and depreciation.
- Tax holiday for eligible startup companies for 3 consecutive years out of 5 years from their incorporation, subject to certain conditions. However MAT would be applicable.
- Capital gains arising to an individuals/ HUF on transfer of residential property to be exempt from tax if invested in an eligible start-ups subject, to conditions
- A startup shall have the benefit of lower rate of tax i.e. 25% of the total income if the following conditions are satisfied:
- Scope for the applicability of buyback distribution tax widened. Earlier, it was restricted to buy back under section 77A of Companies Act 1956 now extended to all buy back of unlisted shares conducted as per the provisions of law relating to companies
- Income by way of dividend from a domestic company received by an individual, HUF or firm, resident in India, in excess of Rs. 10 lakhs shall be taxable at the rate of 10%.
2) Period of holding of debentures before conversion to be considered- Rule 8AA notified
The Central Board of Direct Taxes (‘CBDT’) has, vide an amendment to the Income-tax Rules, 1962 (‘the Rules’), notified Rule 8AA. As per the new Rule, the period for which bond, debenture, debenture-stock or deposit certificate, was held by the taxpayer prior to conversion shall be considered for determining the period of holding of shares or debentures acquired upon conversion.
3) Income/loss arising from transfer of unlisted shares to be deemed capital gains
The CBDT vide its instruction has provided that income from transfer of unlisted shares (for which no formal market exists for trading) would be treated as ‘Capital Gain’ irrespective of period of holding. The above would not be necessarily applied in the following cases where the Tax Office would take an appropriate view:
- genuineness of transactions in unlisted shares itself is questionable; or
- transfer of unlisted shares is related to an issue pertaining to lifting of corporate veil; or
- transfer of unlisted shares is made along with the control and management of underlying business.
4) Protocol for amendment of India-Mauritius tax treaty signed
On 10th May 2016, Governments of India and Mauritius signed a Protocol for amending the treaty dated 24 August, 1982, between India and Mauritius. The key features of the Protocol are as follows:
Source-based taxation of capital gains on shares:
With this Protocol, India gets taxation rights on capital gains arising from alienation of shares acquired on or after 1st April, 2017 in a company resident in India with effect from financial year 2017-18, while simultaneously protection to investments in shares acquired before 1st April, 2017 has also been provided. Further, in respect of capital gains arising (on shares acquired post 31st March, 2017) during the transition period from 1st April, 2017 to 31st March, 2019, the tax rate will be limited to 50% of the domestic tax rate of India, subject to the fulfillment of the conditions in the Limitation of Benefits Article. Taxation in India at full domestic tax rate will take place from financial year 2019-20 onwards.
Source-based taxation of interest income:
From 1st April, 2017, interest arising in India and paid to a resident of Mauritius should be subject to tax in India at rate of 7.5% of the gross amount of interest if the beneficial owner of the interest is a resident of Mauritius.
Taxation of Fee for Technical service:
From 1st April, 2017, fees for technical services arising in India and paid to a resident of Mauritius should be taxable in India at the rate of 10% of the gross amount of fees for technical services if the beneficial owner of the fees for technical services is a resident of Mauritius
Taxation of any Other Income
From 1st April, 2017, as per the revised treaty, income not expressly dealt with in any other provision of the treaty may also be taxed in the country in which the income arises.
5) CBDT : Resident persons investing in start-ups not subject to taxation u/s 56(2)(viib)
The CBDT vide its notification has provided that resident persons investing in start-ups will not be subject to provisions of section 56(2)(viib) i.e. tax on excess consideration received upon issue of shares over its fair market value as Income from Other Sources in the hands of the issuing company.
6) GAAR – grandfathering of investments made prior to 1 April 2017
The CBDT has, vide its notification , amended Rule 10U of the Rules. As per the said Rules, the provisions of Chapter X-A (dealing with GAAR) shall not apply to any income accruing or arising to or deemed to accrue or arise to or received or deemed to be received by any person from transfer of investments made before 1 April 2017.
7) CBDT: Notifies rules relaxing TDS u/s 206AA; Payee to furnish Tax Residency Certificate (‘TRC’), Tax identification number
On 24 June 2016, the CBDT issued a notification and has inserted new Rule 37BC providing for details to be submitted by a non-resident payee for relaxation from deduction of tax at higher rate u/s 206AA (applicable when deductee PAN not available); New Rule provides that a non-resident deductee shall not be subject to higher tax u/s 206AA in respect of payments for interest, royalty, FTS, and transfer of capital assets , where the deductee furnishes ‘specified details/documents’; These include TRC and Tax Identification Number (‘TIN’) or unique identification number in the country of residence alongwith name and address.
- Credit shall also be allowed in respect of foreign disputed tax subject to compliance with conditions;
- To claim the FTC, taxpayer must furnish a statement of income from the overseas country offered for tax and details of foreign tax in prescribed Form.
B. REGULATORY UPDATES
1) Changes in key FDI Sectors- There are 10 sectors in which FDI norms has been relaxed.
2) Change in Foreign Exchange Management Act (‘FEMA’) Regulation 20 (FDI Regulations)
i) New revised Schedule 11 introduced replacing the existing Schedule 11 pertaining to investment by a person resident outside India in an Investment vehicle (includes AIF). Key change in the revised schedule 11 is that the ownership and control of an LLP is to be determined as defined in the FDI policy and the SEBI no longer has the power to determine whether an LLP is foreign owned and controlled in case LLP is acting as sponsor or manager or investment manager to an Investment Vehicle.
- FDI Policy defines the ‘owned and controlled’ of an LLP as follows:
- Owned : An LLP is considered as ‘owned’ by resident Indian citizens if more than 50% of the investment in such an LLP in contributed by resident Indian citizens and/ or entities that are ultimately owned and controlled by resident Indian citizens; and such resident Indian citizens and entities have majority of the profit share.
- Control: Right to appoint majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of the LLP.
ii) New revised Schedule 4 introduced replacing the existing Schedule 4 pertaining to acquisition of securities or units by a Non-resident Indian on Non-repatriation basis
The key changes to revised Schedule 4 is as under:
- A Non-resident Indian (NRI), including a company, a trust and a partnership firm incorporated outside India and owned and controlled by non-resident Indians, may acquire and hold, on non-repatriation basis, equity shares, convertible preference shares, convertible debenture, warrants or units, which will be deemed to be domestic investment at par with the investment made by residents. Without loss of generality, it is stated that
- An NRI may acquire, on non-repatriation basis, any security issued by a company without any limit either on the stock exchange or outside it.
- An NRI may invest, on non-repartition basis, in units issued by an investment vehicle without any limit, either on the stock exchange or outside it.
- An NRI may contribute, on non-repatriation basis, to the capital of a partnership firm, a proprietary firm or a Limited Liability Partnership without any limit.
- The sale/maturity proceeds (net of applicable taxes) of the securities or units acquired under this Schedule shall be credited only to NRO account irrespective of the type of account from which the considerations for acquisition were paid.
iii) New revised Schedule 6 introduced replacing the existing schedule 6 for Foreign Venture Capital Investor (‘FVCI’) investment.
The key changes to revised Schedule 6 is as under:
- FVCI permitted to invest in units of a Venture Capital Fund (‘VCF’) or a Category I Alternative Investment Fund (‘AIF’) or units of a scheme or fund set up by VCF or Category I AIF;
- FVCI permitted to invest in equity / equity linked instruments / debt instruments issued by a start-up irrespective of the sector in which it is engaged. The definition of ‘start-up’ has been included in regulation 2;
- It has been specifically clarified that FVCI shall not require prior RBI approval for any investments made under Schedule 6;
- List of 10 sectors in which FVCI is allowed to invest has been added as Annexure to Schedule 6 and
- FVCI may acquire by purchase or otherwise, from, or transfer, by sale or otherwise to any person resident or non-resident, any security / instrument it is allowed to invest in at a price mutually acceptable to the buyer and the seller/ issuer. FVCI may also receive proceeds of liquidation of VCFs or of Cat-I AIFs or of schemes / funds set up by VCFs or Cat-I AIFs. This will be without any prior RBI approval.
3) Cross border transfer of shares of an Indian company permitted on deferred basis
On 20th May 2016, the RBI issued notification to permit transfer of shares on a deferred basis, subject to compliance with following conditions:
- Maximum 25% of the total consideration can be paid by the buyer on a deferred basis
- The total consideration paid for shares must be compliant with applicable pricing guidelines
- The parties can enter into an escrow arrangement for the consideration payable on deferred basis
- If the total consideration is paid, the seller can furnish an indemnity for the amount of consideration payable on deferred basis
- The consideration payable on deferred basis should be paid within a period of 18 months from date of transfer agreement. Also, the escrow arrangement / period of indemnity cannot exceed 18 months.
The above conditions need to be complied with for transfer of shares on a deferred basis between a resident buyer and a non-resident seller, or vice versa.
4) Companies (Share Capital and Debentures) Third Amendment Rules, 2016
Amendments in relation to startup companies:
- The existing rules restricted companies from issuing sweat equity shares in excess of 25% of the paid up capital at any time and had limitation in terms of the issuance of sweat equity shares per year to 15% of the paid up capital or issue value of Rs.5 crores, whichever is higher. The amendment expressly allows notified start-ups to issue sweat equity shares not exceeding 50% of its paid up capital up to 5 years from the date of its incorporation or registration. However, the yearly limits of 15% of paid up capital or Rs.5 crores, whichever is higher has to be complied with.
- The existing rules restricted issuance of ESOP to employees who are (i) promoters or belong to the promoter group and (ii) director who either himself or through his relative or through anybody corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company. The amendment allows the notified start-ups to issue shares to these classes of employees upto 5 years from the date of incorporation or registration.
Other relevant amendments:
- The existing rules mandated that the securities allotted by way of a preferential issue to be fully paid up at the time of their allotment. Per the amendment, preferential issue of partly paid securities is now permitted.
- The existing rules mandated upfront determination of the price of resultant shares on the basis of a valuation report in case of convertible securities offered on a preferential basis. The amendment permits the issuer to fix the conversion price upfront (at time of issue) or fixing the price 30 days in advance to date when the holder of convertible security becomes entitled to apply for shares based on a valuation report given by the registered valuer not earlier than sixty days of the date when the holder of convertible security becomes entitled to apply for shares. However, the issuer shall take a decision on such fixation of the conversion price at the time of offer of convertible security itself and make such disclosure in the explanatory statement annexed to the notice of the general meeting.
- The existing provisions permitted creation of charge or mortgage as security for debentures issued only on the assets of the issuing company. The amendment allows companies to create charge on the assets of their subsidiaries or holding or associates also in addition to their own assets.
5) Companies (Acceptance of Deposits) Amendment Rules 2016
On 29 June 2016, the Ministry of Corporate Affairs has notified Companies (Acceptance of Deposits) Amendment Rules 2016. The key amendments are:
The Rule 2 of the Deposit Rules has been amended to provide as under:
- Any amount received by the company under any collective investment scheme in compliance with SEBI regulations shall not be regarded as deposit;
- Any amount received by a company from AIF, Domestic Venture Capital Fund (‘DVCF’) and Mutual Funds registered with SEBI in accordance with its regulations shall not be regarded as deposit;
- An amount of INR 25 lakh or more received by a start-up company by way of a convertible note (convertible into equity shares or repayable within a period not exceeding 5 years from the date of issue) in single tranche from a person shall not be regarded as deposit;
- Any amount raised by inter-alia issue of bonds or debentures compulsorily convertible into shares of the company within 10 years shall not be regarded as deposit (earlier, it was convertible into shares within 5 years)
On 17 February 2016, The Department of Industrial Policy and Promotion (DIPP) has issued a notification providing a definition of ‘startup’ to bring uniformity in identifying enterprises which can take benefits of the initiatives taken by various Ministries of the Government of India.
The Notification also states the identified startups as per the definition shall obtain a certificate of an eligible business from the Inter-Ministerial Board of Certification to obtain benefits available to startups.
A) FOREIGN INVESTMENT IN AIF (Notification No. FEMA.355/2015-RB)
Non-residents including FPIs and NRIs permitted to invest in units of inter-alia, SEBI registered AIFs under the Automatic Route
Downstream investment by AIF to be regarded as foreign investment if neither Sponsor nor Investment Manager of the said AIF is Indian “owned and controlled” as defined under the FEMA Inbound Regulations:
- Amount of foreign investment in corpus of AIF not relevant for determining whether downstream investment by AIF is foreign investment
In case Sponsor or Investment Manager is organized in a form other than a company (i.e. LLP, etc), SEBI to determine whether the Sponsor or Investment Manager is foreign owned and controlled
- Subsequent Press Note by DIPP specifically defines “control” and “ownership” in relation to LLP (refer Annexure)
- Dichotomy between RBI Notification permitting FDI in AIF and Press Note 12 (2015 series) defining the “control” and “ownership” in relation to LLP.
Downstream by AIF having foreign investment to conform to sectoralcaps and conditionalities.
AIF having foreign investment to make such report and in such format to RBI or SEBI as may be prescribed.
No Government approval required for investment in automatic route sectors by way of swap of shares
B) ACTION PLAN: STARTUP INDIA-STANDUP INDIA
Compliance Regime based on Self- Certification: To reduce the regulatory burden on Startups thereby allowing them to focus on their core business and keep compliance cost low.
Rolling-out of Mobile App and Portal: Governments shall introduce a Mobile App to provide on-the-go accessibility.
Legal Support and Fast – tracking Patent Examinations at Lower Costs.
Faster Exit for Startups: To make it easier for Startups to wind up operations.
Providing Funding Support through a Fund of Funds with a Corpus of INR 10,000crore: The Fund will be in the nature if Fund of Funds, which means that it will not invest directly into Startups, but shall participate in the capital of SEBI registered Venture Funds and Life Insurance Corporation (LIC) shall be a co-investor in the Fund of Funds.
Credit Guarantee Fund for Startups: To catalyse entrepreneurship by providing credit to innovators across all sections of society.
Tax Exemption on Capital Gains: To promote investments into Startups by mobilising the capital gains arising from sale of capital assets.
This exceptional initiative that shall make investors to invest in start-ups rather than capital gains bonds or house property. This exemption must allow capital gains to be invested in SEBI registered AIFs, Fund of Funds, and angel investments in the start-ups validated by Inter-Ministerial Board. A clarification in the notification on its scope is essential.
Tax Exemption for Startups for 3 years: To promote the growth of Startups and address working capital requirements.
This shall give a huge relief on working capital blocked in TDS for the start-ups. In reality our start-up are loss-making in the initial 3-7 years as they are chasing growth, but we hope the notification shall clarify that the clients of start-ups shall be exempted from deduction of TDS on the invoices. A saving of cash flow that today gets blocked in TDS for 12-18 months shall enable them to run faster.
Tax Exemption on Investments above Fair Market Value (Start-up Tax (Section 56(2)(vii b)): To encourage seed-capital investment in Startups.
This is only an incremental step of exempting the incubation enters in addition to venture capital funds. The CBDT needs to exempt all angel investments for the start-ups to raise funds freely from angels.
SEBI had constituted a standing committee ‘Alternative Investment Policy Advisory Committee’ (AIPAC) under the chairmanship of Shri. N. R. Narayan Murthy in March 2015. AIPAC has submitted its first report to SEBI with various recommendations (the same is attached). Public comments on the said report are invited by February 10, 2016.
We have summarized below the key recommendations made under the said report:
- Clarity on AIF taxation:
- To either abolish the TDS requirement by AIF on distribution or clarify:
- No TDS on exempt income/ exempt investors/ accredited investors.
- Clarity on TDS by AIFs on net income chargeable to tax in hands of investors as against gross income.
- Income of AIF to be characterized as investment income and not business income.
- Losses of AIF to be available for set off by investors.
- Non-resident investors to be subject to tax as per rates in force; If subject to Section 195 of the Income-tax Act, 1961 (‘Act’), should be exempt from Section 194LBB of the Act.
- Non-resident investors to have the option to obtain a NIL/ lower TDS certificate under Section 197 of the Act.
- To either abolish the TDS requirement by AIF on distribution or clarify:
- Exemption to AIF and portfolio companies from applicability of Sections 56(2)(viia) and 56(2)(viib) of the Act
- Exemption from indirect transfer provisions on gains from transfer of shares or interest of the holding companies/entities above eligible investment funds (EIFs) investing in India
- Liberalisation of Safe Harbour norms
- Introduction of Securities Transaction Tax (‘STT’) on all gross distributions of AIFs and elimination of tax withholding/ other taxes in hands of investors.
- STT to be levied on investment/ purchase and sale of AIF units.
- Other recommendations:
- Investors in angel funds/ social venture funds to get incentive in the form of deduction of upto 50% of investment amount
- Allow management fees to be capitalized as ‘cost of improvement’ or allow standard deduction of 3% of cost of acquisition
- Taxation upon ‘sale’ and reduced taxation rates for unlisted shares acquired via ESOPs/employee incentive schemes
- Clarify tax rate of 10% on LTCG on transfer of private company shares
- To align the treatment of capital gains for listed and unlisted companies, both on holding period and tax breaks
- CCPS conversion to be non-taxable event and period of holding to be from date of investment and not date of conversion
- AIFs to be permissible investments for charitable and religious trusts
- Service tax abatement on services fees in respect of funds raised by an AIF from overseas investors
2. FDI in AIF regulation:
- Investment by NRIs from NRO accounts to be permissible
- Permission to LLPs to act as sponsor/and or managers, etc.
- To exclude AIFs with 100% domestic investments with foreign owned or controlled Sponsor and /Manager from foreign investment conditions
3. Reforms to unlock domestic capital pool
- Pension Funds and Charitable Trusts to be permitted to invest in AIFs
- For Insurance cos:
- Investment limits in AIFs to be increased
- to simplify approval process
- For Banks – increase investment limits and lower risk weightage attached to investments in AIFs
- Accredited investors satisfying prescribed conditions to be eligible for investment in AIFs
- Registrar of Companies to permit LLP to carry on investing activities, i.e. register as AIF
- Single Family Offices to be allowed to register specified investment vehicles as QIBs; Family Offices and dedicated state funded vehicles be eligible for registration as AIFs
- FVCI – sectoral restrictions to be liberalized; single stage approval process at designated depository participant level – akin to FPI
- IPO – Allow all AIFs to get an allocation in an IPO; AIFs like Mutual Funds to be allowed to anchor an IPO, even if the lead manager is a group company
- Amendments to AIF regulations for Angel Funds providing relaxation of minimum investment period, minimum investment amount, maximum no. of investors, permission to invest in overseas VCUs.
4. Reforming AIF Regulatory Regime: To regulate the Fund manager instead of the Fund
- To repeal PMS, AIF and IA regulations and introduce a new “SEBI (Alternative Investment Fund Managers) Regulations” (‘AIFM Regulations’)
- to have specific capitalization requirements, which could provide for sub-categories based on the nature of the AIFM’s business (i.e. discretionary, non-discretionary, customized or collective investments)
- Angel Funds/ network and social venture funds to be a separate category of AIF
- Amendments in AIF Regulation
- The definition of VCF and Category I AIF to be expanded to growth stage investee companies
Overseas investment by AIFs: Limits to be extended to (a) 25% of the corpus of an AIF (currently provided by SEBI) or (b) 50% of the offshore component of the corpus of AIF, whichever is higher; SEBI’s requirement of ‘Indian connection’ to be liberalized.
A) VCFs like YourNest permitted to invest upto 25% vs 10% in offshore startups.
Guidelines on overseas investments for AIFs/VCFs circular dated October 1, 2015 (CIR/IMD/DF/7/2015) issued by SEBI as under:
Key changes with respect to overseas investment by VCFs
- VCFs are, from the date of this circular, permitted to invest in Offshore Venture Capital Undertakings which have an India connection upto 25% of the investible funds of the VCF;
- VCFs shall not invest in Joint venture/ Wholly Owned Subsidiary while making overseas investments;
- VCFs shall adhere to FEMA Regulations and other guidelines specified by RBI from time to time with respect to any structure which involves Foreign Direct Investment (FDI) under Overseas Direct Investment (ODI) route;
- VCFs shall comply with all requirements under RBI guidelines on opening of branches/subsidiaries/ Joint venture/ undertaking investment abroad by NBFCs, where more than 50% of the funds of the VCF has been contributed by a single NBFC; and
- The VCFs desirous of making investment in offshore venture capital undertaking shall submit their proposal for investment to SEBI for its prior approval.
B) Fund Tenure period to start from close date:
Guidelines on other issues/clarification circular dated October 1, 2015 (CIR/IMD/DF/7/2015) issued by SEBI as under:
Tenure of any scheme of the AIF shall be calculated from the date of final closing of the scheme (fund launched with effect from 1st October, 2015).
C) Startup Act in Works To Crank up Innovation: Govt plans to simplify rules to unleash entrepreneurial energies & create jobs:(ET, November 3, 2015)
The Narendra Modi government wants to provide a powerful launched for start-ups by drastically simplifying the rules and ensuring that innovators are able to take advantage of such an enabling environment, thus unleashing entrepreneurial energies and creating jobs.
At the heart of the initiative is distilling the cumbersome process of compliances under 22 different laws into a two-page Startup Act, a senior government official told. The Department of Industrial Policy and Promotion (DIPP) is looking to turn India into a startup haven.
On the Agenda of Startup Act:
- One simple Start Up Act replacing multiple laws.
- Focus on reducing compliances & speed up setting of businesses.
- Limit the law to “innovative” product/technology service
- Idea should push manufacturing and generate jobs.
D) New Bankruptcy Bill to Speed up Shutdown of Cost (ET, November 5, 2015):
The Bankruptcy Law reforms commission headed by former secretary TK Viswanathan has proposed insolvency resolution within 180 days and a new regulator oversee the process. It’s also laid down clear and speedy systems for early identification of financial distress and revival of companies.
E) Relatives excluded from definition of “Deposits”
MCA amended the Companies (Acceptance of Deposits) Rules, 2014 on 15th September, 2015 that:
- The definition of “deposit” has been amended to exclude any amount received from a relative of the director of the private company, provided such relative furnishes a declaration that such amount is not out of funds acquired by him by borrowing or accepting loans/deposit from others;
- The company shall disclose the details of money so accepted in the Board’s report.
F) Firms can claim Income-Tax deduction on expenses for IPR acquisition
The Supreme Court on 28th October 2015 (Mangalore Ganesh Beedi Works vs CIT) has held that a firm can claim deduction or depreciation in income tax on expenses incurred for acquisition of intellectual property, such as patent and trademarks rights, copyrights and know-how, as they are capital in nature.
GAAR: Applicability deferred to FY 2017-18 onwards. Exits made before March 31, 2017 won’t attract GAAR. All investments made upto March 31, 2017 will be protected from applicability of GAAR by amendment to be made in Income tax rules (to be notified).
Permanent Establishment Safe Harbour- Fund management activity undertaken in India by an eligible fund manager on behalf of an eligible offshore fund will not trigger business income taxation for the offshore fund in India.
Qualifying criteria for an eligible fund include:
- Fund is a non-resident of India (activities of fund manager in India will not itself result in the offshore fund being regarded resident in India).
- Fund must be resident if a country with which India has a treaty (including information exchange treaty).
- Indian residents cannot own more than 5% of the corpus of the fund.
- Fund must be subject to investor protection regulations in home country jurisdiction.
- Fund must have minimum 25 unconnected members.
- No individual investor (including connected person) can hold 10% or more in the fund.
- Participation interest of 10 or less members along with their connected persons shall be less than 50% of the fund.
- Fund cannot invest more than 20% for its corpus in any entity.
- Fund cannot invest in any associate entity.
- Monthly average corpus of the fund cannot be lower than INR 100cr.
- Fund does not undertake any other business in India.
- Fund does not undertake any other activity in India, which can result into a business connection in India and
- Fund remunerates the fund managers on an arm’s length basis.
Key qualifying criteria for the eligible fund manager include:
- Fund manager cannot be connected person of the fund.
- Fund manager must be registered as a fund manager or investment advisors with SEBI under the regulations stipulated for portfolio manager, investment advisor or such other regulations as my be specified by SEBI.
- Fund manager is not entitled to more than 20% profits earned by the Fund.
Residency of Foreign Companies: Any foreign company with place of effective management in India (“POEM”) at any time during the year will qualify as Indian resident- may not be entitled to claim tax treaty. Currently, only 100% management and control in India triggers residency. POEM linked to key management and commercial decisions of an entity as a whole. Specific exemption for eligible Fund Managers covered in 4 above.
Global Depository Receipts: Definition modified to cover only GDRs with underlying listed Securities- tax planning opportunity curtailed.
Tax Pass-through for AIF 1 and 2:
- Eligible for pass through only for capital gains and interest income (but not for business income)-Fund will have to withhold tax @10%
- Income received by the Fund to be exempted from TDS by portfolio companies (notification to be issued)
- Capital loss cannot be passed on to the investors- Fund will have to carry it forward for set off in future years.
- Business income taxable at trust level-correspondingly distribution of such income exempt for investors.
- Fund will need to file tax return.
Indirect Transfer Taxation related relaxation:
- Substantial assets in India deemed at 50%
- Small shareholders holding 5% or less, directly or indirectly, excluded from the indirect transfer tax.
- Indirect transfer taxation restricted to proportion of assets in India v outside India (rules to be prescribed).
- Reporting obligation on Indian entity in case of taxable indirect transfer.
- Exemption for capital gains income earned by FIIs only- Interest income and short term capital gains on NCDs of FII may be subject to MAT.
- Creates a larger issue for investors other than FIIs- like PE and FDI investors- current debate whether MAT is exempt under the Treaty.
- Income from AOP exempt from MAT.
- Effective corporate tax rate (including BDT and DDT) increased for domestic companies due to increase in surcharge by 2%.
- Corporate tax rates to b reduced from existing 30% to 25% over 4 years starting from April, 2016 accompanied by the removal of many incentive provisions (no change in the current year.
Income Computation Disclosure Standards (ICDS): CBDT notified 10 ICDS on March 31, 2015, which is applicable from FY2015-16.
- Applicable to all assesses following mercantile system of accounting.
- Applicable to compute income chargeable under the head of ‘Profit and gains of business or profession’ or ‘Income from other sources’
- In case of a conflict between the provisions of the Income Tax Act and ICDS, provisions of the Act shall prevail.
- Substantial disclosure norms prescribed under each ICDS- manner of disclosure not yet prescribed.
Specified Domestic Transaction: Transfer pricing provisions to apply for transaction above INR 20crores as against INR 5crores.
Direct Tax Code (DTC): DTC is history.
3) Corporate Law
Changes introduced by Companies (Amendment) Act, 2015:
- Requirement of minimum paid up Share Capital by a company done away with
- Requirement of Common Seal non-mandatory
- Certificate of commencement of business no longer required to be obtained
- Penal provisions has been introduced for contravention related to Acceptance of deposit by Companies
- No person shall be entitled to inspect or obtain copies of the Board Resolutions filed with Registrar
- No dividend to be declared unless brought forwards losses and depreciation not provided on previous year are set off against profit of the company for the current year
- Auditor shall report an offence of fraud to Audit Committee or Board of Director and same shall be forwarded to Government.
- Loan/ guarantee/security provided by the holding company to its wholly owned subsidiary exempted from restrictions under Section 185 of Companies Act 2013, provided loans are utilized or its principal business activity
- Special resolution for approving the related party transaction has been done away with (Section 185). Now even a board resolution valid
- No resolutions required if the accounts of holding and subsidiary company are consolidated and place before shareholders in general meeting for approval
Exemption/Relaxations for private companies notified by Ministry of Corporate Affairs (MCA):
- Issuance of equity shares with differential voting rights without complying with stringent conditions, if provided in MOA and AOA
- Holding, subsidiary, associate, fellow subsidiary companies are not subjected to related party transactions. Member being a related party can vote for approval of such transaction
- Resolutions on providing loans (i) to directors/persons in whom the directors are interested OR (ii) to any person for purchase of its own shares not applicable to private companies, provided
- No other body corporate has invested in the share capital of such company
- Its borrowings from banks/FIs/anybody corporate is less than the lower of twice its paid up share capital or INR 50 crs
- It has not defaulted on repayment of such borrowings subsisting at the time of making the transaction
- Acceptance of deposits from its members without complying with specified conditions, provided the deposits accepted do not exceed aggregate of paid-up share capital and free reserves details of the deposits accepted are filed with the Registrar
- Time limit to offer Right Issue- can be less than 15 days, provided approved by 90% members.
- ESOPs can be issued subject to an ordinary resolution
- Possible for a director to participate in a meeting where the contract in which he is interested is discussed, after disclosure of his interest.
- Indian company permitted to issue partly paid shares and warrants to the FDI Investors under Automatic Route.
- In case of unlisted companies, pricing methodology to determine fair value of shares in case of issue and transfers has been revised.
- Fair value should be determined as per internationally accepted pricing methodology (instead of DCF method prescribed earlier).
- Indian company permitted to issue equity shares, CCPS and CCDs with optionality clause to FDI Investors.
CBDT clarification on Taxation of AIF
- In case Trust Deed either does not name the investors or does not specify their beneficial interest, entire income of the Trust liable to be taxed at MMR-practical difficulties for AIFs set up as Trust.
- In such cases, investors need to be taxed as the corresponding income has already been taxed at MMR at the Trust Level.
- Dividend Distribution Tax increased from 16.995% to 19.994% due to grossing up.
3) Company Law
Companies (Amendment) Bill, 2014-Passed by Lok Sabha
- The requirement of having minimum paid up share capital is omitted, for ease of doing business.
- Having a common seal of the company for authorisation and execution of documents is now optional.
- Ordinary resolution in place of special resolution for approval of related party transactions.
- Board resolution filed with the registrar would not be available for public inspection.
Draft Notification for exemption to Private Company
- Provisions related to equity shares with differential voting rights and related party transactions
- Reduced time limit for making Rights Offer
- Certain relaxations on Loan to Directors or persons in whom director is interested
- Issue of shares under ESOPs to require ordinary resolution instead of special resolution
Foreign Direct Investment (FDI) in India – issue / transfer of shares or convertible debentures – revised pricing guidelines
The RBI has issued A. P. (DIR Series) Circular No. 4 dated 15 July 2014, whereby the extant pricing guidelines in respect of transfer / issue of shares and for exit from investment in equity shares with or without optionality clauses of listed / unlisted Indian companies have been reviewed so as to provide greater freedom and flexibility to the parties concerned under the FDI framework.
The new pricing guidelines shall be as under:
– In case of listed companies:
The issue and transfer of shares including compulsorily convertible preference shares and compulsorily convertible debentures shall be as per the SEBI guidelines;
The pricing guidelines for FDI instruments with optionality clauses shall continue to be in accordance with A.P. (DIR Series) Circular No. 86 dated 9 January 2014, i.e., the non-resident investor shall be eligible to exit at the market price prevailing on the recognised stock exchanges subject to lock-in period as stipulated, without any assured return.
– In case of unlisted companies
The issue and transfer of shares including compulsorily convertible preference shares and compulsorily convertible debentures with or without optionality clauses shall be at a price worked out as per any internationally accepted pricing methodology on arm’s length basis. Thus, the guiding principle will be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment / agreement and shall exit at a fair price computed as above at the time of exit subject to lock-in period requirement as applicable in terms of A.P. (DIR Series) Circular No. 86 dated 9 January 2014.
The changes in the existing pricing guidelines for FDI applicable to transfer / issue of shares and for exit from foreign direct investment with optionality clauses for the unlisted Indian companies are given in the Annex 1 and Annex 2 to the Circular respectively.
An Indian company taking on record in its books any transfer of its shares or convertible debenture by way of sale from a resident to a non-resident and a non-resident to a resident shall disclose in its balance sheet for the financial year, in which the transaction took place, the details of valuation of share or convertible debentures, the pricing methodology adopted for the same as well as the agency that has given / certified the valuation.
- Regulatory: Guidelines on disclosures, reporting and clarifications under AIF Regulations (Circular dated June 19, 2014 CIR/IMD/DF/14/2014)
- Regulatory: SEBI’s draft proposals for crowd funding may restrict it to accredited investors, allow crowd fund AIFs
- Securities market regulator Securities & Exchange Board of India (SEBI) has come up with draft proposals which may provide a legal platform for crowd funding in India, an alternate funding route for startups in the country.
- SEBI’s norm will restrict itself to security-based crowd funding and steer clear of donation and rewards based funding as also peer to peer lending which falls under the purview of RBI. The regulator has categorised three types of crowd funding equity-based (EbC), debt-based (DbC) and fund-based (FbC).
- Some of the key proposals include restricting the crowd funding to accredited investors; capping crowd funding up to Rs.10 crore within a 12-month period including over subscription (which shall be restricted to 25 per cent of the intended fund raise); attract money from maximum of 200 individual investors (besides institutional investors); founders or promoters need to maintain a minimum of 5 per cent stake in the company for at least three years from the date of the issue besides allowing a new class of crowd fund AIF (alternate investment fund which currently covers angel, VC, PE and hedge funds in the country) who can pool in money from other investors to invest in a company, among others.
Corporate Laws: Companies Act, 2013
The Ministry of Corporate Affairs (MCA) has notified most of the sections and has largely operationalized the Companies Act 2013 (2013 Act). All of the notified sections of the new Companies Act 2013 are in force from 1 April 2014.
MCA vide notice dated 24th June, 2014 invited comments for the draft notification under section 462 of the Companies Act, 2013 to ease the operational activity for Private Companies.
Income-tax: Budget Speech 2014-15, The Finance Bill, 2014
- Promotion of entrepreneurship and start-up Companies remains a challenge. While there have been some efforts to encourage, one principal limitation has been availability of start-up capital by way of equity to be brought in by the promoters. In order to create a conducive eco-system for the venture capital in the MSME sector it is proposed to establish a INR 10,000 crore fund to act as a catalyst to attract private Capital by way of providing equity, quasi equity, soft loans and other risk capital for start-up companies.
- Income from sale of unlisted shares and units of non-equity oriented mutual fund, not held for more than 36 months to be taxable as Short Term Capital Gain; the earlier threshold was 12 months.
- REITs and Infrastructure Investment Trusts, to be formed as per regulations to be notified by SEBI, shall enjoy tax pass through status (except in respect of capital gains on disposal of assets). This facility is already extended to VCF like YourNest.
- Allowed manufacturing units with FDI, under the automatic route, to sell their products through retail, including e-commerce platforms, without any additional approval. It should enable VCFs with non-resident investors to invest in e-commerce companies with their own manufacturing unit & brand.
- Mutual funds, Securitization trusts, VCC / VCF are required to furnish a return of income if their total income exceeds the maximum amount not chargeable to tax. Accordingly, the requirement of filing prescribed statement (giving particulars of amount of income distributed to investors, the tax paid thereon, etc.) has been done away with in case of mutual funds and securitization trusts.
- Effective 1 October 2014, dividends distributed by domestic companies and mutual funds to be grossed up for the purpose of computing DDT.
- Income Tax: CBDT Clarification-additional income tax cannot be levied either on mutual fund redemption or at the time of allotment of bonus shares to the existing shareholders (vide circular No.6/2014 dated 11th February, 2014)
- Section 115R of the income-tax Act, 1961 (the Act) provides for levy of additional income-tax on distributed income to the unit holders. However, some field authorities are taking a view that mutual funds/specified companies are required to pay additional income tax under Section 115R(2) of the Act, not only on income distributed by way of dividend but also on payment made at the redemption /repurchase of units as well as the time of allotment of bonus units to existing investors.
- Further, the income so distributed by mutual fund or specified company in the hands of the recipient unit holder is specifically exempt from tax under Section 10(35) of the Act. Provision to section 10(35) of the Act stipulates that exemption of income under this section is not applicable to those cases where transfer of units takes place. The recipient of such income is liable to pay capital gains tax, if applicable, on transfer of such units as per the relevant provisions of the Act and shall not be subject to additional income-tax under section 115R of the Act. Similarly, bonus units at the time of issue would not be subjected to additional income tax under Section 115R of the Act since issue of bonus units is not akin to distribute of income by way of dividend. This may be inferred from provisions of Section 55 of the Act.
RBI permitted issue of non-convertible/ redeemable bonus preference shares or debentures to non-resident shareholders under the automatic route
Prior to issuance of this amendment, the companies required RBI approval for issue of bonus instruments to non-resident shareholders and RBI was considering the same on a case-to-case basis. However, RBI vide Circular dated 6 January 2014, has given a general permission to companies to issue of non-convertible/redeemable bonus preference shares or debentures (bonus instruments) to non-resident shareholders under the automatic route out of its general reserves under a Scheme of Arrangement approved by a Court in India under the provisions of the Companies Act, as applicable subject to no-objection from the Income Tax Authorities.
Unlisted Indian Companies allowed to list and raise capital abroad
At present, unlisted companies incorporated in India are not allowed to directly list in overseas markets without prior or simultaneous listing in Indian markets. It has now been decided that unlisted companies be allowed to raise capital abroad without the requirement of prior or subsequent listing in India. The scheme will be implemented on a pilot basis for a period of two years from 11th October 2013.
The approval to list abroad is subject to certain conditions as prescribed in the notification, like the listing company to be fully compliant with FDI policy, comply with SEBI disclosure requirements etc. The Funds raised overseas to be remitted back to India within 15 days and such money shall be parked only in AD (Authorised Dealer) category banks recognized by RBI to be used domestically, if the same are not utilized abroad, as stipulated in the notification.
SEBI permit pre-emptive rights and put-call options in Shareholders Agreements
Recently, the SEBI has issued a notification wherein it has relaxed certain provisions under Securities Contracts (Regulation) Act, 1956 (‘SCRA’) to boost the interest of investors by allowing them to include preferential clauses like right of first refusal, tag-along, drag-along and call-put option in the share purchase agreements/ Articles of Association subject to certain conditions.
- RBI Notification permitting options
1) The Securities and Exchange Board of India (‘SEBI’) updates regulation in relation to Alternative Investment Fund (“AIF”) and notifies regulation for “Angel Fund”.
With an aim to encourage entrepreneurship in the country by financing small start-ups, SEBI, vide its notification dated 16 September 2013, amended AIF Regulations to notify new norms for angel investors, who provide funding to companies at their initial stages. Such angel funds are to be a sub-category in Category I – Venture Capital Fund.
- This regulation has defined “Qualified Investors” for the purposes of an Angel Fund – In view of the high-risk investments of such funds, certain conditions have been imposed on investors as given below:
- Individual angel investor should have net tangible assets of atleast INR 2 crores (excluding value of his principal residence) and shall satisfy the one of the following conditions:
- has an experience of early stage investment; or
- has experience of a serial entrepreneur; or
- is a senior management professional with at least 10 years of experience
- Corporate angel investor shall be required to have net worth of INR 10 crores; and
- SEBI registered AIF / VCF
- Individual angel investor should have net tangible assets of atleast INR 2 crores (excluding value of his principal residence) and shall satisfy the one of the following conditions:
- The key characteristics of Angel Fund are defined as:
- Angel Fund shall have a corpus of atleast INR 10 crores (as against INR 20 crores for other AIFs);
- Minimum investment by an investor shall be INR 25 lakhs (may be accepted over a period of maximum 3 years) as against INR 1 crore for other AIFs;
- The continuing interest by sponsor / manager in the Angel Fund shall be not less than 2.5% of the corpus or INR 50 lakhs (as against existing limit of INR 5 crores), whichever is less;
- No scheme of Angel Fund shall have more than 49 angel investors;
- Manager of the Angel Fund is required to obtain an undertaking from every angel investor confirming his approval before making any investment in a venture capital undertaking (‘VCU’); and
- Units of Angel Fund cannot be listed on any recognized stock exchange.
(Note: YourNest Angel Fund is a SEBI registered Venture Capital Fund. It does not fall under the new regulations & notification announced by SEBI for an Angel Fund on dated 16 September 2013.)
2) Amendment to Securities Contracts (Regulation) Act, 1956 (‘SCRA’)
SEBI has issued a notification on 3 October 2013 wherein the SEBI has relaxed certain provisions under Securities Contracts (Regulation) Act, 1956 (‘SCRA’) to boost the interest of investors by allowing them to include preferential clauses like right of first refusal (‘ROFR’), tag-along, drag-along and call-put option in the share purchase agreements / Articles of Association subject to certain conditions.
3) Listing of SME
SEBI has notified on 9 October 2013 “SEBI (Listing of Specified Securities on Institutional Trading Platform) Regulations, 2013” to permit listing of Startups and Small and Medium Enterprises (‘SMEs’) in Institutional Trading Platform (‘ITP’) without making an Initial Public Offering (‘IPO’).. The move is aimed at providing easier exit options to informed investor (such as Angel Investors, Venture Capital Funds and Private Equities).
The key eligibility criteria’s for SMEs are given below:
- The company has not completed more than 10 years from incorporation;
- Revenue has not exceeded INR 100 cr in any previous financial year;
- Paid up capital of the company has not exceeded INR 25 cr in any of the previous financial years;
- No regulatory action has been taken against the company, its promoter or director by prescribed regulatory authorities within a period of 5 years prior to the date of application for listing
- The company shall satisfy any one of the following criteria:
- Investment of atleast INR 50 lakhs in equity shares of the company by AIF, VCF, other SEBI approved investors or specified angel investor;
- Company has received finance (no minimum threshold specified) from a scheduled bank for its project financing / working capital requirement atleast before 3 years and the same has been fully utilised;
- Investment of atleast INR 50 lakhs in equity shares of the company by registered Merchant Banker / Qualified Institutional Buyer which shall be locked in for 3 years from date of listing; and
- a specialised international multilateral agency or domestic agency or a public financial institution has invested in the equity capital of the company (no minimum threshold specified).
4) Unlisted Indian companies allowed to list and raise capital abroad
The Ministry of Finance (MoF) in its Press Release dated 27 September, 2013 dealing with listing of Unlisted Indian Companies on overseas exchanges decided that unlisted companies allowed on a pilot basis for 2 years to raise capital abroad without the requirement of prior or simultaneous listing in India.
Further notification and amendment issued on 11thOctober, 2013 by MoF & on 8th November, 2013 by RBI are as under:
- Unlisted companies shall list abroad only on exchanges in IOSCO or FATF compliant jurisdictions or those jurisdictions with which SEBI has signed bilateral agreements;
- The companies shall file a copy of the return, which they submit to the proposed exchange/ regulators, also to SEBI for the purpose of PMLA. They shall comply with SEBI’s disclosure requirements in addition to that of the primary exchange prior to the listing abroad;
- While raising resources abroad, the listing company shall be fully compliant with the FDI Policy in force;
- In case the funds raised are not utilised abroad, such companies shall remit the money back to India within 15 days and may be used domestically;
- The ADRs/ GDRs shall be issued subject to sectoral cap, entry route, minimum capitalisation norms, pricing norms, etc. as applicable as per FDI regulations notified by the Reserve Bank from time to time;
- The pricing of such ADRs/GDRs to be issued to a person resident outside India shall be determined in accordance with the captioned scheme as prescribed under paragraph 6 of Schedule 1 of Notification No. FEMA. 20 dated May 3, 2000, as amended from time to time;
- The number of underlying equity shares offered for issuance of ADRs/GDRs to be kept with the local custodian shall be determined upfront and ratio of ADRs/GDRs to equity shares shall be decided upfront based on applicable FDI pricing norms of equity shares of unlisted company;
- The unlisted Indian company shall comply with the instructions on downstream investment as notified by the Reserve Bank from time to time;
- The criteria of eligibility of unlisted company raising funds through ADRs/GDRs shall be as prescribed by Government of India;
- The capital raised abroad may be utilised for retiring outstanding overseas debt or for bona fide operations abroad including for acquisitions;
5) Insurance Companies allowed to invest in Category II AIFs
In March 2013, life and general insurance companies were allowed to invest in Category I AIFs, comprising infrastructure funds, SME funds, venture capital funds and social venture funds. The Insurance Regulatory and Development Authority (‘IRDA’), vide its circular dated 23 August 2013, has now expanded the permissible investment category to Category II AIFs subject to the condition that at least 51 per cent of the funds of such AIFs should be invested in infrastructure entities, SME entities, venture capital undertakings or social venture entities. Insurers, however, are not permitted to invest in AIFs that have the nature of funds of funds and leverage funds.
The overall exposure to venture funds and AIFs put together should not exceed 3 per cent in the case of a life insurance company and 5 per cent in the case of a general insurance company. Exposure to a single AIF or venture fund should not be more than 10 per cent of the fund size (20% of the fund size in case of Infrastructure Funds).
B) Corporate Laws
The Companies Act, 2013, which seeks to replace the Companies Act, 1956 in consonance with changes in national and international economic environment, was notifies on August 30, 2013.
The Companies Act, 2013, has, inter alia, introduced enhanced corporate governance standards particularly in relation to the independent directors, audit, corporate social responsibility, mandatory valuation, private placement of securities, cross-border mergers (including merger of Indian companies into foreign companies) and class action suits.
The Companies Act, 2013 has introduced the concept of ‘One Person Company (OPC)’ and a “Small Company” that is a good step for Indian Start-ups. An idea or an Intellectual Property can be floated in an OPC with the benefits of limited liability and perpetual succession. Further, Small Company brings some ease in doing business during the early days of a venture.
- Angel Fund shall have a corpus of atleast INR 10 crores (as against INR 20 crores for other AIFs);
SEBI (Investment Advisers) Regulations, 2013
The Securities and Exchange Board of India (“SEBI”) issued the SEBI (Investment Advisers) Regulations, 2013 vide notification dated 21 January, 2013. It is applicable on
- Every person providing investment advice to any person for consideration (including non-cash benefit) would be required to obtain registration under the Regulation.
- Investment advice inter-alia includes advice relating to investing in, purchasing, selling, financial planning or otherwise dealing in securities or investment products, through any means of communication (including oral) for the benefit of the client.
Companies Bill, 2012
The Companies Bill, 2011 was laid before the Parliament in December 2011 and was then referred to the Parliament Standing Committee on Finance headed by Mr. Yashwant Sinha (‘the Committee’). Based on the recommendations of the Committee, the Companies Bill, 2011 was amended and introduced as the Companies Bill, 2012. The Companies Bill, 2012 was passed in the Lok Sabha on December 18, 2012. The Bill has 470 clauses and divided into 29 chapters.
It includes changes such as –
- Concept of “One person company” introduced [Clause 2(62)]
- One of the directors of the Company shall be a person stayed in India for 182 days or more [Clause 149]
- The maximum number of members in case of private company is increased from the existing 50 to 200.
- Concept of “Corporate Social Responsibility” introduced [Clause 135]
- Specific provisions for conversion of LLP into Company [Clause 366]
- Provisions for further issue of capital now applicable to both, private as well as public companies [Clause 62]. Accordingly, any shares will have to be offered to all shareholders on pro-rata basis (except in case of preferential issue through special resolution)
- Definition of listed company provided to mean a company which has any of its securities listed on any recognized stock exchange [Clause 2(52)].
- Indian company can be merged with foreign Company or vice-versa with prior approval of RBI [Clause 234]
- Concept of fast track merger introduced to facilitate merger of 2 or more “small companies” or between holding company and its wholly owned subsidiary [Clause 233]
- Majority shareholders may offer to purchase remaining shares from minority shareholders at a price determined by registered valuer in accordance with rules as may be prescribed (alternatively, minority shareholders may offer to sell) [Clause 236]
- Shares of public company are freely transferable. However, contract or arrangement between two or more persons in respect of transfer of securities (such as pre-emption rights and put / call options shall be an enforceable contract [Clause 58]
The Finance Bill 2013 (“the Bill”) was introduced as part of the Union Budget 2013 on February 28, 2013. The Bill received the assent of the President of India on 13 May 2013.
The key amendments to the Act by the Finance Act 2013, which would be relevant to the Fund and its investors are given below:
- Tax Residency Certificate (TRC) requirement – Section 90A of the Act has been amended to provide that a non-resident assessee, to whom a relevant treaty applies, can obtain the treaty benefits by furnishing the TRC issued by the respective foreign tax authorities.
- Pass through status granted to Category I Alternate Investment Funds (AIF) – The Finance Act, 2013 has extended the pass through status under section 10(23FB) to a Venture Capital Fund (VCF) or a Venture Capital Company (VCC) registered with SEBI as a sub-category of Category I AIF under the SEBI AIF Regulations.
- Distribution tax on buyback of shares by unlisted companies – A distribution tax on the buyback of shares by unlisted companies has been introduced effective from June 1, 2013.
- General Anti-avoidance Rule (GAAR) – GAAR to come in force from 1 April 2016 i.e. FY2015 – 16, AY 2016-17.
Other key announcement from the speech of the Finance Minister include
- Angel investors bring both experience and capital to new ventures. SEBI will prescribe requirements for angel investor pools by which they can be recognised as Category I AIF venture capital funds.
- Incubators play an important role in mentoring new businesses, which start as a small or medium business. The new Companies Bill obliges companies to spend 2 percent of average net profits under Corporate Social Responsibility (CSR). It was announced that the Ministry of Corporate Affairs will notify that funds provided to technology incubators located within academic institutions and approved by the Ministry of Science and Technology or Ministry of MSME will qualify as CSR expenditure.
- Expending support to MSMEs through SIDBI and privileges for 3-years beyond scaling up shall enable MSMEs to prosper.
- Listing of MSMEs without IPO for informed investors shall create a market for the risk-capital starved sector.