Private equity

handbook

Tax and regulatory reckoner

January 2013

Contents
A. Foreign investment in India

04

B. Types of instruments

12

C. Repatriation and exit

18

D. Tax rates

20

E. Domestic fund structuring

26

Foreign investments
in India

Foreign investment
framework

Alternative routes for

investing in India

The Foreign Direct Investment (FDI)

regime has been progressively liberalized
in India over the last two decades, with
most restrictions on foreign investment
being removed and procedures being
simplified. With limited exceptions,
foreigners can invest directly in India
either on their own or as part of a joint
venture.

Foreign investment in India is permitted

under the direct investment and portfolio
investment routes.

The FDI policy in India is formulated

by the Department of Industrial Policy
and Promotion within the Ministry of
Commerce and Industry, Government of
India. The consolidated FDI policy is issued
annually and is updated for press releases
and clarifications issued during the year.
The FDI policy framework is notified by
the Reserve Bank of India (RBI) under the
Foreign Exchange Management (Transfer
or Issue of a Security by a Person Resident
Outside India) Regulations, 2000 and is
amended from time to time.

Direct investment route

Any person resident outside India (subject
to a few limitations) can invest in India
under the direct investment route (FDI
route). Persons resident outside India
registered as Foreign Venture Capital
Investors (FVCI) with the Securities and
Exchange Board of India (SEBI) are also
allowed to make direct investments in
India with some concessions (FVCI route).

Portfolio investment route

This route is available to persons resident
outside India registered with SEBI as
Foreign Institutional Investors (FII)/
sub-accounts, and to Qualified Foreign
Investors (QFI) and non-resident Indians
(NRIs).

Private equity handbook Tax and regulatory reckoner

Foreign investments in India

Entities into which

foreign investment can be
made
Foreign investment in Indian companies is
typically permitted subject to conditions
(where applicable). Foreign investment
in partnerships and proprietary concerns
is restricted only to NRIs and persons of
Indian origin1. Further, foreign investment
in trusts is prohibited unless the trust is
a SEBI registered venture capital fund
(VCF)2. Investment in VCF (other than
by FVCIs) requires prior approval of the
Foreign Investment Promotion Board
(FIPB)3. Foreign investment in limited
liability partnership (LLP) is allowed only
under the FDI route and only in sectors
where FDI is allowed under the automatic
route and where there are no FDI-linked
performance conditions (such as minimum
capitalization, lock-in conditions, etc.)
under the approval route.

Investments by NRIs/PIOs in partnerships and

proprietory concerns on a non-repatriation
basis are under the automatic route. However,
investments by NRIs/PIOs in partnerships and
proprietory concerns require prior approval of the
RBI.

VCF is a domestic venture capital fund set up

as a company or trust that primarily invests
in domestic unlisted companies in accordance
with SEBI (Venture Capital Funds) Regulations,
1996. The said regulations were repealed in May,
2012 and SEBI (Alternative Investment Funds)
Regulations, 2012(SEBI AIF Regulations) were
notified in May 2012.

FIPB considers proposals for foreign investment

that do not qualify for automatic approval. The
FIPB is empowered and chaired by the Secretary
of the Ministry of Finance and has been set up
specifically to expedite the approval process for
foreign investment proposals.

FDI route
Foreign investments under the FDI
route can be made either under the
automatic route or under the approval
route depending on the sector/activities
in which the Indian company is engaged.
Foreign investment in most sectors is
permitted under the automatic route
without any ownership restrictions or
conditions. Foreign investment caps,
minimum capitalization norms and lock-in
requirements are specified for certain
sectors/activities. Further, certain sectors
are prohibited4 from FDI.

Prohibited sectors include lottery business,

gambling and betting, chit funds, nidhi company,
trading in transferable development rights
(TDRs), real estate business or construction
of farm house, activities/sectors not open for
private sector investments ( e.g., atomic energy,
railway transport)

Private equity handbook Tax and regulatory reckoner

FDI norms for select sectors:

Sectors

Sectoral
caps

Caps
applicable to

Entry route

Additional
conditions*

Broadcasting

26% to
74%

FDI, NRI, PIO,

FII#

Approval

Yes

Banking-Public sector

20%

FDI and FII

Approval

Yes

Banking-Private sector

74%

FDI and FII

Automatic upto
49%

Yes

Cash and carry

wholesale

100%

FDI

Automatic

Yes

Courier

100%

FDI

Approval

Construction
development of
townships, built-up
infrastructure
townships, etc.

100%

FDI

Automatic

Yes

Defence

26%

FDI

Approval

Yes

E-commerce activities

100%

FDI

Automatic

Yes

Education

100%

FDI

Automatic

Hospital

100%

FDI

Automatic

Hotel & Tourism

100%

FDI

Automatic

Industrial parks

100%

FDI

Automatic

Infrastructure

100%

FDI

Automatic

Insurance

26%

FDI

Automatic

Private equity handbook Tax and regulatory reckoner

Yes
Yes

Foreign investments in India

Sectors

Sectoral
caps

Caps
applicable to

Entry route

Additional
conditions*

Multi-brand retail

51%

FDI

Approval

Yes

Non-banking financial
services companies

100%

FDI

Automatic

Yes

Pharmaceuticals

100%

FDI

Automatic
(Green-field)
/ Approval
(Brownfield)

Print media

26%

FDI, FIIs, NRIs,

PIOs

Approval

Yes

Single brand retail

100%

FDI

Approval

Yes

Special economic zone

100%

FDI

Automatic

Test marketing

100%

FDI

Approval

Yes

Telecommunications
(Other than
manufacturing of
equipments)

74%

FDI

Automatic up
to 49%

Yes

For detail conditions applicable on each sector, please refer to The Consolidated FDI Circular dated
April, 2012 and subsequent Press Notes issued by Department of Industrial Policy and Promotion till date.

NRI and PIO investments are allowed only in certain activities under the broadcasting sector

Private equity handbook Tax and regulatory reckoner

Eligible instruments

Pricing norms

Investments under the FDI route

can be made only by way of equity
shares, compulsorily and mandatorily
convertible preference shares (CCPS), and
compulsorily and mandatorily convertible
debentures (CCD). Investments by way
of warrants and partly paid shares of an
Indian company are allowed subject to
prior approval of the FIPB. Further, listed
Indian companies can also issue American
depository receipts/global depository
receipts as per the prescribed5 guidelines.

Pricing guidelines for investment under

the FDI route for issue/transfer of
capital:

Other types of preference shares/

debentures, i.e., non-convertible, optionally
convertible, or partially convertible, are
considered as debt and need to comply
with external commercial borrowing (ECB)
norms pertaining to eligible borrowers,
recognized lenders, amount and maturity,
end-use stipulations, etc. Instruments such

as foreign currency convertible bonds and

foreign currency exchangeable bonds are
also considered as ECBs and are required
to comply with ECB norms.

Issue or
transfer of
capital listed on
a recognized
stock exchange
in India

Price is worked out

in accordance with
SEBI guidelines, as
applicable

Issue or
transfer of
capital not
listed on any
recognized
stock exchange
in India

The fair valuation of

shares is undertaken
by a SEBI registered
Category I Merchant
Banker or a Chartered
Accountant as per the
discounted free cash
flow method

The price of shares issued/transferred to

persons resident outside India under the
FDI policy cannot be less than the value

determined as per the above guidelines.

Further, in the case of the issue of CCPS
and CCDs, the price/conversion formula
is to be determined upfront at the time of
the issue of instruments. In such cases,

Issue of Foreign Currency Convertible Bonds and

Ordinary Shares (Through Depository Receipt
Mechanism Scheme), 1993 and guidelines issued
by the Government of India

Private equity handbook Tax and regulatory reckoner

Foreign investments in India

the price at the time of conversion should

not be lower than the valuation worked
out at the time of the issuance of such
CCPS/CCD.

to make any downstream investments.

A methodology has been prescribed to
determine the level of foreign investment
in a multi layered investment structure.

The transfer of shares of an Indian

company by a person resident outside
India to a person resident in India cannot
be undertaken at a price that is higher
than the value determined as per the
pricing guidelines. Pricing guidelines do
not apply to the transfer of shares of
an Indian company between two nonresidents.

FVCI route
FVCIs are persons resident outside India
and registered with the SEBI as FVCIs.
They make investments in India under the
applicable SEBI regulations.
SEBI has been granting approvals to FVCI
only for investments in certain specified
sectors9 and in SEBI-registered VCFs.
Further, SEBI regulations have been
recently amended to permit FVCIs to
invest in Category I Alternative Investment
Funds (AIF)10.

Downstream investment6
Downstream investments by an Indian
company owned7 or controlled8 by nonresident entities are required to comply
with sectoral caps, entry conditions,
pricing norms, etc, as specified under the
FDI route. LLPs with FDI are not allowed

FVCIs can invest in units of VCFs

and Category I AIFs or investment in
equity or equity-linked instruments,
debt instruments of Venture Capital
Undertakings (VCUs)11/ Non-VCUs subject

Downstream investment means indirect foreign

investment by one Indian company into another
Indian company by way of subscription or
acquisition
A company is considered as owned by nonresident entities if more than 50% of the capital
in it is beneficially owned by non-resident citizens
and/or entities, which are ultimately owned and
controlled by non-residents.
Control has been defined to mean power to
appoint the majority of directors

Specified sectors include (i) infrastructure sector

(as defined under ECB norms), (ii) biotechnology,
(iii) information technology relating to hardware
and software development, (iv) nanotechnology,
(v) seed research & development, (vi) research
and development of new chemical entities in
pharmaceutical sector, (vii) dairy industry, (viii)
poultry industry, (ix) production of bio-fuels and
(x) hotel-cum-convention centers with seating
capacity of more than 3,000.

10 AIFs are domestic pooling vehicles that are

governed by SEBI (Alternative Investment Funds)
Regulations, 2012 (SEBI AIF Regulations). They
are discussed in detail in a subsequent chapter.
11 VCU means a company incorporated in India
whose shares are not listed on a recognized stock
exchange in India and which is not engaged in an
activity specified under the negative list specified
by the SEBI.

Private equity handbook Tax and regulatory reckoner

to specified conditions by way of private

placement/purchase from third party.
FVCIs are not subject to pricing guidelines
or ceiling on dividends. The valuation on
purchase/transfer can be mutually decided
between the buyer and seller.
FVCIs enjoy certain additional regulatory
advantages:

The transfer of shares from FVCIs to

promoters is exempted from public
offer provisions under SEBI takeover
regulations.

FVCIs are granted the status of a

qualified institutional buyer and enjoy
certain relaxations on pricing norms
and longer conversion period for
securities under SEBI regulations.

FVCIs are not subject to lock-in

requirements post the initial public
offering of an Indian company under
SEBI regulations subject to certain
conditions.

Portfolio investment route

FII route
FII investments are governed by SEBI
regulations. FIIs are institutions established
or incorporated outside India that propose
to make investments in India. Sub-accounts
are persons resident outside India on whose
behalf investments are proposed to be made
in India by the FII. Qualifying conditions
have been specified for FII registration.
Apart from entities that can register as
FIIs, other foreign investors could choose
to register as sub-accounts. These may be
collective investment funds and institutions,
proprietary funds, or foreign corporations
and nationals meeting certain conditions.
No sector restrictions are typically
applicable to investments under the FII
route, unless specifically provided for
within sectoral caps prescribed under the
FDI route12. FIIs are allowed to invest in
recognized stock exchange only through a
registered broker. FIIs are also permitted
to invest through private placement/initial
public offers.
FIIs are allowed to invest in shares or
debentures of an unlisted company or a
company that is listed on a recognized stock
exchange in India, as well as government
securities/treasury bills, listed nonconvertible bonds/debentures, listed/
unlisted non-convertible infrastructure
bonds, commercial papers, units of domestic
mutual funds, security receipts (only for
FIIs) and perpetual debt instruments.

12 Please refer to the table on page 6-7 relating to FDI

norms on select sectors

10

Private equity handbook Tax and regulatory reckoner

Foreign investments in India

Investment limits for FIIs in shares and convertible debentures:

Total holding by each
FII / sub-account

10% of the paid-up equity capital or paid-up value of each

series of debentures

Total holding by all FII /

sub-account

24% of the paid-up equity capital or paid-up value of each

series of debentures (the limit can be increased to the FDI
sectoral cap by a special resolution at the general body
meeting of the investee company)

5% of the total paid-up equity capital or 5% of the paid-up

Foreign corporate and
individuals registered as value of each series of convertible debentures subject to
the overall ceiling of 24%
sub-accounts
Specific overall monetary limits are
prescribed for investments in listed
corporate debt, unlisted long-term
infrastructure bonds and government
securities (including treasury bills).

also required to obtain permanent account

number from Indian tax authorities.

QFI route
QFIs are persons resident in a country
that is compliant with Financial Action
Task Force (FATF) standards (including
residents of countries that are part of a
group that is a member of FATF) and that
is a signatory to the IOSCO13 multilateral
memorandum of understanding, European
Union (EU) or Gulf Cooperation Council
(GCC) or a signatory of a bilateral MOU
with SEBI. Further, such person should not
be registered as FII/sub-account or as FVCI
with SEBI.

QFIs are permitted to invest in the equity

shares of listed companies on a recognized
stock exchange, listed corporate debt, as
well as in the units of equity and debtoriented mutual funds.
QFIs are permitted to invest in listed
equity shares up to an individual limit of
5% of the paid-up capital of the company
(overall limit of 10% of the paid-up capital
of the company). Further, separate overall
monetary limits have been prescribed for
investments by QFIs in listed corporate
debt, equity-oriented mutual fund
schemes and debt mutual fund schemes
(including infrastructure debt funds).

Unlike FIIs, QFIs are not required to be

registered with SEBI. However, they are
required to open a demat account with a
qualified depository participant14 and are

13 International Organization of Securities

Commission
14 Qualified depository participants are those
depository participants registered with SEBI who

fulfill the eligibility criteria specified by SEBI to act

as a depository participants for QFIs

Private equity handbook Tax and regulatory reckoner

11

Types of instruments

An Indian company can raise funds

by way of shares or debt. Shares of a
company are categorized as equity or
preference shares. Equity shares have the
fundamental characteristic of representing
ownership interest in a company and
carrying voting rights. While a public
company may create classes of shares
having differential rights as to voting,
dividend, etc., subject to applicable
restrictions, a private company can issue
shares with differential rights without any
restriction. Preference shares are entitled
to a fixed rate of dividend, do not typically
carry any voting rights and get a priority
over equity shares in the distribution of
assets in event of liquidation. Preference
shares can be converted into equity
(either optional or mandatory) and/or
can be redeemed (period not exceeding
20 years). Redemption can only be out
of accumulated profits, which would
otherwise be available for dividend or
out of fresh issue of shares made for
redemption.

12

Debt securities that are issued by

companies are called debentures or
bonds. Debenture is an instrument of debt
executed by a company acknowledging
its obligation to pay interest on the
debt at a fixed rate at regular intervals.
Debentures do not carry any voting
rights and are generally secured against
property. Additionally, debentures can
be redeemed or converted into equity
or a combination of both. Debt funding
from non-resident lenders [excluding
compulsorily convertible instruments and
listed non-convertible debentures (NCDs)]
is generally referred to as ECB and is
closely regulated specifically with respect
to end use, party from whom lending
is sought, interest payment, amount of
funding, maturity period, etc.
Either of the above mentioned instruments
or their combination could be used for
investing in an Indian company.
From a regulatory perspective, a resident
can invest in an Indian company using
any of the instruments mentioned above

Private equity handbook Tax and regulatory reckoner

without any restrictions. However, a nonresident is subject to several restrictions,

depending on the type of instrument.
For example, funds brought in as equity
(including instruments mandatorily
convertible into equity) are generally

permitted automatically under the

FDI policy, subject to sector-specific
restrictions. All other instruments would
be considered as debt and would require
compliance with ECB guidelines.

Pictographic representation of the types of instruments for foreign investment

in India:
Types of instruments

Equity shares

Equity
shares

Compulsorily
convertible
preference shares
Compulsorily
convertible
debentures
Optionally
convertible
preference shares

FDI - No
end use
restriction

Future prot
repatriation
possible

ECB Specied
end use
restrictions

Tax
efcient
prot
repatriation
could be
factored

Hybrid
instruments

Non-convertible
preference shares
Optionally
convertible
debentures
Non-convertible
debentures
Shareholders
loan

Debt

Tax
efcient
interest
payout
possible

Tax
arbitrage
may be
available
on
interest
payouts

Private equity handbook Tax and regulatory reckoner

13

Key tax and regulatory features pertaining to each type of instruments:

Criteria

Equity
shares

Treated as

FDI

ECB

Restriction
on amount

NA

Automatic route up to USD 750

million16
Approval route USD 750 million16

End Use
restrictions

NA17

NA17

NA17

Cannot be used
for specified
purposes18

All in cost

Not
specified

Maximum
dividend
that can be
paid is SBI
PLR + 300
bps

Not
specified
(possible
view);
interest
rate cannot
exceed rate
prescribed
for CCPS)

For maturity of 35 years 6 month

LIBOR + 350 bps

Price/
Conversion
formula
to be
determined
upfront at
the time of
issue based
on pricing
guidelines
prescribed
by the RBI;
price at
the time of
conversion
cannot

Price/
Conversion
formula
to be
determined
upfront at
the time of
issue based
on pricing
guidelines
prescribed
by the RBI;
price at
the time of
conversion
cannot

Optionally
Convertible
Preference
Shares (OCPS)
pricing guidelines
prescribed by the
RBI to be complied
with at the time of
conversion

Pricing
guidelines

Pricing
guidelines
prescribed
by the
RBI to be
complied
with at the
time of issue
of shares or
acquisition
of shares
from a
resident

CCPS

15 Excluding listed NCDs

16 To be read as USD 200 million for corporates in
services sector viz. hotel, hospital and software.
17 Downstream investment into Indian companies
is permissible if compliant with the regulatory
framework

14

CCDs

Optionally
convertible/
redeemable
preference shares

Shareholder
loans/other
debentures15

Cannot be
used for
specified
purposes18

For maturity > 5 years 6 month

LIBOR + 500 bps

Optionally
Convertible
Debentures
(OCDs)
pricing
guidelines
prescribed by
the RBI to be
complied with
at the time of
conversion

18 Specified purposes:

- On-lending, investment in capital market,
acquiring a company in India or a part thereof
(except for specified companies)

- In real estate

- For working capital, general corporate purpose
and repayment of existing rupee loans (except for
specified companies subject to specified conditions)

Private equity handbook Tax and regulatory reckoner

Types of instruments

Criteria

Equity
shares

Pricing
guidelines
(contd.)

CCPS

CCDs

Optionally
convertible/
redeemable
preference shares

Shareholder
loans/other
debentures15

be lower
than the
minimum
price
determined
upfront at
the time of
issue

be lower
than the
minimum
price
determined
upfront at
the time of
issue

Non Convertible
Preference Shares
(NCPS) pricing
guidelines not
applicable

NCDs pricing
guidelines not
applicable
Shareholder
loans pricing
guidelines not
applicable

Right of
dividend/
interest

Can be
paid only
from profit
after tax
(PAT) and
after the
payment of
preference
dividend

Right to
receive
dividend
over equity
shares and
can be paid
out of PAT

Interest
can be paid
irrespective
of the
availability
of profits

Right to receive
dividend over
equity shares and
can be paid out of
PAT

Interest
can be paid
irrespective of
the availability
of profits

Voting rights

Available
Further,
flexibility for
differential
voting rights
available,
subject to
conditions

Available if
dividend is
not paid for
two years
or post
conversion
into equity
shares

Available
post
conversion
into equity
shares

Available if
dividend is not paid
for two years and
in respect of part
converted into
equity shares

Not available
except in
respect of part
converted into
equity shares

Prepayment /
Repatriation

Equity share
capital can
be cancelled
by way of
a buyback/
capital
reduction

Possible
view:
Buyback/
Capital
reduction
of CCPS
not possible
before the
conversion
of CCPS
into equity
shares

Possible
post
conversion
into equity
shares
through
cancellation
by way of
buyback/
capital
reduction

ECB up to USD 20
million = minimum
average maturity
3 years

ECB up to USD
20 million
= minimum
average
maturity 3
years

Preference
shares Maximum
time - 20
years from
the date of
its issue

No time
limit for CCD

Minimum
time
period for
redemption

Not
Applicable

ECB > USD 20

million and up to
USD 750 million =
minimum average
maturity 5 years
Preference shares
maximum time
20 years from the
date of its issue

ECB > USD

20 million and
up to USD
500 million
= minimum
average
maturity 5
years

Private equity handbook Tax and regulatory reckoner

15

Criteria

Equity
shares

CCPS

CCDs

Optionally
convertible/
redeemable
preference shares

Shareholder
loans/other
debentures15

Withholding
on dividend /
interest

Not required
An Indian
company
is required
to pay DDT
at 15%19 on
the amount
of dividend
distributed

Not required
An Indian
company
is required
to pay DDT
at 15%19 on
the amount
of dividend
distributed

Tax
required to
be withheld
on interest
at lower of
the rates, as
specified in
tax treaty
or the
domestic
tax law

Not required An
Indian company
is required to
pay DDT at 15%19
on the amount
of dividend
distributed

Tax required
to be withheld
on interest
at lower of
the rates, as
specified in
tax treaty or
the domestic
tax law

Tax
deductibility
of dividends/
interest

Equity
dividend not
deductible
for tax
purposes

Preference
dividend not
deductible
for tax
purposes

Interest
is tax
deductible
subject to
appropriate
withholding
of tax

Preference
dividend not
deductible for tax
purposes

Interest is tax
deductible
subject to
appropriate
withholding
of tax

Applicability
of Indian
transfer
pricing
regulations

Not
applicable

Not
applicable

Applicable

Not applicable

Applicable

Taxation on
conversion

Not
applicable

No clear
provisions
arguably
may be
exempt

Exempt

No clear provisions
arguably may be
exempt

NA/Exempt

19 Tax rates are excluding the applicable surcharge

and education cess

16

Private equity handbook Tax and regulatory reckoner

Types of instruments

Furthermore, the following instruments

could also be considered:
ADRs/GDRs: Depository receipts are
securities issued by a bank or depository
outside India against underlying Rupee
shares of a company incorporated in India.
These are treated as foreign securities
issued by an Indian company and are
usually denominated in USD. Holders
of ADR/GDR have the right to sell these
instruments outside India or convert them
into equity shares at any point of time.
Listed NCDs: Under this route, any
private or public company could list NCDs
on the wholesale debt market segment of
any recognized stock exchange. Any FII
or any sub-account of an FII entity could
purchase these NCDs subject to prescribed
allocation methodology. For an exit, these
debentures may either be sold on the floor
of the stock exchange or redeemed by the
issuing company. The terms of listed NCDs
are not subject to ECB or FDI guidelines.

Warrant: A warrant is a security that

entitles the holder to buy the underlying
stock of the issuing company at a
fixed exercise price until the expiry
date. Warrants can be issued to nonresidents under the approval route. The
government, at the time of granting
approval, may prescribe the minimum
amount to be brought upfront and the
period within which the warrants holder
needs to exercise his right. The upfront
payment for the issue of warrants is
forfeited if the warrants are not converted
into equity shares.

Private equity handbook Tax and regulatory reckoner

17

Repatriation and exit

Alternative options for

repatriation of capital and
returns
Dividend
Dividend distribution is the typical
route for the repatriation of profits
by a company. Dividend payments
are considered as an appropriation of
profits rather than as an expense for tax
purposes. Dividend payment is required
to be made to all shareholders of a
company. In case the companys capital is
divided into different classes of share, the
company may distribute dividend only to a
specific class of shareholders.

18

Buyback
Buyback of shares is a scheme wherein
an Indian company re-purchases its own
shares from its shareholders. Under the
Indian tax laws, buy back is treated as the
sale of shares by the shareholder. Offer
for buy back is required to be made to
all shareholders (holding shares of the
same class) and is at the discretion of
the shareholder to accept or reject. For
listed companies, in certain situations, a
specified class of shareholders may not be
eligible to tender their shares in the offer
for buyback.

Capital reduction
Capital reduction is a court regulated
process of cancellation of subscribed
capital of an Indian company or reduction
of the face value of shares. From a tax
perspective, capital reduction typically
involves distribution of capital and
accumulated profits.

Private equity handbook Tax and regulatory reckoner

Key aspects relating to each of the above repatriation options:

Criteria

Dividend

Buyback under
section 77A of the
Companies Act, 1956

Capital Reduction under

section 100 of the
Companies Act, 1956

Taxation in the hands

of shareholder

No

Subject to capital gain

tax, shareholders can
claim tax exemption
under an applicable tax
treaty20

Subject to capital gain tax

on distribution in excess
of accumulated profits;
shareholders can claim
tax exemption under the
applicable tax treaty20

Taxation in the hands

of the company

At the rate
of 15%21 on
dividend
distributed

No

At the rate of 15%21 to the

extent of accumulated profits
distributed

Court process

No

No

Yes

Approval of creditors

No

No

Yes22

Selective distribution

No

Depends on response
to buyback offer20

Yes

Applicability of RBI
pricing guidelines

NA

Yes

Yes

Requirement of
regulatory approval

No

No

No

20

- In light of a recent judicial precedent, there is a

risk that the ITA may consider the buy-back as
payment of dividend.
- Availability of treaty benefits subject to
applicability of GAAR to the transaction.

21 Tax rates are excluding the applicable surcharge

and education cess
22 Unless dispensed by the Court.

Private equity handbook Tax and regulatory reckoner

19

Tax rates

The table below enumerates the applicable

tax rates under the domestic tax law on
income derived from investments in Indian
securities (shares and debentures). The

rates mentioned are base rates, to be

increased by applicable surcharges. For
Indian residents, rates are provided in the
context of a corporate tax payer.

Tax rates on interest and dividend income under various routes23

Income

Foreign
investors

QFI/ FVCI

FII

Indian
residents

Interest on foreign
currency borrowing by
Indian concerns

20%

Not
applicable

20%

Not
applicable

Interest on approved
long-term infrastructure
bonds/loan agreements

5%

5%

5%

Not
applicable

Dividends on equity
shares

Exempt;
however,
subject to
dividend
distribution
tax at 15%

Exempt;
however,
subject to
dividend
distribution
tax at 15%

Exempt;
however,
subject to
dividend
distribution
tax at 15%

Exempt;
however,
subject to
dividend
distribution
tax at 15%

Interest on Rupeedenominated debt

40%

40%

20%

30%

23 Tax rates are excluding the applicable surcharge

and education cess

20

Private equity handbook Tax and regulatory reckoner

Other key aspects

Direct sale
On sale of shares of an Indian company,
the difference between the cost of
acquisition and the value of consideration
received would be deemed to be capital
gains. Capital gains on the sale of shares
affected on stock or through an offer for
sale in an IPO are either exempt or taxable
@15% depending on whether there is
LTCG or STCG, respectively. Capital gains
tax can be mitigated if investment is made
through a tax-efficient jurisdiction. Key
jurisdictions considered while investing

in India are Mauritius, Singapore, Cyprus

and the Netherlands. Subject to the
fulfillment of certain conditions, rights to
tax capital gains on the transfer of shares
of Indian companies by tax residents of the
mentioned countries have been granted
only to the mentioned countries. Refer to
the table provided in the next chapter for
tax rates under select tax treaties.

However, recently, the tax department

has been questioning tax exemption on
the exit of investments made through
the mentioned jurisdictions. The lack of
commercial substance has been the main
concern of tax authorities.

Indirect sale
As per the recent amendments in tax laws,
any indirect transfers, i.e., situations
where shares of a foreign company are
transferred with substantial underlying
assets in India, would be taxable in
India, subject to the availability of treaty
benefits.

However, there is lack of clarity on several

parameters related to the taxation of
indirect transfers. For example, what
would constitute as substantial is not
mentioned; date as on which substantial
value criteria needs to be determined is
not clarified; whether the entire gains on a
transaction would be taxable or only gains
proportional to the Indian element will be
taxable is not clear, and so on.

Private equity handbook Tax and regulatory reckoner

21

General Anti Avoidance Rules

(GAAR)
GAAR provisions were introduced in
the Income-tax Act, 1961 by Finance
Act 2012 to deal with aggressive tax
planning. Consistent with international
practice, GAAR provisions seek to codify
the substance over form doctrine.
These provisions would empower tax
authorities to declare an arrangement
to be an impermissible avoidance
arrangement if the main purpose or one
of the main purposes of an arrangement
(or step or part thereof) is to obtain
a tax benefit. These provisions are
applicable to all tax payers and are
equally applicable to domestic, as well
as international transactions. Once an
international transaction is declared to be
an impermissible avoidance arrangement,
the provisions of GAAR would override
the beneficial provisions of the relevant
tax treaty.
Expert Committee (EC) appointed
by Prime Minister of India to review
GAAR provisions has given its final
recommendations, which have mostly
been accepted by the Finance Ministry.
Some of the major changes include
clauses pertaining to GAAR provisions
coming in effect from financial year
201516 instead of 201314 and an
arrangement would be impermissible
if the main purpose of the same is to
obtain a tax benefit; however, it would
not merely be one of the main purposes.
Further, investments made prior to 30
August 2010 would be grandfathered.
However, the consequential changes in
law are still to be effected.

22

Private equity handbook Tax and regulatory reckoner

Tax rates

Capital gains tax rate24

Particulars

Resident company

Non-resident company

LTCG

STCG

LTCG25

STCG26

Sale of listed shares SE

transaction27

Exempt

15%

Exempt

15%

Sale of listed shares

off-market transaction
(i.e., sale of listed shares
through private deal)

10%28/20%29

30%

10%30/20%

40%31

Sale of unlisted shares offer

for sale to public under IPO27

Exempt

15%

Exempt

15%

Sale of unlisted shares

20%29

30%

10%32/20%

40%31

Sale of listed debentures

10%28/20%29

30%

10%30/20%

40%31

Sale of unlisted debentures

20%29

30%

10%32/20%

40%31

25

26

24 Tax rates are excluding the applicable surcharge

and education cess
25 Period of holding more than 12 months for shares
and specified securities
26 Period of holding less than or equal to 12 months
for shares and specified securities
27 STT payable on the value of transaction
28 Without indexation benefit
29 With indexation benefit
30 Foreign exchange adjustment possible along with
10% rate. However, there are conflicting judicial
precedents on the availability of lower rate of 10%.
31 30% for FIIs
32 Without foreign exchange rate adjustment.
Further, it is unlikely that the concessional rate
of 10% would be available on sale of shares of a
private limited company

Private equity handbook Tax and regulatory reckoner

23

Tax rates under select tax treaties:

Particulars

Treaty in force Capital gain on Capital gains

sale of shares on sale of
debentures

Interest

Mauritius

Yes

Not taxable

Not taxable

Taxable at
20%33/40%34

Singapore

Yes

Not taxable
subject to the
limitation of
benefit clause
(LOB clause35)

Not taxable
subject to LOB
clause35

Taxable at 15%

Cyprus

Yes

Not taxable

Not taxable

Taxable at 10%

The
Netherlands

Yes

Not taxable
subject to
conditions36

Not taxable

Taxable at 10%

Luxembourg

Yes

Taxable

Not taxable

Taxable at 10%

The United
States of
America

Yes

Taxable

Taxable

Taxable at 15%

The United
Kingdom

Yes

Taxable

Taxable

Taxable at 15%

Taxable

Taxable

Taxable

Cayman Islands No

24

Private equity handbook Tax and regulatory reckoner

Tax rates

33 On borrowings in foreign currency. Tax rates are

excluding the applicable surcharge and education
cess
34 On borrowings in Indian currency. Tax rates are
excluding the applicable surcharge and education
cess
35 A Singapore resident availing the capital gain
exemption under the India-Singapore tax treaty
must satisfy the following conditions:
i. Its affairs are not arranged with the primary
purpose to take advantage of the benefits of
the LOB clause under the treaty; and
ii. It should not be a shell/ conduit company
i.e. its annual expenditure on operations
in Singapore is equal to or more than SG$
200,000 in the immediately preceding
24 months from the date on which capital
gain arise from the transfer of shares/
debentures;or
iii. It is listed on a recognized stock exchange in
Singapore.

36 Capital gains from the sale of shares in an Indian

company would not be taxable in India under
the India-Netherlands tax treaty, if the following
conditions are satisfied:
i. In case of shares of an unlisted real estate
company in India, the shares form part of less
than 25% interest in the capital stock in the
company
ii. In case of shares of any other company in India;
a. The shares are sold to a non-resident;
b. The shares are sold to a resident and the
shares form part of less than 10% interest
in the capital stock in the company; or
c. The shares are sold pursuant to a
corporate organization, re-organization,
amalgamation, division or similar
transaction.

Private equity handbook Tax and regulatory reckoner

25

Domestic fund
structuring

India has a regulatory framework for

raising an alternative investment fund.
The framework is contained in the AIF
Regulations, which were notified in May
2012 and repealed the erstwhile SEBI
(Venture Capital Funds) Regulations, 1996
(VCF Regulations). Funds registered under
the VCF Regulations are grandfathered
until they are wound up and are prohibited
to launch any new scheme or increase the
targeted corpus.
Under AIF Regulations, funds are
mandatorily required to obtain registration
and comply with the investment and other
conditions.

37 Guidelines for foreign investments in AIFs

(excluding FVCI investment into Category I AIF)
are yet to be notified by the Government.

26

An AIF has been defined as a privately

pooled investment vehicle that collects
funds from investors, whether Indian
or foreign37, in accordance with a
defined investment policy. An AIF can be
established as a company, a trust or a
LLP, or any other body corporate. AIFs are
segregated into the following categories
for the purpose of registration:

Private equity handbook Tax and regulatory reckoner

Category I AIF

Category II AIF

Category III AIF

Funds that invest in startup or

early-stage ventures or social
ventures or Small and Medium
Enterprises (SMEs) or infrastructure
or other sectors or areas that the
government or regulators consider
as socially or economically desirable

Funds that do not fall

in Category I and III
AIF and that do not
undertake leverage or
borrowing other than
to meet the permitted
daily operational
requirement

Funds that employ

diverse or complex
trading strategies and
may employ leverage
including through
investment in listed or
unlisted derivatives

Include venture capital funds,

SME funds, social venture funds,
infrastructure funds and such other
AIFs, as may be specified

Include hedge funds

Include private equity

funds and debt funds

All AIFs are required to mandatorily seek

registration in one of the categories
mentioned in the table above. In case of
Category I AIF, they also need to register
under one of the sub-categories as
prescribed. An AIF can launch schemes
without seeking prior SEBI approval.

Various eligibility criteria such as minimum

commitment, minimum investment
per investor, sponsor commitment,
minimum maturity, track record for key
investment team manager, term of the
funds and conditions as to open ended
and close ended have been prescribed for
registration.

Private equity handbook Tax and regulatory reckoner

27

Investment conditions and restrictions

AIF Regulations prescribe detailed conditions/restrictions for each category/
sub-category of AIF:
Category I AIF
Venture Capital
Fund

Minimum 66.67% of its corpus in equity and equity-linked

instruments of VCUs and SMEs and balance 33.33% in debt
instruments, public offer/preferential allotment of listed
companies (subject to conditions)

Infrastructure Fund

At least 75% of its corpus in VCUs or investee companies

engaged in infrastructure and balance also in listed securitized
debt instruments, as well as listed debt instruments

Social Venture Fund

At least 75% of its corpus in social venture funds

Small and Medium

Enterprise Fund

At least 75% of its corpus in VCU and/or investee companies38

that are SMEs

Category II AIF
Private Equity Fund

Primary investment in equity and equity-linked instruments of

unlisted companies

Debt Fund

Primary investment in debt or debt securities of unlisted

securities

Category III AIF

Hedge Funds etc.

Permitted to invest in securities of listed or unlisted investee

companies or derivatives or complex or structured products

Furthermore, Category I AIFs are

permitted to invest in units of Category I
AIFs of the same sub-category. Category
II and Category III AIFs are permitted to
invest in units of Category I and Category
II AIFs. AIFs are not permitted to invest in
fund-of-funds.

38 Company, SPV, LLP, or other body corporate

28

Private equity handbook Tax and regulatory reckoner

Domestic fund structuring

Other key aspects

Taxation

AIF Regulations prescribed conditions

for investment in associate companies,
borrowing, leveraging/hedging, listing of
AIFs, and valuation of units of AIFs. They
also prescribed certain governance norms
pertaining to conflict of interest, fiduciary
responsibility of the investment manager,
transparency, etc.

Category I AIFs have been granted passthrough status. Specified income received
by such funds is taxed directly in the hands
of beneficiaries. However, Category I (for
non-specified income), Category II and
Category III AIFs are not accorded a passthrough status. Tax implications for such
funds would be based on the legal status
of such funds, i.e., whether such funds are
set up as companies, LLPs or trust.

Private equity handbook Tax and regulatory reckoner

29

Contacts
If you would like to discuss any of the insights in this report or opportunities in India,
please contact your Ernst & Young advisor or any of the contacts below.

Sudhir Kapadia
National Tax Leader
Email: sudhir.kapadia@in.ey.com

Amrish Shah
National Leader - Transaction Tax
Email : amrish.shah@in.ey.com

Avinash Narvekar
Private Equity Tax Leader
Email: avinash.narvekar@in.ey.com

Subramaniam Krishnan
Partner, Tax and Regulatory Services
Email : subramaniam.krishnan@in.ey.com

For any private equity related enquires, please contact:

Mayank Rastogi
Email: mayank.rastogi@in.ey.com

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