GST pangs. PE industry players rue GST on fund management fees

The domestic private equity industry is keen that the government ensures a level-playing field between the locally set up PE funds and those established abroad on the taxation front. The existing 18 per cent GST on ‘fund management fees’ of PE funds continues to be a “big tax friction” affecting the onshoring of fund management activity in India, they said.

While management fees charged to a VC/PE fund located in an offshore jurisdiction are exempt from GST, the management fees charged to an onshore fund located in India attracts 18 per cent GST.

The main thorny issue in this GST levy is that no input tax credit is available for the India domiciled fund, which has to fork out the GST. Since an Alternate Investment Fund (AIF) is only a pooling vehicle for investments and does not provide any service, there is no output GST liability, and it is not able to utilize input tax credit of GST. Thus, this incremental GST outgo becomes an additional cost for the investors in the AIF and acts as an impediment to onshoring of funds into India via AIFs, say players who are keen to see the growth of locally pooled investment vehicles.

Higher operation cost

Ashish Fafadia, Partner, Blume Ventures, pointed out that the cost of operations in India are much higher than the situation abroad, largely due to the GST levy. He noted that most overseas fund managers in their respective jurisdictions are not subjected to a GST charge for a variety of reasons and this clearly gives them an edge over domestic funds.

Explaining with an example, Fafadia said that say a ₹100 fund size is usually subjected to management fee of ₹ 18-20 over its life of 10-12 years. On this ₹18-₹ 20, the GST will be ₹ 3.54. “This means in each fund we are losing 3-4 per cent of the corpus on account of GST. The 3-4 per cent of the loss that we suffer on account of GST would have eventually gone to portfolio companies that would result in job creation., attract even a higher capital from overseas investors and result in a higher IRR to the Indian investors who are anyways subjected to capital gains taxes”, he said.

If a fund saved the GST leakage of ₹ 3.5 and was able to plough the capital into its portfolio companies and deliver a 5X (which a typical fund endeavours to generate), it means it would have got incremental ₹ 17.5 for the investors. Of this, 20 plus per cent will be capital gains tax anyway which will be ₹ 3.50. So the exchequer has not really lost out whereas the investors would have been able to create incremental wealth and India’s risk return profile increases marginally.

Over the last decade, there has been a manifold increase in flows of PE/VC investments into India. The good news is that contribution of Indian investors in VC/PE market has been steadily rising even as India continues to be heavily dependent on foreign capital for its fund management industry.

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