How to Structure a Venture Capital Fund by Himanshu Mandavia

Structuring a Venture

Capital Fund - Tax and

Regulatory Aspects

July 2012

2© 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Contents for discussion

Domestic Pooling – Aspects to be Considered

Typical Fund Structure

AIF Regulations – Key Aspects

2

Foreign Investment in Domestic Pooling Vehicle

Unified vs. Co-invest


Domestic pooling – Aspects to be considered

Aspects to be considered

Category of investors

Number of investors

Target sectorsPeriod of investments

Taxation issues




Management fee + carry

Target

AMC

Investors

Management agreement

Pooling

vehicle


Alternative Domestic Pooling Structures

NBFC

PMS

LLP

Unregistered trust

AIF

VCF


Typical Fund Structure - Key issues

• Need for flexibility in making investments

• Overseas presence for management activities

• Costs involved in set-up and time lines for set-up (including approvals etc.)

• Characterization of income on sale of investments

• Deductibility of carried interest / management fee against exit gains

• Taxation of AMC

o LLP structure

o Carry taxation

- Capital gains v. Business income

- Service tax issue

• Tax compliance

o Tax payments, credit distribution, etc

AIF Regulations – Key Aspects


AIF Regulations – Categories of AIF

CATEGORY I

• AIFs with positive spillover effects on the economy

• Incentives given by SEBI, GOI, or other regulators in India

CATEGORY II

• No incentives given by SEBI, GOI, or other regulators in India

CATEGORY III

• AIFs which trade for making short term returns

• Employs diverse or complex trading strategies

VCF,SME Funds,

Social Venture funds,Infrastructure funds

Private equity funds,Debt funds,

Other funds not classified under Category I or III

Hedge funds

SEBI released AIF Regulations on May 21, 2012 to regulate all funds established in India, raising funds from Indian or foreign investors


AIF Regulations – Key conditions applicable to all AIFs…

•Any fund established or incorporated in India (excludes offshore funds)

Registration

•Trust or a Company or a LLP or a body corporate

Form of AIF

•Family trusts,

•ESOP trusts,

•Employee welfare trusts,

•Gratuity trusts,

•Holding companies,

•SPVs not managed by fund managers and regulated by other regulators,

•Securitization / reconstruction companies registered with RBI,

•Funds regulated by SEBI /any other regulator in India

Exclusions from AIF Regulations

•INR 20 crores

Minimum corpus

•1,000 investors

Maximum investors


…AIF Regulations – Key conditions applicable to all AIFs

•INR 1 crore from investor (INR 25 lakhs from employees or directors)

Minimum contribution per

investor

•Continuing minimum Sponsor contribution - at least 2.5% of the corpus or INR 5 crore, whichever is lower

Sponsor contribution

•Possible for closed ended AIFs with minimum tradable lot of INR 1 crore, however funds are not to be raised through the stock exchange mechanism

Listing

•May invest in securities of companies incorporated outside India (subject to conditions of RBI / SEBI)

Foreign Investments




Set up as a Company

• FIPB approval not required for investment in a company registered with SEBI as an VCC. Only Category I AIFs can be VCC.

• FIPB approval required for AIFs under categories II and III.

Set up as a Trust• Prior FIPB approval required for making foreign investment in Trust.

• On repatriation RBI approval would be required.

Set up as a LLP• Prior FIPB approval required for making foreign investment in LLP.

• FVCI not allowed to make any investment into LLP.

Unified Vs. Co-invest

© 2012 KPMG, an Indian Partnership and a member firm of the KOMG network of independent member firm affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Unified vs. Co-investment structure

Offshore

India

Investee companies

DVCF/AIF

Unified

Investee companies

Investors

DVCF/AIF

Co-investment

FDI / FVCI

Offshore

India

Co-investment arrangement

Offshore AMC

Domestic AMC

Fund management agreement

Investment advisory agreement

Management agreement

Domestic investors

Investment Management AgreementDomestic

AMC

Domestic investors

Investors

FDI / FVCI

15


Glossary of Terms

VCF Venture Capital Fund

DVCF Domestic Venture Capital Fund

SEBI Securities and Exchange Board of India

AIF Alternative Investment Funds

AIF Regulations SEBI (Alternative Investment Funds) Regulations, 2012

SEBI VCF Regulations SEBI (Venture Capital Funds) Regulations, 1996

FVCI Foreign Venture Capital Investor

GOI Government of India

SME Small and Medium Enterprise

LLP Limited Liability Partnership

SPV Special Purpose Vehicle

VCC Venture Capital Company

FIPB Foreign Investment Promotion Board

FDI Foreign Direct Investment

Thank You

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2012 KPMG, an Indian Partnership and a member firm of the KOMG network of independent member firm affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Alternate Domestic Fund Structures

Structure Key Benefits Key Concerns

NBFC

• Regulated Entity• No restrictions on Advisory fee• Carried interest, if any, could be in the form of

fees

• Tax inefficient• RBI Prudential norms to be adhered to• RBI registration

PMS

• Can invest across listed and unlisted securities• Regulated by SEBI• Pass through treatment for tax purpose

• Investment to be held directly in the name of investors and not through pooled account

• Liquidity

- Listing of PMS scheme not possible

- PMS scheme to mandatorily provide for an exit option to investors

•Fees to be linked to drawdown and not commitment

• Applicability of AIF regulations in case of pooling of funds?

LLP

• Pass-through treatment for tax purposes- Tax is applicable at the LLP level and distributions

are not taxed ensuring one-level taxation• Limited liability of partners • No restrictions on management fee

• Low on investor comfort• Liquidity to investors - No mechanism for listing of

LLP• Characterization of income (Business Income v/s

Capital gains)• RBI approval• Applicability of AIF regulations

Unregister-ed Trust

• Pass-through treatment for tax purposes• No restrictions on Advisory fee• No restrictions on investment in group companies

• Registration under AIF regulations• Post AIF regulations should be on same footing as

DVCF

18

Annexure 1

Economy & Finance

How to Structure a Venture Capital Fund by Himanshu Mandavia