India’s private equity industry could be set to benefit from the country’s latest budget.
The Union Budget unveiled last week by finance minister Nirmala Sitharaman marks the Modi government’s first budget since the prime minister was re-elected in June 2024.
The latest Budget seeks to eliminate Angel Tax – an existing tax regime stipulating that if the total amount invested into an unlisted company exceeded the investee company’s fair market value, the excess was treated as taxable income for the recipient.
Though the Angel Tax was previously applicable only for investments made by local investors, it was expanded in April 2023 to include overseas investors. In May this year, however, investments from funds based in 21 countries – including the US, UK and France – were exempted, though key geographies such as Singapore, the Netherlands, Mauritius and the United Arab Emirates remained subject to the regime.
Angel Tax was seen as a significant hindrance to private equity and venture capital deals.
“In a typical funding structure, when there are both primary and secondary transactions, most secondary transactions providing exit to angel investors are usually negotiated at a price lower than the primary issue price,” partner at India-based advisory Grant Thornton Bharat Priyanka Duggal told Private Equity International.
“The introduction of Angel Tax thus resulted in adverse tax outcomes at various instances to ensure compliance with valuation guidelines under Angel Tax and the Foreign Exchange Management Act,” she added.
The change comes as part of a government bid to lessen financial pressures on private companies in India and to improve the ease of investing in the country.
According to Vivek Soni, a partner and national leader in private equity services at EY India, the removal of the Angel Tax is a “big positive”.
“It removes a lot of friction between start-ups and tax authorities on what is fair value and, why should the excess valuation thus determined and given by an investor be subject to tax?” he said. “The PE/VC community had a view that this was a tax on capital and not on income and hence they were keen to see it go away.”
Updates on capital gains taxes
Sitharaman also announced updated rates for long-term capital gains (LTCG) tax. For private securities, the LTCG tax rate has been lowered from 20 percent to 12.5 percent for realised gains. Meanwhile for listed securities, the rate has been increased from 10 percent to 12.5 percent.
According to EY’s Soni, the now-equal tax rates for both private and public equities levels the playing field between both asset classes, enabling investors to evaluate their market participation based on the comparative attributes of the two rather than tax.
However, this positive could be negated somewhat by the government’s simultaneous decision to eliminate India’s existing indexation benefit, which calculated the tax payable on these capital gains according to inflation-adjusted returns.
“Investors might end up paying more tax on the nominal gains rather than the real gains adjusted for inflation,” said Grant Thornton Bharat’s Duggal. “Having said that, in most of the cases, the taxpayers will benefit substantially where the gain is higher vis-a-vis inflation.”
Some expect the end of this indexation benefit to potentially deter private equity and venture capital investment. “We believe because of this; it would be more taxation rather than lesser,” said Manvinder Singh at Indian law firm JSA. “Foreign investors were used to getting calculated on a dollar basis, they’ve never had a benefit of indexation and so it doesn’t impact the foreign investors, but for Indian investors, it’s actually not a great idea.”
EY’s Soni therefore described the overall policy change regarding LTCG as a “give and take”, with the decision to shave 7.5 percentage points off the tax rate remaining a possible catalyst for private investments in India. “It bodes well for the entire PE/VC ecosystem: this should increase the inflow of domestic capital into GPs because the tax arbitrage between listed and unlisted shares has been removed.”
A sign of positivity
India’s private equity market has been attracting global attention in recent years given the country’s steady economic growth and expanding stock markets. The number of buyout opportunities is also growing, with local manager ChrysCapital among those expecting to put more of their latest flagship into control deals.
While the latest Budget included several changes specific to private markets, Soni cited the Modi government’s continuity in policy and reform-focused approach as additional potential catalysts for private markets growth.
“Overall, the Budget is a net positive for the PE/VC industry,” he added. “These tax calibrations here and there, they don’t fundamentally change the investment thesis of why folks are investing in India: whether you pay 2 percent more tax or you pay 2 percent less tax – that doesn’t really break the bank. What matters is the underlying growth of the economy and whether the government is walking the talk of increasing ease of doing business.”
Duggal also noted the Budget announcement provided greater regulatory certainty for domestic and foreign investors, with policy updates reflecting the “growing maturity of India for inviting PE/VC investments”. “The Budget’s influence on the PE/VC industry appears to be leaning towards positive, with significant steps taken to enhance the investment landscape in India.”