Before delving into the subject of Foreign Venture Capital Investment, it is necessary to understand what Venture Capital means. Venture Capital is a method of seed-funding where ‘capital’ is invested by an outsider in ‘ventures’ which are new, growing, small or troubled. It is different from traditional sources of funding such as banks, in the sense that the capital is not given as a loan. Instead, it is invested in exchange for an equity stake in that particular venture, in the hope that it will yield high returns. Since Venture Capitalists choose to fund companies and start-ups which have a limited operating history, but great ideas and potential for future growth, it is said to be a “high return, high risk” investment.
The term refers to investments made by a Non-Resident / Foreign investor in Venture Capital Undertakings (“IVCU”) and Venture Capital Funds (“VCF”). In India, such investments are governed by the Securities Exchange Board of India (“SEBI”) Regulations and the Foreign Exchange Management Regulations.
The foreign country which chooses to invest in India’s Venture Capital is known as the Foreign Venture Capital Investor (“FVCI”). The term has been defined under Regulation 2(g) of SEBI (Foreign Venture Capital Investors) Regulations, 2000 as an investor which is incorporated and established outside India, is registered under this Regulation and has proposed to invest in VCF or Venture Capital Undertakings (“VCU”s) in India.
The Foreign Direct Investment Policy, 2020 (“FDI Policy”), gives a similar definition of the term FVCI by stating FVCI is an investor incorporated and established outside India, registered under the SEBI (FVCI) Regulations, 2000 (“FVCI Regulation”) which proposes to invest according to these Regulations.
Thus, from the above two definitions we can conclude that there are 3 essentials which a foreign investor must satisfy before it can start making investments in India’s venture capital enterprises:
In order to be recognized by SEBI as an FVCI, the applicant/ foreign investor must fulfil certain conditions which have been listed in Regulation 4 of the FVCI Regulations. These include:
If the application is incomplete or the necessary criteria have not been fulfilled, the Board may reject the application after giving the applicant time to remove the objections / an opportunity of being heard. Contrarily, if the Board is satisfied that the applicant satisfies the eligibility conditions, it shall grant a certificate of registration as FVCI to the applicant.
Once the Foreign investor has been granted an FVCI certificate by SEBI and received approval from the RBI for making investments in India, it can enter into 2 types of investments:
VCUs are generally newly inaugurated, private companies that are yet to establish themselves in the market and require finances and expert advice from investors. It may be defined as a company:
As the name suggests, it is a ‘fund’ that has been established as a trust or a company. It must:
Now that it is clear what VCUs and VCFs are, it is important to understand the conditions imposed by SEBI for investing in them. The FVCI can only invest from the “investible funds”, which refers to the corpus of funds committed for making investments in India and includes the net expenditure for managing and administering the funds. The investment criteria have been detailed in Rule 11 of the FVCI Regulations. The Rule provides that an FVCI shall only invest in the following manner:
It must be noted that the Rule also permits an FVCI to invest 100% of its funds in a domestic VCF registered under SEBI. The investment strategy chosen by the Foreign Venture Capital Investor and the life cycle of the funds must be disclosed to the Board before making any investments in India. Apart from this important duty, an FVCI has many other responsibilities to pay heed to while making such investments.
These obligations have been given in Chapter IV of the FVCI Regulations. They are:
In India, the taxation system is governed by the Income Tax Act, 1961. However, the Indian government has also entered into Double Taxation Avoidance Agreements (“DTAA”) with many countries. The DTAA aims to restrict the authority of countries to levy tax on income received by a Non-Resident from its business activities in that particular country. While assessing the income of a Non-Resident of India, the provisions of both must be taken into consideration. Section 90(2) of the Income Tax Act provides that the assessee is to be taxed under the Income Tax Act, or the DTAA, whichever is more beneficial.
With respect to tax on Venture Capital companies, 2 provisions of the Income Tax Act are primarily relevant:
This section provides that while calculating the total income of any person in a previous year, any income of a venture capital fund/company in a VCU shall not be included.
This section provides that any income received by a person from the investment made in a Venture capital fund/company shall be chargeable to income tax, in the same way as if it were income received by the person directly had he made investments directly in the VCU.
Thus, the two sections when read together constitute an integrated code: The venture capital funds and companies are exempt from taxation on any income earned from the investment. However, when the income is distributed to investors, it becomes taxable. The nature of the income determines its tax treatment. In the hands of shareholders, dividend income is free, but the company distributing the dividend has to pay a 16.99% dividend distribution tax. Otherwise, capitals gain tax are when the shares of the investee companies are sold.
Thus, the FVCI ultimately does not get any tax exemption. However, it can avail of the benefits of the DTAA. Treaties with certain jurisdictions have proven to be quite favourable for investors. One such example is the India-Mauritius DTAA according to which, the capital gains earned by a resident of Mauritius will only be taxable in Mauritius and will be exempted in India. Since Mauritius does not levy a tax on capital gains, the investor reduces his tax liability and benefits from the arrangement. Such treaties have made the venture advantageous and paved the way for making investments in India.
In order to facilitate such investments in India, FVCI has been granted a number of relaxations, including:
Foreign Venture Capital Investors in India are allowed to invest only in the following sectors:
To be registered under SEBI, the applicant must make an application to the Board in Form A of FVCI Regulations, which is attached to the Regulations and provide all the details and supporting documents asked for. The Applicant must deposit the fee prescribed in Part A of the Second Schedule and pay it in accordance with the manner given in Part B of the same schedule of FVCI Regulations. Upon receiving the application, the Board analyses it and raises objections/grants the certificate, as the case may be.
Exit strategy refers to the method using which a venture capitalist can exit/get out of the investment it made in the past. It is also known as a “liquidity event’ or a ‘harvest strategy” since it is a calculated decision to harvest maximum profits while cutting back on expenditure. A special exemption has been made for FVCIs which provides that they can sell or acquire their Indian shares / convertible preference shares / convertible debt / any other unit invested at a rate that is mutually acceptable to both parties. Thus, there are no entry or exit restrictions imposed on an FVCI which makes the investment arrangement more advantageous for them.
Yes. Under Rule 21 of the FVCI Regulations, the Board has the right to suspend the certificate if the FVCI:
The Board also has the power to cancel the certificate granted if the FVCI:
From the above discussion, one may conclude that Foreign Venture Capital Investments are a crucial method of promoting enterprise and innovation in India, while also facilitating the conversion of knowledge-based ideas and scientific technology into a means of commercial production. The policy structure of India offers a large number of exemptions to FVCI and lays down clear and detailed guidelines for the eligibility, registration, obligations and investment restrictions for an FVCI.
India possesses a number of factors that make it a favourable country for foreign investments, such as cost-competitive labour, skilled manpower, R&D, technology and policy support. Recent initiatives such as Start-up India have further boosted the entrepreneurial spirit and invited investments. It is an ardent hope of the Indian government that these steps lead to a flourishing venture capital industry, and fill the gap between the financing from banks and the capital requirements of new start-ups in the country.
Your email address will not be published *
This guide seeks to empower entrepreneurs with the expertise and resources necessary for flourishing in India's vibrant manufacturing industry.View More
Bharatiya Nyaya Sanhita has done away with the “General Explanation” clauses as contained in Sections 8 to 52A of Chapter II of IPC. All these Sections contained definitions as there was no definition clause in IPC.View More
Delhi (Head Office)
Plot No. 66, LGF, #TheHub, Okhla Phase III, Okhla Industrial Estate, New Delhi 110020, India.