ICICI Econet Judgement

TAX LIABILITY ON VENTURE CAPITAL
FUNDS
Presentation by Abhishek Jha

(Final Year, MNLU Aurangabad)
ICICI ECONET AND INTERNET TECHNOLOGY

FUND V COMMISSIONER OF CENTRAL TAX
Service Tax Appeal No 2900 of 2012
BACKGROUND
Venture Capital Fund (VCF) isa fund in form of a trust setup as per Securities and
Exchange Board of India (Venture Capital Funds) Regulations 1996 (“SEBI Regulations”). In
India, Venture Capital Funds (VCF) are provided a "pass-through" status, the return on
investments are not taxed at the 'fund' level.
In the present case, ICICI Econet and Internet Technology Fund ("Appellant") was a VCF
set up under the SEBI Regulations.
Among the allotted units, Class B/C unit-holders were entitled to receive a surplus
return, known as Carried Interest ("CI").Class B/C units carried special privileges and were
issued to the Asset Management Company (AMC), which in this case was ICICI Venture
Limited, and its nominees belonging to the ICICI group
BACKGROUND
(Continued)
Upon investigation, an Order was passed confirming taxability of

services allegedly rendered by the Appellant, under the entry Banking
and Other Financial Services" ("BoFS") as per Section 65(12) of the
Finance Act, 1994.
The order was in appeal before the Customs Excise and Service Tax
Appellate Tribunal (CESTAT)/(the Tribunal)
ISSUE-1
Whether a VCF registered under

SEBI regulations can be treated
as a juridical person?
Findings
Unlike a company, a trust is not a separate legal entity and therefore

for the purpose of taxation not taxed at the fund level. However, the
tribunal observed that under the SEBI Regulations, VCFs are treated
as 'juridical persons'.
Further relying on Paramount Bio-Tech Industries v UOI (Allahabad HC

(2004) 120 Comp Cas 18), wherein it was held that SEBI Act and
regulations are special laws and will prevail over the provisions of the
companies Act and other Acts which lay down the general law.
Therefore, although Trusts are not juridical persons, however upon

registration as a VCF under the SEBI Regulation, they become liable to
tax.
ISSUE-2
Whether the appellant have

voilated the Doctrine of
Mutuality?
Findings
The Tribunal referred Yum! Restaurants (Marketing) Private Ltd. v CIT
Delhi [ Civil Appeal No. 2847 of 2010] to was held that doctrine of
Common identity or Mutuality
As per the judgement, "there can be distinction between contributors

and participants but they should one or equal in terms of sharing the
surplus/ profits."
The appellant was involved in commercial activity pertaining to

investment and capital appreciation and by treating a certain class
differently i.e. class B/C and providing them with extra profits and
benefits. Therefore the tribunal held that the appellants had breached
the doctrine of mutuality.
ISSUE-3
Whether the VCF renderd

Taxable service?
Findings
The tribunal held that the payments made by the appellant are not in
the nature of entry and exit expenses. The Carried Interest (CI) was a
performance fee for achieving certain levels of performance and thus
it is an expenditure for the AMC.
Distribution of an amount by terming it as CI was not a return on

investment for the AMC, but an extra amount received based on
realizations made by exiting portfolio investments.
Based on disproportionate amounts paid to Class B/C unit holders,

the Tribunal concluded that such amounts could not be termed as
return on their investments
Way Forward
This ruling has a far ranging impact on similar structured investment funds and the
Venture Capital Industry in general. This is the first incidence of a ruling confirming tax
liability on Venture Capital Funds and the controversy is expected to knock the doors
of the Apex Court.
As per the SEBI Advisory report dated October 15, 2003, the intent of pass through
status provided to the Venture Capital Funds was derived from the same principles
governing other type of pool investments. Since investments pooled together, they are
not to encouraged to be taxed at the fund level but as income at the hands of Investor.
(CONTINUED)
Way Forward
However, this decision goes against such principles and could be used as a precedent to
disallow the pass-through status of investment funds and scrutiny could be expected at
other VCFs, as Carried Interests structured as return on Investment is a prevalent
market practice.
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TAX LIABILITY ON VENTURE CAPITAL

Presentation by Abhishek Jha

ICICI ECONET AND INTERNET TECHNOLOGY

Upon investigation, an Order was passed confirming taxability of

Whether a VCF registered under

Unlike a company, a trust is not a separate legal entity and therefore

Further relying on Paramount Bio-Tech Industries v UOI (Allahabad HC

Therefore, although Trusts are not juridical persons, however upon

Whether the appellant have

As per the judgement, "there can be distinction between contributors

The appellant was involved in commercial activity pertaining to

Whether the VCF renderd

Distribution of an amount by terming it as CI was not a return on

Based on disproportionate amounts paid to Class B/C unit holders,

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