PE and VC Funds May be Taxed While Entering Deals

The Finance Ministry has proposed that any firm buying shares at less than fair market value will have to pay tax on the difference.

The CBDT has notified that this rule of ‘fair market value’ will be applicable to listed and unlisted companies. This will complicate the investment process for PE/VC and hamper the discovery of fair value.

Fair market value of unlisted companies will be calculated by ‘net asset value’ methodology while for listed companies this will be the lowest quoted price on a recognised stock exchange on the valuation date. This will affect restructuring activities if shares are transferred at no cost or below fair market value.

Foreign entities will be taxed at 42% while domestic entities will be taxed at 33%. This means PE and VC funds, especially those investing in distressed assets may have to pay a 33% to 42% tax on the difference between fair market value and the buying price.

This additional consideration will increase the complexity of the transaction and increase transaction cost at entry. It will also take away a big part of any advantage that a distressed asset investor might have at the time of entering the transaction. PIPE deals would go down in number because of this rule.

This might also affect the functioning of asset reconstruction companies. They regularly have restructuring programs involving transfer of shares at no cost, though these are held in a separate trust.

There is also the matter of capital gains tax at the time of exits. Funds currently pay long terms capital gains tax on selling unlisted investments. It is not clear whether an investor would receive any setoff against the tax paid at the time of entry.

Reference: Mint

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