INCOME TAX ACT, 1961

Exemption under section 10(23FB)- Income of Venture capital fund-Interest on FDR

Assessee, a venture capital fund, was constituted under a trust deed executed by Gujarat Venture Finance Ltd. The main object of the fund was to obtain capital growth by making investments in the concerns engaged in information technology sector or related business. It claimed exemption in respect of its entire income under section 10(23FB). AO was a view that assessee should have invested 66.67 per cent of the corpus fund in the equity link instruments, as per regulation 12 of the SEBI (Venture Capital Fund) Regulations, 1996. Since the assessee failed to do so, AO rejected the claim of assessee. AO did not accept submission of the assessee that it was not required to invest 66.67 per cent of the entire corpus but only of investible funds. But claim of the assessee was accepted by CIT(A). Held: Venture capital is finance capital provided by different investors to early stage, high potential, high risk, growth start up companies. The venture capital fund makes money by investing in equities in such high risk growth, start up companies which use new technology or new business model such as bio-technology, IT software etc. Since it may not be possible for an individual investor to take risk in investing its funds in such a high risk but high potential new technology companies, several of such investors come together, pool their money, lock in for certain number of years say 8 to 10 years, identify such high risks, high potential new technology companies and invest in their equity and make money. They also provide to such new start up companies their managerial and technical expertise, in addition to capital. The profit earned in such growing companies is shared by investors which gives them adequate return on their investment. A venture capital fund is also referred as pooled investment vehicle.

Section 10(23F) was inserted with effect from 1-4-1996 first provided the definition of venture capital fund`, in clause (a) to explanation. The basic ingredients of a Venture Capital Fund (V.C.F.) as per this definition are (i) It should operate under a trust deed (ii) The trustees can raise money for investment (iii) Such investment should be mainly in acquiring equity shares of venture capital undertakings. By the Finance Act, 1999, with effect from 1-4-2000, the operation of this clause came to an end. In its place section 10(23FA) was inserted which provided practically the same definition of VCF but the definition of venture capital undertaking, in which venture capital fund was required to make investment by acquiring equity shares, was amended and enlarged. Earlier in section 10(23F) the definition of venture capital undertaking whose equity shares was to be acquired by venture capital fund were confined to limited industries such as business of generation and distribution of electricity or any other firm of power or engaged in the business of tele-communication services or engaged in the business of other communication services, or developing, maintaining or operating infrastructure facilities, or engaged in the manufacture or production of specified articles or things. In section 10(23FA) definition of venture capital undertaking in whose equity shares venture capital fund would invest was enlarged. It included particularly those undertakings which are engaged in the business of software, information technology, production of basic drugs in the pharmaceutical sector, bio-technology, agricultural and allied sector or any other sector specified by Central Government. However, the new provision of section 10(23FA) remained operative only for one year and was substituted by new section 10(23FB) where definition of venture capital fund was made more specific. This definition was effective from 1-4-2001. The definition of venture capital undertaking was also enlarged in section 10(23FB) thereby inserting more industries, where venture capital fund can make investment in equity shares. Income earned therefrom would be exempt under section 10(23FB). [Para 18]

Finance Act, 2007 amended the provision of section 10(23FB) with effect from 1-4-2008 thereby inserting in place of the words set up to raise fund for investment`, the words from investment` in section 10(23FB). It means that income of VCF would be fully exempt upto assessment year 2007-08 and would be partly exempt since assessment year 2008-09 to the extent of income earned from investment in venture capital undertakings only. Other income would be taxable. [Para 20]

In the present assessment year the definition of venture capital fund required following conditions to be satisfied-(1) The venture capital fund is a trust which is registered under the provisions of Registration Act, 1908. (2) It has been granted a certificate of registration under the Securities and Exchange Board of India Act (15 of 1992) and Regulation made therein, 1992. (3) It would mean the conditions as specified by Securities and Exchange Board of India after the approval of the Central Government and by notification in the Official Gazette, where a fund which should be a trust satisfies the three conditions, it would be a venture capital fund within the meaning of section 10(23FB).