Union finance minister Nirmala Sitaraman, while presenting the Budget for 2024-25 on Tuesday, announced the formation of variable capital companies or VCCs in India. This move will boost capital flow from global and domestic investors in the alternative investments space in Gift IFSC.
The government will enable pooled private equity fund structures through VCCs, a system popular in tax-friendly jurisdictions such as Singapore and Mauritius. Mint explores the details of VCCs and how they are likely to be attractive to overseas investors.
Unlike typical funds where investors share risks and rewards uniformly, a VCC allows for sub-pools with different investment objectives, investors, and asset classes, all governed by the same board and managed by a single fund manager, custodian, auditor etc.
Under the current Securities and Exchange Board of India (Sebi) and International Financial Services Centres Authority (IFSCA) regulations, an AIF may be set up as a trust, an LLP or a company. However, a VCC would necessarily have to be a company or at least an incorporated entity, said Vinod Joseph, partner at Economic Laws Practice. Many regulations applicable to companies would need to be disapplied to give flexibility to VCCs, he added.
However, the legal aspects of governing the VCC structure are still not clear. “It remains to be seen how the government will operationalize the VCC structure, whether it will be done under the Companies Act, 2013 or under a different law,” Joseph said.
Investors and industry experts have cheered the introduction of the structure. They believe that the move would create sources of capital beyond just the private equity and venture capital ecosystem and will give another avenue for early-stage companies and founders to raise funds in a constrained environment.
“AIFs in Gift IFSC can look forward to a variable capital company (VCC) structure, a globally recognized and accepted vehicle for investment funds,” said Siddarth Pai, founding partner, 3one4 Capital, an early-stage venture capital firm. “Trusts were not conceived for the complex operations of VC/PE funds and the VCC structure will make Gift IFSC even more attractive.”
EY India’s Jaiman Patel, among other efficient funding announcements, said VCCs promise enhanced financial and operational flexibility to the Gift City ecosystem.
“Despite these advancements, anticipated reforms such as the tax framework for ODIs by non-banking units, reverse flipping of startups to Gift City IFSC, clarity on taxation of insurance proceeds in IFSC, etc remain pending,” Patel added.
Other experts said the move would reduce compliance burden while making follow-on investments in startups when only a certain number of LPs are willing to participate. “When you set up a fund, it comes with compliance requirements and so on. VCC structure is basically one umbrella structure. And then within that, there will be multiple teams you can create…teams or specific carve-outs for each portfolio,” Blume Venture’s Mitul Mehta said.
The budget also announced more inclusions into what constitutes a “specified fund”. This fund could avail a tax exemption for capital gains arising out of investing in Indian debt securities. Generally, businesses operating in Gift City enjoy a general ten-year tax holiday which is applicable only to “business income” and not to “capital gains”.
Until recently, a specified fund was defined as a Category III AIF located in any IFSC and whose units (other than units held by its sponsor or manager) are held by non-residents. The specified fund is the only Gift City entity that is eligible for an exemption from income tax on capital gains.
The latest budget has also included a retail scheme or an exchange-traded fund into the broader specified funds qualification, which can avail similar tax exemptions. In other words, if a retail scheme or an exchange-traded fund is set up in Gift City, it can raise monies from overseas retail investors, and such funds can invest in Indian debt securities. The capital gains arising from investments in Indian debt securities would not be taxable, Joseph explained.
EY’s Patel said this will attract global fund managers and boost the broader fund management ecosystem. “Additionally, IFSC finance companies now enjoy an exemption from thin capitalization rules, encouraging the establishment of Finance Companies and treasury units,” he added.
While the government is undertaking measures to ensure a steady flow of capital, there are certain challenges that various entities continue to face in Gift City. One such impediment is talent, especially in fund administration management.
An improving funding environment and as more funds start routing from Gandhi Nagar, some of these obstacles may see ease with institutions looking to hire more with competitive salaries. “Over the next two to three years, people will start paying higher salaries, solving the talent problem,” said Yagnesh Sanghrajka, founder and CFO, of early stage venture capital firm 100X.vc.
Sanghrajka also emphasized issues such as approval, licensing and capacity for institutions in Gifty City. As per the Economic Survey, released on Monday, there has been rapid growth in fund management entities (FMEs) and AIFs registered with IFSCA over the last three years. The cumulative FMEs and funds registered rose from 39 and 33 as of September 2022 to 114 and 120 as of March 2024, the survey said.
While investors believe there are ample opportunities to deploy capital, they encounter significant challenges in receiving approvals. “The number of funds growing in this area have received approval but haven't started channelling funds into India yet. Approvals are there, but things take time,” Sanghrajka said.
He added that the IFSC demands funds to show presence and carry out affairs in the Gift City. “Fund managers will need to travel to Ahmedabad for board meetings. IFSC is driving this emphasis on substance over form. However, they offer substantial benefits like 100% tax exemption for 10 years and no GST on fees, which justify the costs of maintaining a presence there.”
