Multiple norms hamper growth of VCFs

In addition to theabove, offshore funds also require FIPB/RBI approval for investment in domestic funds as well as in investee companies. Domestic funds with offshore contributions require RBI approval for the pricing of securities to be purchased in investee firms likewise, at the time of disinvestment, RBI approval is required for the pricing of the securities.

“The multiple set of guidelines and requirements create inconsistencies and detract from the overall objectives of development of venture capital industry. All the three set of regulations prescribed different investment criteria for VCFs,” the SEBI panel said.

There are several anomalies which need to be rectified. SEBI regulations permit investment by venture capital funds in equity or equity related instruments of unlisted companies and also in financially weak and sick industries whose shares are listed or unlisted. However, the government of India guidelines and the Income Tax Rules restrict the investment by venture capital funds only in the equity ofunlisted companies.

SEBI regulations provide that at least 80 per cent of the funds should be invested in venture capital companies and no other limits are prescribed. However, the income tax rules provide that VCF should invest only upto 40 per cent of paid-up capital of the company and also not beyond 20 per cent of the corpus of the venture capital fund. The Government guidelines also prescribe similar restrictions.

Further, SEBI regulations do not provide for any sectoral restrictions for investment except investment in companies engaged in financial services. The government guidelines also do not provide for any sectoral restriction.

However, there are sectoral restrictions under the Income Tax guidelines which provide that a VCF can make investment only in companies engaged in the business of software, information technology, production of basic drugs in pharma sector, bio-technology, agriculture and allied sector and such other sectors as notified by the central government and for production ormanufacture of articles or substance for which patent has been granted by the National Research Lab or any other scientific research institution approved by the Department of Science and Technology, if the VCF intended to claim income tax exemption.

In fact, erstwhile Section 10 (23F) of Income Tax Act was much wider in its scope and permitted VCFs to invest in VCUs engaged in various manufacture and production activities also. It was only after SEBI recommended to CBDT that at least in certain sectors as specified in SEBI’s recommendations, the need for dual registration/approval of VCF should be dispensed with. CBDT instead of dispensing with the dual requirement, restricted investment to those sector only. “This has further curtailed the investment flexibility,” the panel said.

The concurrent prevalence of multiple set of guidelines and requirements of different organisations has created inconsistencies and also the negative perception about the regulatory environment. Since the SEBI is responsiblefor the overall regulation and registration of VCFs, the need is to harmonise and consolidate all this within the regulations of SEBI to provide for uniform, hassle-free, one-window clearance. There is already a functional and successful pattern available in this regard in the case of mutual funds which are regulated through one set of regulations under SEBI Mutual Fund Regulations. Once a mutual fund is registered with SEBI, it also enjoys automatic tax exemption entitlement. Similarly, in the case of FIIs tax benefits and foreign inflow/outflow are automatically available once these entities are registered with the SEBI.

Said the SEBI panel, “It is therefore necessary that there is a single regulatory framework under the SEBI Act for registration and operation of VCFs.” It may be mentioned that Government guidelines were framed on September 20, 1995 and SEBI regulations in 1996 pursuant to the amendment in the SEBI Act 1995 giving SEBI the mandate to frame regulations for venture funds.