Private equity (PE) investments in India have gained significant traction as investors seek high returns. However, understanding the tax implications of private equity investments, including Long-Term Capital Gains (LTCG), Short-Term Capital Gains (STCG), and Dividend Distribution Tax (DDT), is critical for investors and fund managers. The Income Tax Act, 1961, governs these aspects, and various amendments have been introduced to ensure a fair tax regime.

This article explores the taxation structure of private equity investments, relevant provisions, and common FAQs to help investors direct the tax site effectively.

About Private Equity Taxation in India

Private equity investments involve investments in unlisted companies, venture capital funds, or alternate investment funds (AIFs). The tax treatment of these investments depends on holding period, source of income (capital gains vs. dividends), and fund structure.

- Capital Gains Tax on Private Equity Investments

Capital gains arise when a PE investor sells shares or securities at a profit. The tax treatment varies based on the holding period:

A. Long-Term Capital Gains (LTCG) - Section 112A & 112

• If private equity investments in listed shares or units of equity-oriented mutual funds are held for more than 12 months, gains are treated as LTCG.

• If investments are in unlisted shares, they must be held for more than 24 months to qualify as LTCG.

• Tax Rate: LTCG is taxed at 10% on gains exceeding ₹1 lakh per financial year under Section 112A (for listed shares). For unlisted shares, LTCG is taxed at 20% with indexation benefits under Section 112.

• Exemptions: Investments in startups (Section 54GB) can get capital gains tax exemption if reinvested in eligible businesses.

B. Short-Term Capital Gains (STCG) - Section 111A

• If listed shares or units of equity-oriented funds are sold within 12 months, the gains are categorized as STCG.

• For unlisted shares, a holding period of less than 24 months results in STCG treatment.

• Tax Rate: STCG on listed shares is 15% under Section 111A, whereas for unlisted shares, STCG is taxed at slab rates applicable to the investor.

Indexation Benefit for Unlisted Shares

• Indexation adjusts the purchase cost for inflation, reducing taxable LTCG.

• Available only for unlisted shares and non-equity-oriented mutual funds.

Dividend Distribution Tax (DDT) & Dividend Taxation

Dividend income is another source of earnings for private equity investors. However, the taxation of dividends has undergone changes in recent years.

- Dividend Distribution Tax (DDT) - Abolished in 2020

• Until FY 2019-20, companies were required to pay DDT at 15% (effective rate 20.56%) before distributing dividends.

• From April 1, 2020, DDT has been abolished, and dividends are now taxed in the hands of shareholders under Section 56(2)(i).

- Tax on Dividends (Post 2020) - Section 115BBDA

• Dividends are now taxed at slab rates applicable to the recipient.

• TDS on dividends: Companies must deduct 10% TDS under Section 194 if the dividend exceeds ₹5,000 in a financial year.

• Exemptions: No tax on dividends received by certain funds (e.g., mutual funds under Section 10(23D)).

Taxation of Alternate Investment Funds (AIFs)

Private equity funds often operate through AIFs, categorized into three types under SEBI regulations.

- Category I & II AIFs (Pass-Through Taxation) - Section 115UB

• These AIFs enjoy pass-through status, meaning the tax liability is passed on to investors.

• LTCG & STCG apply at individual investor rates.

• Business income is taxed at maximum marginal rate (MMR) of 42.744%.

- Category III AIFs (Taxed at Fund Level)

• Unlike other AIFs, Category III AIFs pay tax at fund level.

• STCG is taxed at 15%, LTCG at 10%, and business income at 42.744%.

Tax Exemptions & Benefits for Private Equity Investors

- Exemptions Under Section 54F

• If LTCG from unlisted shares is reinvested in residential property, the gain is exempt under Section 54F.

• The new property must be held for at least 3 years.

- Exemption Under Section 54EE (Investment in Startups)

• Capital gains reinvested in eligible startup funds qualify for tax exemption up to ₹50 lakh.

- Tax Benefits for Foreign Investors (DTAA Agreements)

• India has Double Taxation Avoidance Agreements (DTAA) with multiple countries.

• Foreign PE investors can claim lower tax rates on capital gains.

Compliance & Filing Requirements for Private Equity Investors

• TDS on Sale of Unlisted Shares: Buyer must deduct TDS at 10% under Section 194Q if the sale exceeds ₹50 lakh.

• Form 67 (DTAA Benefit): Foreign investors must file Form 67 to claim DTAA benefits.

• ITR Forms: PE investors must file ITR-2 or ITR-3 depending on income type.

Frequently Asked Questions (FAQs)

- How are capital gains taxed on private equity investments?

LTCG is taxed at 10% (listed shares) or 20% (unlisted shares with indexation). STCG is taxed at 15% (listed) or slab rates (unlisted shares).

- What is the minimum holding period for LTCG treatment?

For listed shares, the holding period is 12 months. For unlisted shares, it is 24 months.

- Is DDT still applicable on private equity dividends?

No, DDT was abolished in 2020. Dividends are taxed in the hands of investors at their applicable tax slabs.

- How do AIFs impact private equity taxation?

Category I & II AIFs offer pass-through taxation, while Category III AIFs pay tax at the fund level.

- Can PE investors claim indexation benefits?

Yes, indexation benefits apply only to unlisted shares and debt-oriented funds.

- Is there TDS on private equity investments?

Yes, TDS at 10% applies to dividends exceeding ₹5,000 per year under Section 194.

- Are foreign PE investors taxed differently?

Yes, they can avail DTAA benefits to reduce capital gains tax.

- How can PE investors save taxes?

Investing in residential property (Section 54F) or startups (Section 54EE) helps in capital gains exemption.

- Do foreign investors need to file tax returns in India?

Yes, if they earn taxable income in India, they must file Form 67 and ITR-2.-

- What is the impact of the 2020 tax changes on PE investments?

The removal of DDT has shifted tax liability to investors, making tax planning critical.

Conclusion

Private equity taxation in India involves capital gains tax, dividend tax, and AIF taxation. Understanding LTCG, STCG, and exemptions under the Income Tax Act, 1961, helps investors minimize liabilities and optimize tax savings. With India’s evolving tax laws, it is essential for PE investors to engage in proactive tax planning and compliance to ensure smooth financial transactions and maximize investment returns.