Venture Capital Funds liable to pay Service Tax on Expenditure incurred in Administration of Fund and Carried Interest: CESTAT [Read Order]

Venture Capital Funds - Service Tax - Administration of Fund - CESTAT - Taxscan

The Customs Excise and Service Tax Appellate Tribunal (CESTAT), Bangalore bench confirmed service tax liability on expenses incurred by a venture capital fund (VCF) incorporated as a trust, as consideration received towards asset management services. Disbursement of “carried interest” to the Asset Management Company (AMC) and other expenses incurred by the VCF in the course of its operations have also been characterized as service income of the trust.

The appellant, ICICI Econet and Internet Technology Fund was a VCF set up under the SEBI Regulations. Against the contributions received from investors, the Appellant had allotted various classes of units, each with its own set of rights and privileges. While Class A units were ordinary units, Class B/C units carried special privileges and were issued to the AMC, which in this case was ICICI Venture Limited, and its nominees belonging to the ICICI group. The process of Disbursement of dividend/profits earned from the Appellant investments was governed by its Private Placement Memorandum (“PPM”) and related documents. Firstly, disbursement of an amount equal to the capital and a promised rate of return was made to Class A unitholders. These amounts were also paid to Class B/C unitholders of the fund. However, Class B/C unitholders were additionally entitled to receive a share from the surplus profits generated by the management of the fund, known as Carried Interest (CI).

The tax department conducted an investigation, which culminated in an Order confirming taxability of services allegedly rendered by the Appellant, under the entry Banking and Other Financial Services” (BoFS) as per Section 65(12) of the Finance Act, 1994. The Appellant as a VCF was held to be responsible for capital appreciation of the contributors’ investments and providing other financial assistance. The amounts retained by the Appellant for incurring its own expenses and the CI paid to Class B/C unitholders were together held to represent consideration towards the aforesaid services. In particular, the CI paid to Class B/C unitholders (which included the AMC and its nominees) was deemed to be a “Performance Fee” and not a return on investment. The Order was challenged in appeal before the Tribunal.

The primary issue before the Tribunal was whether expenses incurred by the Appellant in the course of its operations, together with the CI paid to Class B/C unitholders represented consideration towards services provided by it to contributors. The Tribunal, in its decision, upheld the Order of the tax department and in doing so, decided appeals pertaining to 11 funds belonging to the ICICI group.

Mr. Vikram Nankani, Senior Advocate for the Appellant submitted that ) Provisions of service tax did not recognize the arrangement between the Appellant (trust) and its contributors/beneficiaries to be a relationship between a service provider and a service recipient. Liability under the category of BoFS arises when services are rendered by a bank, non-banking financial company, body corporate, or any other commercial concern. )No service provider-recipient relationship arises when a fund is formed out of amounts invested by the contributors/subscribers.

On the other hand, the department’s contention on the doctrine of mutuality was that pooled investments were deployed for the purpose of profit maximization. Contributions were used to advance loans to portfolio companies or buy financial instruments. These activities indicated that the trust funds were put into commercial activities.

The two-member bench of Judicial Member S.S.Garg and Technical Member, P.Anjani Kumar held that the Appellant could not be treated as a “trust” for the purposes of service tax law, since it was involved in commercial activity pertaining to investment and capital appreciation, thereby vitiating doctrine of mutuality. The Tribunal termed the concept of trust in the present case, as merely a facade.

The CESTAT allowed the request of the appellants for re-calculation of the gross value of the taxable services (taking into account the appellant‟s submissions on amounts under different Heads of accounts were wrongfully considered as expenses); availability of CENVAT credit and cum duty benefit. We find that for achieving the above objective, the issue needs to go back to the adjudicating authority for computation of the same.

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