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    ARTICLE - India

    VC Funds Not Subject to Service Tax Karnataka High Court Rules:

    17 Feb

    VC Funds Not Subject to Service Tax - Introduction

    In a landmark decision on 8 February 2024, the Karnataka High Court overruled a Central Excise and Service Tax Appellate Tribunal (CESTAT) Order.

    The CESTAT Order

    This previous ruling recognised Venture Capital Funds (VCFs) set up as Trusts as 'distinct entities' from their investors, thereby subjecting them to service tax for providing asset management services. The CESTAT's decision was based on the premise that VCFs, by managing portfolios or assets for their contributors, were rendering taxable services. This interpretation was challenged in the High Court, leading to a significant legal examination of the nature of VCFs under tax law.

    Trusts Not Recognised as Juridical Persons Under Finance Act

    The High Court's judgment clarified that the Finance Act, 1994, which governs service tax, does not recognise 'trusts' as juridical persons. This distinction is crucial as the CESTAT had argued that since trusts are treated as juridical entities under the Securities and Exchange Board of India (SEBI) regulations, they should also be considered the same for taxation purposes. The High Court disagreed, emphasising that statutory definitions must align with the objectives and purposes of the specific legislation in question, in this case, the Finance Act.

    VCFs as 'Pass Through' Entities

    The Court further deliberated on the nature of VCFs' operations, highlighting their role as 'pass through' entities. This means that VCFs aggregate funds from contributors and invest these funds based on the investment manager's advice, without altering the fundamental ownership of the assets. The High Court recognised this function, affirming that VCFs act in a trustee capacity, managing investments without directly offering taxable services to the investors.

    Application of the Doctrine of Mutuality

    Central to the High Court's ruling was the application of the doctrine of mutuality, which posits that a service cannot be rendered to oneself. In the context of VCFs, the Court observed that the relationship between the contributors and the trust is inherently mutual. The funds invested by contributors are managed in trust, negating the notion of a service transaction between two separate entities.

    VC Funds Not Subject to Service Tax - Conclusion

    This ruling is a significant victory for Venture Capital Funds set up as Trusts, affirming that their asset management activities do not constitute taxable services under the Finance Act, 1994. The Karnataka High Court's decision brings clarity to the taxation status of VCFs, ensuring that their operations are not unduly burdened by service tax liabilities. This judgment not only aligns legal interpretation with the operational realities of VCFs but also supports the broader investment ecosystem by recognising the unique structure and function of venture capital investments.

    Final thoughts

    If you have any queries about this article on VC Funds Not Subject to Service Tax then please get in touch.
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