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TMI BlogSpecial Provisions Relating to Pass-Through Entities in Venture Capital Structures : Clause 222 of Income Tax Bill, 2025 Vs. Section 115U of Income Tax Act, 1961X X X X Extracts X X X X X X X X Extracts X X X X ..... etailed comparative analysis with Section 115U and Rule 12C, highlighting continuities, departures, and the evolving policy rationale. The analysis is structured to offer both a granular legal interpretation and a broader policy perspective on the treatment of pass-through entities in the Indian tax regime. Objective and Purpose Legislative Intent and Policy Framework The primary objective of Clause 222 is to provide clarity and certainty in the taxation of income generated by investors through investments in venture capital companies and funds. The legislative intent, as reflected in both Clause 222 and its predecessor Section 115U, is to ensure a "pass-through" tax treatment for such income. This means that the income is taxed in the hands of the ultimate investors as if they had invested directly in the venture capital undertaking, thereby avoiding double taxation at both the fund and investor levels. The policy rationale for such a regime is rooted in the recognition that venture capital funds serve as intermediaries, pooling resources from multiple investors to invest in high-growth, high-risk companies. Taxing the income at the fund level and again at the investor level w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scribed" delegates the specification of deadlines and procedural details to the rule-making authority, allowing for flexibility and periodic updating. Sub-section (3): Nature and Proportion of Income This provision clarifies that the income distributed or credited to the investor retains the same character and proportion as it had in the hands of the VC company or fund. For example, if the fund earns capital gains and interest, the investor is deemed to have received capital gains and interest in the same proportion. This is crucial for determining the applicable tax rates, exemptions, or deductions for each component of income, and prevents the recharacterization of income at the investor level. Sub-section (4): Exclusion from Certain Procedural Chapters The sub-section provides that the provisions of Chapter XIX-B (which deals with settlement of cases) do not apply to the income paid by a VC company or fund under this Chapter. This exclusion is intended to streamline the tax treatment and avoid procedural complexities in the context of pass-through income. Notably, this differs from Section 115U(4), which excluded Chapters XII-D, XII-E, and XVII-B (relating to dividend dist ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g double taxation. The deemed credit mechanism (sub-section 5) prevents deferral of tax, while the exclusion of double taxation on actual payment (sub-section 6) protects investors from being taxed twice on the same income. Investors are also provided with detailed information on the nature and proportion of income through the prescribed statement, facilitating accurate tax compliance. Impact on Venture Capital Funds/Companies VC companies and funds are subject to rigorous reporting obligations, requiring timely and accurate furnishing of statements to both investors and tax authorities. The requirement to allocate income in the same proportion and character as received at the fund level adds administrative complexity but enhances transparency. The deemed credit provision may necessitate careful cash flow management, as tax liabilities may arise for investors even before actual distribution of income. Regulatory and Administrative Considerations The pass-through regime simplifies tax administration by aligning the tax treatment of VC income with economic reality. However, it imposes significant compliance burdens on funds, especially in tracking and reporting the character an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dated terminology ("tax year" instead of "previous year," "prescribed" for forms and manner), reflecting modernization and harmonization with international standards. Procedural Compliance: Rule 12C and Its Interface Rule 12C operationalizes the reporting requirements u/s 115U(2) (and by extension, Clause 222(2)). It prescribes that the statement of income paid or credited must be furnished by 30th November of the financial year following the previous year, to the Chief Commissioner or Commissioner within whose jurisdiction the principal office of the VC company or fund is located. The statement must be in Form No. 64, verified by an accountant, and filed electronically under digital signature. The Director General of Income-tax (Systems) is tasked with specifying filing procedures and ensuring data security. The procedural framework is designed to ensure accuracy, traceability, and ease of compliance, while minimizing the risk of evasion or misreporting. Clause 222(2) provides for similar reporting, though the specific forms, deadlines, and manner are to be "prescribed" under the new Bill's rules, suggesting continuity with potential for refinement. Ambiguities and Poten ..... X X X X Extracts X X X X X X X X Extracts X X X X
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