Taxation of Private Equity Investment in India
- What Is Private Equity?
- Private Equity Investment Explained: How It Works In India?
- Structure and Functions of PE Fund
- Taxation of Private Equity Funds in India
- Conclusion
What Is Private Equity?
With the private equity funds in India reaching $13.7 billion in the first quarter of 2025, the scope of investments has also surged significantly. It has brought a shift among HNIs and UHNIs who wish to invest in companies and help them succeed and expand. This move has also resulted in more buyouts than minority stakes in early-stage startups and growing entities. However, individuals planning to invest in private equity should also consider the tax implications.
This blog will provide an overview of private equity, its structure, the functions of private equity firms, and the taxation of such investments in India. Keep reading!
Private equity refers to the type of investment made by private companies that are not listed on the stock exchange. These shares are not tradable in the secondary market. Hence, investment primarily occurs in unlisted companies, either entirely or through buyouts.
In contrast to public equity, where individuals can easily buy or sell shares of a company (stock), an exit strategy is required here. Only then is it feasible for investors to sell their stake and exit from that company. Additionally, all these are handled by private equity firms, which ensure that the value increases before they exit their investments later.
Private Equity Investment Explained: How It Works In India?
Private equity investment involves investing in private companies in exchange for a stake, while providing support to their businesses. Here, investors try to provide the fuel and guidance required to scale the business. When the company has improved its performance (or reached its goal), investors eventually sell their stake for a yield and exit.
The entire structure of private equity investment involves key players like private equity firms, investors, and public (or delisted) companies. It includes:
- Private equity (PE) firms: Responsible for raising funds for private companies. After achieving the goal, they take their part and exit from these entities.
- Limited partners (LPs): The capital providers in a private equity fund,
but they do not manage the fund. This group of LPs includes:
- High-Net-Worth Individuals (HNWIs)
- Family Offices
- Pension Funds
- Sovereign Wealth Funds
- Endowments and Trusts
- Insurance Companies
- Public or Portfolio Companies: These are the companies in which PE funds
invest. They could be:
- Startups (in growth equity)
- Mature businesses (in buyouts or turnaround strategies)
Structure and Functions of PE Fund
Depending on the structure, the major functions or types of private equity include:
- Venture Capital: Early-stage startups and growing businesses often need capital to fund innovative projects. Private equity is feasible for them to raise capital, and in exchange, investors acquire equity (ownership) in such firms. The unavailability of debt brings in extreme risk exposure, but VCs are eligible for better yields than other instruments.
- Buyouts: Leveraged buyout funds (LBOs) occur in mature businesses or public companies that have turned private (or been delisted). A private equity firm acquires a stake in such entities by paying a significant portion. Management can even participate in the buyout session if they wish to.
Before initiating a buyout, previous investors (or shareholders) must cash in their shares and exit. Once done, the PE firm can enter and become the sole investor in that company. Investors should own more than a 50 percent stake. This buyout can happen in two ways:
- Management Buyout: When a public company wants to undergo internal restructuring (such as converting into a private company), management buyouts can be a helpful option. Through a PE firm, they may raise funds and take a minority stake in the company. The management team of another company is not eligible to participate in this buyout.
- Leveraged Buyout: Companies where a significant portion is financed via debt (or loan) are known as LBOs. Both companies (the acquiring company and the target) use their assets as collateral to secure this loan.
Taxation of Private Equity Funds in India
The following is the taxation of private equity funds in India:
Taxation for Category I and II AIFs
- Category I and II AIF investments are now explicitly classified as "capital assets" under the Income Tax Act.
- Income (except business profits) is exempt at the AIF level but is taxable from the investor’s side.
- Business profits are taxed at the AIF level, which is exempt for investors.
- Non-residents are taxed directly on income (rates depend on type + tax treaty benefits).
- The LTCG tax rate for retail and foreign investors on unlisted securities has been standardized at 12.5%.
Taxation of Category III AIFs
- Company: They get taxed at corporate tax rates, where dividends reside with the investors (with TDS).
- LLP: LLP is taxed on income earned. However, distribution (share) is exempt for both LLP and investors.
- Trust (typical structure): Income taxed either in the hands of the trustee (as representative assessee) or directly in investors' hands. If business income is present, the entire income is taxed at the maximum marginal rate at the trust level.
Special Regime for Category III AIFs in GIFT City
- If units are held only by non-residents (except for the sponsor/manager), the interest/dividend gets taxed at 10%.
- Capital gains (except for shares of Indian companies) are exempt.
- Non-resident investors are exempt from Indian tax filing only if they earn from an AIF (with taxes withheld).
Conclusion
With the evolving investing landscape, the trend of private equity has acquired the mindset of the ultra-wealthy population. Plus, private equity has allowed investors to access growth companies and alternative asset classes. However, understanding the structure, functions, and especially the taxation of private equity funds in India is crucial and helpful for informed decision-making.
Disclaimer:This is for educational/information purposes only. The general topic and information do not aim to influence the investment/trading decisions of any investors.
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