Interest income earned by joint venture FDRs prior to 1 April 2008 exempt under Section 10(23FB) of the Income Tax Act, 1961

ITO Vs Gujarat Information Technology Fund (ITAT Ahemdabad)- Interest income earned on bank deposit is exempt u/s 10(23FB) and there is no decision of SEBI that there is any violation of SEBI (Venture Capital Funds) Regulation 1996 and, therefore, the AO cannot hold that there was such violation. The AO is duty bound to inquire whether the assessee trust is registered under the Registration Act, 1908 and has been granted a certificate of registration by SEBI under SEBI (Venture Capital Funds) Regulations, 1996 and not beyond that.

IN THE INCOME TAX APPELLATE TRIBUNAL
AHMEDABAD BENCH “A” AHMEDABAD

Before S/Shri M.K. Shrawat, JM and D.C.Agrawal, AM

ITA No.	C.O.No.	Asst. Year
2264/Ahd/2007		2003-04
245/Ahd/2009	24/Ahd/2009	2001-02
246/Ahd/2009	25/Ahd/2009	2004-05
247/Ahd/2009	26/Ahd/2009	2005-06
5. 2773/Ahd/2008	222/Ahd/200 8	2002-03

 

Income-tax Officer, Ward 10(2), Ahmedabad.	Vs.	Gujarat Information Technology Fund, 1st floor, Premchand House, Ashram Road, Ahmedabad.
(Appellant)	..	(Respondent)

 

Revenue by :-	Shri D. C. Patwari, CIT, DR & Shri S. A. Bohra, Sr.DR
Assessee by:-	Shri S. N. Soparkar, Sr.Advocate & Shri P. M. Mehta, AR

O R D E R

Per D.C. Agrawal, Accountant Member.

Since all these appeals and Cross Objections pertained to the same assessee and they involve common issue, they are taken up together for the sake of convenience. The lead year for the discussion is Asst. Year 2003-04. In this year the Revenue has raised following ground:-

(1) The ld. CIT(A) has erred in law in granting exemption u/s 10(23FB) of the IT Act, to the assessee on income earned from Bank Deposit of Rs.75.56 lacs by the assessee.

2. Thus the only issue involved in the appeal is whether the assessee is entitled to exemption u/s 10(23FB) of the IT Act, 1961 (hereinafter referred to as the Act) in respect of interest income of Rs. 75.56 lacs earned from Bank Deposits.

3. The facts relating to the issue are that the assessee, Gujarat Information Technology Fund (a venture capital fund) is constituted under a trust deed executed by Gujarat Venture Finance Ltd. on 21.3.2000 with initial corpus of Rs.5 lacs. The main object of the fund was to obtain capital growth by making investments in the concerns engaged in information technology sector or related business. During the year under consideration total receipts was shown at Rs.85,87,919/- with break up as under :-

Nature of Income	Amount
(i) Income from Venture Assistance	10,31,478/-
(ii) Other Income	75,56,551/-

The assessee claimed exemption in respect of entire income u/s 10(23FB) of the Act. The AO examined the past as well as subsequent return of income and found that income earning activities of the firm vis-à-vis object of the firm were as under :-

Sl. No.	Asst. Year	R.R.No.	Dt.of filing	Income from Venture Capital Assistance (Rs.)	Income from other sources (Rs.)
1	2002-03	6646	18/10/2002	3,81,281/-	76,49,395/-
2	2003-04	6596	23/10/2003	10,31,478/-	75,56,441/-
3	2004-05	5080	25/10/2004	8,34,286/-	49,97,348/-
4	2005-06	2243	11/08/2005	5,64,988/-	60,46,638/-

The AO examined the claim of the assessee and opined that it does not fulfill various conditions laid down in that section. While concluding the assessment the AO gave following reasons for denying the claim to the assessee: –

“Conclusion:

11.1 In view of the foregoing discussion, it is noticed that the assessee fund has violated the provision of the Income-tax Act, SEBI Regulations and the Trust Deed itself. The violations are mentioned in a nut-shell below-

11.2 Violation of Income-tax Act, 1961:

The assessee has not fulfilled the criteria for venture capital fund as enumerated in explanation (1)(b)(ii) and (1)(b)(iii) to section 1 0(23FB).

11.3 Violation of SEBI Regulations:

(i) The assessee has violated the regulation 12(b) of Securities and Exchange Board of India (Venture capital Funds) Regulations, 1996 (as it stood prior to 15/09/2000).

(ii) The fund has also violated the regulation 12(d) of Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 (as amended by notification dated 1 5/09/2000).

(iii) The fund has violated the regulation 8 of Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996.

(iv) the fund has also violated the regulation 2(m) of Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996.

11.4 Violation of provisions of Trust Deed:

(i) The trust deed declaration in page 2(iv) states that “The funds shall not be applied directly or indirectly for any purpose other than the purposes specified herein. The assessee has made substantial investments in Bank deposits which violates the provisions of trust deed.

(ii) The trust deed declaration in para 5(B)(i) of the lays down that “Gujarat IT Fund will be deemed to have been fully invested when 80% of the corpus of Gujarat IT Fund is invested in the Assisted Concerns including loans and the balance in cash and/or highly liquid money market instruments. The investment pattern violates the said provisions of the deed.

(iii) The trust deed declaration in para 5(A)(i) lays down the mode of investments of the fund, which does not include investment in Bank deposits to earn interest.

11.5 From the above discussion, it can be concluded that the assessee fund is not a venture capital fund within the meaning of Section 10(23FB) of the Act, as it violates the provisions of SEBI Regulations as well as the provisions of the Trust deed. In view of the same, the receipts of the assessee need to be taxed as income from other sources since, the income of the assessee comprises of (i) interest income (ii) scrutiny fee (iii) royalty and miscellaneous income. All these income fall under the head of Income from other sources. The income of the assessee is thus taxed as income from other sources and the expenses are allowed as per the provision of section 57 of Income-tax Act, 1961 as discussed below. Similar action is being taken for preceding years as well as subsequent years since, the investment pattern as well as the income earning pattern of the assessee violates the provisions of the IT Act, SEBI Regulations and provisions of the Trust Deed.”

While explaining conclusion in para 11.2 the AO mentioned that the restriction granted u/s 7(3) of Securities and Exchange Board of India (Venture Capital Fund) Regulation, 1996, the venture capital fund is subject to the condition specified in the Act and the Regulations made thereunder. The fund does not come within the meaning of Venture Capital Fund since the fund failed to adhere to the conditions and Regulation mentioned in SEBI (Venture Capital Fund) Regulation, 1996 and, therefore, violated explanation 1(b)(ii) and 1(b)(iii) contained in section 10(23FB). In respect of conclusion drawn in para 11.3 the AO explained in the assessment order that as per SEBI (Venture Capital Fund) Regulation, 1996, the assessee fund is required to make investment in accordance with the Regulations laid down therein as per Regulation No.12 :-

“12. (a) the venture capital fund shall not invest in the equity shares of any company or institution providing financial services.

(b) at least 80% of funds raised by a venture capital fund shall be invested in

(i) the equity shares or equity related securities issued by a company whose securities are not listed on any recognized stock exchange;

(ii) the equity shares or equity related securities of a financial weak company or a sick industrial company, whose securities may or may not be listed on any recognized stock exchange;

(iii) providing financial assistance any other manner to companies in whose equity shares the venture capital fund has invested under sub-clause (i) or sub-clause (ii) as the case may be.”

However, investment during the year under specified security is less than the prescribed limit as per regulation 12(b) wherein at least 80% receipts should be invested in specified activities. Total fund raised during the year is 19.05 crores and, therefore, 80% thereof which comes to Rs. 15.24 crores should have been invested in the specified activities. However, the assessee has invested only Rs. 10.54 crores which falls substantially short of minimum stipulated investment.

4. In respect of conclusion drawn in para 11.3 (ii) the AO mentioned that not making investment in the specified activities to the extent required is a violation of regulation 12(a) of the SEBI (Venture Capital Funds) Regulation 1996. As per that regulation investment is required to be made as under :-

(i) at least [66.67%] of the investible funds shall be invested in unlisted equity shares or equity linked instruments [of venture capital undertaking].

(ii) Not more than [33.33%] of the investible funds may be invested by way of

(a) subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed

(b) debt or debt instrument of a venture capital undertaking in which the venture capital fund has already made an investment by way of equity.]

(c) Preferential allotment of equity shares of a listed company subject to lock in period of one year

(d) the equity shares or equity linked instruments of a financially weak company or a sick industrial company whose shares are listed.

According to above, the assessee should have invested Rs.12.7 crores in Venture Finance Assistance whereas it has invested only Rs. 10.54 crores.

5. In respect of conclusion drawn at para 11.3(iii) that there is a violation of regulation 8 of SEBI (VCF) Regulation, 1996 the AO explained that the regulation -8 requires to fulfill following conditions :-

(a) The venture capital fund shall abide by the provisions of the Act, and these
regulations;

(b) The venture capital fund shall not carry on any other activity other than
that of a venture capital fund;

(c) The venture capital fund shall forthwith inform the Board in writing if any information or particulars previously submitted to the Board are found to be false or misleading in any material particular or if there is any change in the information already submitted.

However, the assessee has shown following investment pattern :-

Sl. No .	Asst. Year	Investment in Venture Capital Assistance	%        of invest mentout     of funds raised	Income from venture capital assistance (Rs.)	Investment     in bank deposits	%          of investment out of funds raised	Income from other sources (Rs.)
1	02-03	8,95,93,450/-	49%	3,81,281/-	9,18,53,488/-	51%	76,49,395/-
2	03-04	10,45,49,049/-	55%	10,31,478/-	8,90,96,815/-	45%	75,56,441/-
3	04-05	10,47,10,049/-	55%	8,34,286/-	8,38,01,808/-	45%	49,97,348/-
4	05-06	11,08,43,383/-	47%	5,64,988/-	12,36,51,599/-	53%	60,46,638/-

Thus the assessee has mainly income from other sources for last many years. It is a violation of regulation 8(b) which clearly states that Venture Capital Fund cannot carry out other activities. Making F.D. in bank and earning interest therefrom does not constitute the activities of a Venture Capital Fund.

6. While explaining conclusion 11.3(iv) the AO mentioned that definition of Venture Capital Fund as given in regulation 2(m) is as under:-

2(m) venture capital fund’ means a fund established in the form of a trust or a company including a body corporate and registered under these regulations which –

(i) has a dedicated pool of capital,

(ii) raised in a manner specified in the regulations, and

(iii) invests in accordance with the regulations

Since investment made by the assessee firm is not in accordance with the regulation it will not come within the meaning of Venture Capital Fund.

7. While explanation violation of provision of trust deed the AO mentioned that –

(1) It has violated the basic purpose of the trust deed particularly para 2.4 thereof which states that the fund shall not invest directly or indirectly, for any other purposes other than the purpose specified therein. Para 5(B)(i) provides investment of 80% of the corpus in the assisted concern including loans and balance in cash and/or highly liquid money market instruments. Thus the assessee was required to invest only in information related concern and not as bank deposits. He also observed that income earned as interest from bank deposits would be taxable as income from other sources and not income of venture capital fund which would get exemption u/s 10(23FB). In nutshell the AO rejected the claim and exemption u/s 10(23FB) mainly on three counts –

(i) investment pattern of the assessee firm does not conform to the requirement of SEBI Regulation and trust deed.

(ii) there is a violation of SEBI Regulation and the provisions of the trust deed.

(iii) Income from bank deposits is taxable as ‘income from other sources’ and is not an income from assisted concern and hence should not get exemption u/s 10(23FB).

8. The ld. CIT(A) in a detailed and reasoned order allowed the claim of the assessee. His findings in this regard are as under :-

“24. After having carefully considered the arguments of both the sides, I find force in the arguments of the counsel for the appellant. The explanation (1)(b) to section 10(23FB) defines the Venture Capital Fund. The conditions stipulated by this provision are that the fund should be registered under the Registration Act, 1908, it should have been granted a certificate of registration under the Securities and Exchange Board of India Act, 1992 and Regulations made there-under and it should fulfill the conditions as may be specified by SEBI with the approval of the Central Govt. by Notification in official gazette. I am inclined to agree with the arguments of the counsel for the appellant. As per the definition of the Venture Capital Fund, it is nowhere stipulated that the provisions of SEBI Regulations, 1996 have to be complied with. What the appellant has to comply with are the conditions which are to be specified by SEBI with the approval of Central Govt. by Notification in official gazette. No such conditions have been specified by the SEBI and hence, there is no violation of the same by the appellant. The other two conditions viz. registration under the Registration Act and obtaining a certificate of registration from SEBI has been fulfilled by the appellant. All the three conditions specified by the explanation 1(b) have been fulfilled by the appellant and therefore, the appellant qualifies for exemption u/s 23(FB). The AO is not justified in saying that since the appellant has to obtain a certificate from SEBI under the SEBI Act and the Regulation made there-under, the appellant is required to fulfill the SEBI Regulations 1996. This is nowhere provided in section 10(23FB). I further agree with the arguments of the appellant that the investment pattern mentioned in the SEBI Regulations has not specified the life cycle. It is only in 2004 that an explanation has been inserted below the Regulation 12(d) which mentions that investment condition shall be achieved by the fund by the end of life cycle. The life cycle of the appellant is 10 years from the date of establishment and the same has not been completed as yet since the appellant has been created vide trust deed dated 2 1/03/2000. The AO is not right in saying that the investment conditions stipulated in Regulation 12(b) and 12(d) should be achieved at all points of time. The counsel for the appellant is right in saying that the parking of funds in the bank deposits cannot be called investment of funds and hence SEBI Regulations have not been violated. Thus I agree with the counsel for the appellant that the provisions of SEBI Regulations 1996 have not been violated by the appellant. In view of the arguments of the counsel for the appellant, it is held that the appellant has fulfilled the conditions prescribed in section 10(23FB) for claiming exemption and has moreover has not violated the provisions of SEBI Regulations, 1996. The AO is directed to allow the exemption to the appellant u/s 10(23FB). The ground No.2 of the appellant is allowed.”

The gist of the reasoning given by ld. CIT(A) is that –

(1) For getting exemption u/s 10(23FB) it is nowhere stipulated in that section that provisions of SEBI Regulations have to be complied with;

(2) Assessee has obtained registration of the trust deed under the Registration Act and Certificate of Registration from SEBI.

(3) SEBI have not specified life cycle of the investment. The explanation inserted in 2004 provides the fulfilling the investment pattern by the end of life cycle of the fund which is 10 years.

(4) Parking of fund in bank deposits is not a violation of SEBI Regulation.

9.  Before us, the ld. DR submitted that –

(1) Object of the trust for which it was created was not fulfilled. Its investment pattern is in contravention of the Regulation.

(2) For examining whether assessee is a venture capital fund as per section 10(23FB) one has necessarily to look as to whether assessee fits into the conditions laid down in that section. For this purpose AO has liberty to look into whether regulations of SEBI are followed by the assessee or not. Similarly he has liberty to see whether there is a violation of provisions of trust deed.

(3) Exemption of income has to be examined each year and AO is duty bound to examine the investment pattern of the venture capital fund every year independently and see whether there is a violation of provisions of the trust deed or SEBI regulations.

(4) In fact assessee has for own purpose mentioned that investible fund is only 80% of the corpus. In fact for running administration and management only small fund is required and, therefore, 80% of the corpus should be invested in specified activities and when counted from this point, assessee’s investment falls short of the requirement. The ld. DR strongly supported the order of AO and submitted that order of ld. CIT(A) is cryptic and does not deal with the argument of ld. AO.

10. Against this, the ld, AR for the assessee submitted that the AO has mis-understood the entire scheme of capital venture fund. In fact the capital venture fund is a via media to allow various investors to come together to invest their funds in specified industries such as information technology in the present case and thereafter share income earned by such venture capital fund which will be taxable in their hand by virtue of section 15U(1). He referred to that section as under :-

“115U. (1) Notwithstanding anything contained in any other provisions of this Act, any income received by a person out of investments made in a venture capital company or venture capital fund shall be chargeable to income-tax in the same manner as if it were the income received by such person had he made investments directly in the venture capital undertaking.”

In order to prevent the double taxation of same income once in the hand of venture capital fund and other in the hands of individual investor section 10(23FB) has been enacted providing exemption to its income. In fact according to the ld. AR similar provisions existed prior to 1.4.2001 in the form of section 10(23FA) which provided exemption to dividend and long term capital gains earned by a venture capital fund from investment made by way of equity shares in venture capital undertaking i.e. assisted concerns. In order to enlarge the scope of income to be earned by venture capital fund or venture capital company section 10(23FB) has been enacted by Finance Act, 2000 with effect from 1.4.2001. For the sake of convenience he referred to that section as under :-

10(23FB) any income of a venture capital company or venture capital [from investment] in a venture capital undertaking.

Explanation[1].—For the purposes of this clause,—

(a) “venture capital company” means such company—

(i) which has been granted a certificate of registration under the Securities and Exchange Board of India 1992 (15 of 1992), and regulations made there-under

(ii) which fulfills the conditions as may be specified, with the approval of the Central Government, by the Securities and Exchange Board of India, by notification in Official Gazette, in this behalf;

(b) “venture capital fund” means such fund—

[(i) operating under a trust deed registered under provisions of the Registration Act, 1908 (16 of 1908; operating as a venture capital scheme made by the I Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963);]

(ii) which has been granted a certificate of registry under the Securities and Exchange Board of India 1992 (15 of 1992), and regulations made there-under;

(iii) which fulfills the conditions as may be specified, with the approval of the Central Government, by the Securities and Exchange Board of India, by notification in Official Gazette, in this behalf; and

(c) “venture capital undertaking” means such domestic company whose shares are not listed in a recognized stock exchange in India and which is engaged in the—

(i) business of –

(A) nanotechnology;

(B) information technology relating to hardware and softward development;

(C) seed research and development;

(D) bio-technology;

(E) research and development of new chemical entities in the pharmaceutical sector;

(F) production of bio-fuel;

(G) building and operating composite hotel-cum-convention centre with seating capacity of more than three thousand; or

(H) developing or operating and maintaining or developing, operating and maintaining any infrastructure facility as defined in the Explanation to clause (i) of sub-section (4) of section 80-IA; or

(ii) dairy or poultry industry]

The ld. AR then pointed out that up to 3 1.3.2008 the words “set up to raise fund for investment” existed in place of words “from investment” which was inserted by the Finance Fact, 2007 w.e.f. 1.4.2008. It would mean that any income earned by venture capital company or venture capital fund would be exempt up to 31.3.2008. This exemption aspect has been curtailed w.e.f. 1.4.2008 by inserting the words “from investment” in place of words “set up to raise fund for investment”. Thus w.e.f. Asst. Year 2008-09 only the income earned from investing in venture capital undertakings would be exempt and income from investment elsewhere would be taxable. In other words, if assessee venture capital fund has two sources of income, one investment in venture capital undertakings, and other, say deposit in the bank, then it is only the income from investment in venture capital undertaking would be exempt and income from interest from bank deposit would be taxable u/s 56. Such distinction did not exist up to 31.3.2008. Therefore, up to Asst. Year 2007-08 any income earned by venture capital fund would be exempt u/s 10(23FB).

11. The ld. AR then submitted that it is incorrect to hold that assessee is not a venture capital fund. The assessee is a trust, which came into existence through a trust deed registered under the provisions of Registration Act. It has been granted certificate of registration by SEBI. It fulfills all the conditions laid down by SEBI. The SEBI has given a certificate to this effect. Assessing authority is not empowered to look into whether there is any violation of regulation of SEBI or violation of provisions of trust deed. Once assessee has been given certificate by SEBI and trust is registered under Registration Act then requirement of explanation-1(b) of section 10(23FB) is fulfilled. If AO finds any violation then he has to report to the SEBI which can take necessary action against the assessee by canceling the registration.

12. The ld. AR also submitted that it is incorrect on the part of AO to hold that investment pattern is not in accordance with trust deed or SEBI regulation. He submitted that trust deed permits only 80% of the corpus of the investible funds and rest is allowed to be preserved for administration and management of the fund. Out of the investible fund which is 80% of the corpus assessee is required to invest only 66.67% in assisted concern and rest in specified securities. By this calculation the investment in assisted concern should be only Rs. 10.16 crores whereas assessee has made investment of Rs. 10.54 crores. He submitted that sanctioned fund for assisted concern is 14.54 crores which is about 90% of the investible fund which is calculated at Rs. 15,24 crores which is 80% of the corpus fund of Rs. 19.05 crores. It is incorrect on the part of the AO to hold that entire corpus fund is investible fund.

13. The ld. AR then submitted as per amendment made in section 12(d) of SEBI (VCF) Regulation 1996, an explanation has been inserted though w.e.f. 5.4.2004 according to which investment patter as per clause (d) of regulation 12 should be achieved by the venture capital fund by the end of life cycle which is 10 years in the present case. Therefore, the condition of investment in assisted concern by 66.67% of investible fund should be achieved at the end of life cycle of the Venture Capital Fund and not every year. Even though the ld. AR submitted this explanation has been inserted w.e.f. 5.4.2004 but this date is incidental in nature and, therefore explanation would be applicable to all existing venture capital funds. Notwithstanding, assessee venture fund has achieved the investment pattern in the year itself. The ld. AR then submitted that even though there is no violation of any regulation by investment in Fixed Deposit but still trust deed provided for investment of temporary surplus into bank deposits. He referred to clause 5(B)(iv) of the trust deed. Once investment is according to the trust deed which is registered by the Commissioner of charities under Registration Act then it cannot be alleged that there is a violation of trust deed or SEBI regulation.

14. The ld. AR then referred to section 2 (hh) of SEBI (VCF) Regulation 1996 which provides that investible funds means corpus of the fund, net of expenditure for administration and management of the fund. Therefore, assessee fund has followed the regulation in defining what should be the investible fund. Once trust has defined investible fund as 80% of the corpus fund then assessee fund has only followed the trust deed in this regard. Thus there is no violation of any provisions of the trust deed.

15. The ld. AR submitted that assessee fund has been filing annual return with the SEBI and no fault has been found therein. It has been clearly returning to the SEBI the pattern of investment every year.16. The ld. AR referred to the decision of Hon. Gujarat High Court in CIT vs. Hazarat Pir Shah-E-alam Roza Estate Trust (2002) 256 ITR 193 (Guj) and that of Hon. Supreme Court in the case of Gestetner Duplicators P. Ltd. vs. CIT (1979) 117 ITR 1 (SC) for the proposition that if trust deed is found in order by the Commissioner of Charities then the AO has to abide by it.

17. The ld. AR advancing the discussion on the subject referred to the decision of Hon. Gujarat High Court in the case of CIT vs. Hazarat Pir Shah-E-alam Roza Estate Trust (supra) for the proposition that entries in the register of public trust showing that the trust is registered as a public trust and properties are registered in the name of the trust would be relevant material before an authority or a court to decide as to whether the public trust existed and as to whether the properties shown in its name are really the properties of the public trust. The inquiry to be carried out by the AO in this regard is an enquiry for adjudicating upon the title of the property but only limited to inquiry for ascertaining whether exemption claimed u/s 11 is warranted. The scope of the inquiry under the IT Act is wholly different from the scope of inquiry under the Bombay Public Trust 1915. The ld. AR also submitted that a similar view was taken in the case of Gestetner Duplicators P. Ltd. vs. CIT (supra).

18. We have heard the rival submissions and carefully perused the material on record. The main question to be decided is whether the assessee is entitled to exemption to its interest income earned from deposits in bank and also to other income u/s 10(23FB) of the Act. In order to address this question several intermediate issues arise for discussion. Each of these issues is discussed as under :-

(1) What is Venture Capital Fund:

During the course of discussion with the parties it is gathered that venture capital is finance capital provided by different investors to early stage, high potential, high risk, growth start up companies. The venture capital fund makes money by investing in equities in such high risk growth, start up companies which use new technology or new business model such as bio-technology, IT software etc. Since it may not be possible for an individual investors to take risk in investing its funds in such a high risk but high potential new technology companies, several of such investors come together pool their money, lock in for certain number of years say 8 to 10 years, identify such high risks, high potential new technology companies and invest in their equity and make money. They also provide to such new start up companies their managerial and technical expertise, in addition to capital. The profit earned in such growing companies is shared by investors which gives them adequate return on their investment. A venture capital fund is also referred as pooled investment vehicle.

(2) Venture capital fund as per I.T. Act.

Section 10(23F) which was inserted by the Finance Act, 1995 w.e.f. 1.4.1996 first provided the definition of ‘venture capital fund’, in clause (a) to explanation therein as under :-

Explanation.–For the purposes of this clause,–

(a) “venture capital fund” means such fund, operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908), establishing to raise monies by the trustees for investments mainly by way of acquiring equity shares of a venture capital undertaking in accordance with the prescribed guidelines

The basic ingredients of a Venture Capital Fund (V.C.F.) as per this definition are (i) It should operate under a trust deed (ii) The trustees can raise money for investment (iii) Such investment should be mainly in acquiring equity shares of venture capital undertakings. This provision remained in force till 1999-2000. By Finance Act, 1999, w.e.f. 1.4.2000, the operation of this clause came to an end. In its place section 10(23FA) was inserted which provided practically the same definition of VCF but the definition of venture capital undertaking, in which venture capital fund was required to make investment by acquiring equity shares, was amended and enlarged. Earlier in section 10(23F) the definition of venture capital undertaking whose equity shares was to be acquired by venture capital fund were confined to limited industries such as business of generation and distribution of electricity or any other firm of power or engaged in the business of tele-communication services or engaged in the business of other communication services, or developing, maintaining or operating infrastructure facilities, or engaged in the manufacture or production of specified articles or things. In section 10(23FA) definition of venture capital undertaking in whose equity shares venture capital fund would invest was enlarged. It included particularly those undertakings which are engaged in the business of software, information technology, production of basic drugs in the pharmaceutical sector, bio-technology, agricultural and allied sector or any other sector specified by Central Government. However, the new provision of section 10(23FA) remained operative only for one year and was substituted by new section 10(23FB) where definition of venture capital fund was made more specific. This definition effective from 1.4.2001 was as under :-

(b) ‘‘venture capital fund’’ means such fund—

(i) operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908) ;

(ii) which has been granted a certificate of registration under the Securities and Exchange Board of India Act, 1992 (15 of 1992), and regulations made there-under ;

(iii) which fulfills the conditions as may be specified, with the approval of the Central Government, by the Securities and Exchange Board of India, by notification in the Official Gazette, in this behalf ;

The definition of venture capital undertaking was also enlarged in section 10(23FB) thereby inserting more industries, where venture capital fund can make investment in equity shares. Income earned therefrom would be exempt u/s 10(23FB).

19. Hon. Finance Minister while inserting new provisions of 10(23FB) stated in the Lok Sabha on May 2000 while moving Finance Bill 2001 for consideration the house as under:-

“Venture Capital Fund shall enjoy a complete pass through status. There will be no tax on distributed or undistributed income of such funds. The income distributed by the funds will only be taxed in the hands of investors at the rates applicable to the nature of income”.

20. Thereafter Finance Act, 2007 prospectively amended the provision of section 10(23FB) w.e.f. 1.4.2008 thereby inserting in place of the words “set up to raise fund for investment”, the words “from investment” in section 10(23FB). Thus earlier section 10(23FB) read as under :-

10(23FB) any income of a venture capital company or venture capital fund set up to raise funds for investment in a venture capital undertaking.

This change was explained in the Memorandum explaining the amendments as under :-

10(23FB) any income of a venture capital company or venture capital fund set up to raise funds for investment in a venture capital undertaking.

“Under the existing provisions of clause 23(FB) of section 10, any income of a venture capital company or venture capital fund set up to raise funds for investment in a venture capital undertaking is exempt from tax…..

It is proposed to amend the said clause so as to provide that such exemption will now be available only in respect of income of a venture capital company or venture capital fund from investment in a venture capital undertaking engaged in specified business or industries

This amendment will take effect from 1^st April, 2008, and accordingly apply in relation for the assessment year 2008-09 and subsequent years.”

It means that income of VCF would be fully exempt upto Asst. Year 2007-08 and would be partly exempt since Asst. Year 2008-09 to the extent of income earned from investment in venture capital undertakings only. Other income would be taxable. The effect of this change will be discussed in the following paragraphs also.

21. In the present Asst. Year i.e. Asst. Year 2003-04 or other Asst. Years upto 2005-06 involved in the appeals before us, the definition of venture capital fund required following conditions to be satisfied:-

(1) The venture capital fund is a trust which is registered under the provisions of Registration Act, 1908.

(2) It has been granted a certificate of registration under the Securities and Exchange Board of India Act (15 of 1992) and Regulation made therein. 1992.

(3) It would mean the conditions as specified by Securities and Exchange Board of India after the approval of the Central Government and by notification in the Official Gazette, where a fund which should be a trust specifies the three conditions it would be a venture capital fund within the meaning of section 10(23FB)

In other words for the purpose of claiming exemption to its income either fully (prior to Asst. Year 2008-09) or partly thereafter (Asst. Year 2008- 09) the venture capital fund should satisfy these three conditions. If they satisfy their income would be exempt accordingly.

(3) Venture Capital Fund Under SEBI RULES:

Securities and Exchange Board of India (SEBI in short) issued u/s 30 of SEBI Act, 1992 regulations called Securities and Exchange Board of India (venture capital fund) Regulation 1996 for regulating the formation and functioning of venture capital funds. Regulation 2(m) thereof defines venture capital fund as under :-

“venture capital fund” means a fund established in the form of a trust or a company including a body corporate and registered under these regulations which –

(i) has a dedicated pool of capital;

(ii) raised in a manner specified in the regulations; and

(iii) invests in accordance with the regulations;

The venture capital fund has to satisfy above definitions contained in Regulation 2(m) for getting a certificate from SEBI as required u/s 10(23FB) (b)(ii) of IT Act, 1961. These conditions are provided in regulation -8 of above rules. They are as under :-

Conditions of certificate

8. The certificate granted under regulation 7 shall be inter alia, subject to the
following conditions, namely:-

(a) the venture capital fund shall abide by the provisions of the Act and these regulations;

(b) the venture capital fund shall not carry on any other activity other than that of a venture capital fund;

(c) the venture capital fund shall forthwith inform the Board in writing if any information or particulars previously submitted to the Board are found to be false or misleading in any material particular or if there is any change in the information already submitted.

The certificate is granted by SEBI as per regulation 7 which reads as under :-

7(1) If the Board is satisfied that the applicant is eligible for the grant of certificate, it shall send an intimation to the applicant.

(2) The Board shall on receipt of the registration fee grant a certificate of registration in Form –B.

It also provides in Regulation 10 that in case where the venture capital fund is not granted certificate and its application is rejected then it shall not carry on any activity as a venture capital fund.

22. There are other conditions of investment and restriction imposed as per regulation -12 which a venture capital is required to follow. These regulations are as under :-

Investment conditions and restrictions.

12. All investment made or to be made by a venture capital fund shall be subject to the following conditions, namely :-

(a) venture capital fund shall disclose the investment strategy at the time of application for registration;

(b) venture capital fund shall not invest more than 25% corpus of the fund in one venture capital undertaking;

(c) shall not invest in the associated companies; and

(d) venture capital fund shall make investment as enumerated below:

(i) at least 66.67% of the investible funds shall be invested in unlisted equity shares or equity linked instruments of venture capital undertaking;

(ii) not more than 33.33% of the investible funds may be invested by way of –

(a) subscription to initial public offer of a venture capital undertaken whose shares are proposed to be listed

(b) debt or debt instrument of a venture capital undertaking in which the venure capital fund has already made an investment by way of equity

(c) preferential allotment of equity shares of a listed company subject to lock­in-period of one year;

(d) the equity shares or equity linked instruments of a financially weak company or a sick industrial company whose shares are listed.

Explanation-1 for the purpose of these regulations, a financially weak company” means a company, which has at the end of the previous financial year accumulated losses, which has resulted in erosion of more than 50% but less than 100% of its networth as at the beginning of the previous financial year;

(e)Special purpose vehicles which are created by a venture capital fund for the purpose of facilitating or promoting investment in accordance with these Regulations;

Explanation-The investment conditions and restrictions stipulated in clause (d) of regulation 12 shall be achieved by the venture capital fund by the end of its life cycle;

(e) venture capital fund shall disclose the duration of life cycle of the fund.

In brief, if a VCF satisfies conditions for grant of certificate laid down u/s SEBI (VCF) Regulation, 1996 and a certificate is so granted by SEBI on satisfaction of such conditions then it will operate as a VCF. It would in turn also satisfy the conditions laid down u/s 10(23FB) explanation 1(b)(ii).

(4) Whether assessee is a venture capital fund:

From the perusal of records submitted before us, particularly the orders of AO and of the ld. CIT(A), we notice that assessee trust has been registered under the provisions of Registration Act, 1908 on 7^th April, 2000. The registration is recorded at Sr.No. 1125 in the book No.4 with the Commissioner of Charities. This trust deed was executed on 21^st March, 2000 and submitted to the Registrar on 22^nd March, 2000 and was accordingly registered by the Sub-registrar on 7^th April, 2000.

23. The assessee trust is also registered under SEBI as per Regulation 7(3) of Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 on June 26, 2000 as per copy of certificate enclosed on page 87 of assessee’s paper book. Once this certificate is issued to the assessee trust then it satisfies the conditions laid down in sub-clause (ii) of clause (b) of Explanation-1 of section 10(23FB). Similarly it satisfies the conditions laid down in sub-clause (i) of clause (b) under that explanation, as it is a trust registered as discussed above. From this it follows that it satisfies the two conditions of clause (b) of Explanation-1. On the other hand, clause (iii) requires the trust to fulfill the conditions as may be specified by SEBI. When we go through the Regulations of 1996 under which the assessee trust was granted certificate as per Regulation 7(3), we find two sets of conditions. One set of conditions are given in Regulation No.8 and the other set of conditions are given in Regulation No.12. Conditions given in regulation -8 are required to be fulfilled by the assessee trust prior to getting certificate from SEBI. Once a certificate is issued it follows that it is satisfying those conditions. Conditions laid down in regulation no.12 are post certificate conditions required to be followed by the assessee trust during the course of conducting its business. In case of violation of any of the conditions laid down in these regulations, regulation No.30 provides procedure for action in case of default as under:-

Procedure for action in case of default

Liability for action in case of detault.

30. Without prejudice to the issue of directions or measure under regulation 29, a venture capital fund which –

(a) contravenes any of the provisions of the Act or these regulations;

(b) fails to furnish any information relating to its activity as a venture capital fund as required by the Board;

(c) furnishes to the Board information which is false or misleading in any material particular;

(d) does not submit periodic returns or reports as required by the Board;

(e) does not co-operate in any enquiry, inspection or investigation conducted by the Board;

(f) fails to resolve the complaints of investors or fails to give a satisfactory reply to the Board in this behalf

shall be dealt with in the manner provided in the Securities and Exchange Board of India (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002.

Thus so long as there is no default found by SEBI in any of the clauses of Regulation 30 it can be said that it is fulfilling the conditions laid down in the SEBI (Venture Cepital Funds) Regulations 1996. Neither the AO nor the ld. DR could point out any default noticed by SEBI or action taken by SEBI for such default. Accordingly, there is no reason to hold that assessee trust does not fulfill any condition laid down even in Regulation No.12 of SEBI (Venture Capital Funds) Regulations 1996. In view of above, we hold that assessee is a venture capital fund within the meaning of clause (b) under Explanation-1 to section 10(23FB).

(5) Whether AO can look into whether venture capital fund fulfills conditions laid down in SEBI (Venture Capital Funds) Regulations, 1996.

24. In our considered view the AO is duty bound to enquire whether the assessee trust is registered under the Registration Act, 1908 and has been granted certificate of registration by SEBI under SEBI (Venture Capital Funds) Regulations, 1996. But his role is confined to satisfy himself with such certificates granted and not beyond. Sub-clause (i) and sub-clause (ii) of clause (b) under explanation-1 only requires to ensure that assessee trust has certificates as mentioned therein. Even if certificates are granted under mis-representation of facts then it is for the concerned authorities to look into the matter and take action under the provisions of the concerned statute under which certificates are granted. In this regard the observations of the Hon. Supreme Court in the case of Gestetner Duplicators P. Ltd. vs. CIT (supra) are very relevant. In that case the Commissioner had granted recognition to the P.F. as far back as 1937. The assessee a private limited company paid to sales-men a fixed monthly salary and commission at fixed percentage of turnover and also paid employer’s contribution to the P.F. on the basis of monthly salary as well as commission and credited them into individual account of these sales-men in P.F. maintained and recognized by the Commissioner. A part of such commission and consequently provident fund on such commission was sought to be disallowed. The matter went up to the Hon. Supreme Court. It observed as under :-

“It would be conducive to judicial discipline and the maintaining of certainty and uniformity in administering the law that the taxing authorities should proceed on the basis that the recognition granted and available for any particular assessment year implies that the provident fund satisfies all the conditions under rule 4 of Part A of the Fourth Schedule to the Act, and not sit in judgment over it.”

Thus it was held that it was not open to the AO to take the view contrary to the registration already granted by the CIT and therefore disallow a part of the contribution. It was pointed out that when recognition continues in operation it would be implied that the conditions laid down there-under are satisfied and any part of disallowance would tentamount to questioning the recognition. In other words entries made in the register of independent body should be accepted as true and they should not be questioned while deciding the issue relating to the matters concluded by the entries made in such registers. From this it follows that if assessee trust is registered with SEBI as per certificate granted under Regulation 7(3) then it should be accepted that such certificate is granted after ensuring that conditions laid down before granting of such certificate are fulfilled. In other words conditions laid down in sub-clause (i) and sub-clause (ii) are deemed to be fulfilled under explanation-1(b) to section 10(23FB), the moment relevant certificates are produced before the AO.

Therefore, he is not required to go into violation of conditions, if any, pertaining to the matters of grant of such certificates.

26. So far as condition laid down in sub-clause (iii) of clause (b) under explanation-1 is concerned what we consider appropriate for the AO is to find out whether any action for default has been taken by SEBI under regulation -30 as referred to above for default committed by the assessee trust. So far as any violation of investment pattern as laid down in regulation 12(d) is concerned it is also covered under clause (a) of regulation-30 which shows that assessee trust can be penalized for contravention of any provision of this Act or these regulations. Thus, if assessee trust contravenes regulation-12 (d) then SEBI is competent to penalize assessee trust within the powers given under regulation 30. So long as SEBI does not find any default of any contravention of the provisions of the SEBI Act or SEBI (VCF) Regulation 1996 then it can be inferred that assessee trust fulfills the conditions laid down under these regulations. The AO, however, can look into the issue whether assessee trust fulfills such conditions as laid down in regulation 12 (d) (and not under regulation-8) and report the matter to SEBI taking a protective view under I.T. Act, 1961. If finally SEBI does not find any default on the part of the assessee trust then view of the AO that there is violation cannot survive. In other words fulfillment of condition under sub-clause (iii) is subject to the final finding by SEBI authorities. Their final view on the alleged contravention by the assessee trust will prevail over the view of AO. Thus in our view role of the AO in examining the issue about fulfillment of conditions laid down in clause (b) is limited to the extent as described above.

(6) Whether there is any violation of investment norms:

27. It is undisputed fact that during the Asst. Year in question assessee has invested a sum of Rs. 10.54 crores in venture fund assistance i.e. in the equities of specified undertakings. It had a corpus of 19.05 crores this year. View of the AO is that as per regulation 12(d)(i) assessee should have invested 66.67% of the corpus fund in the equity link instruments. He worked out such 66.67% of total corpus of 19.05 crores and held that it should have invested 15.25 crores in the equities of specified companies. As against this, it has invested only 10.54 crores and hence there is a violation of investment norms. The case of the assessee is that it is not required to invest 66.67% of entire corpus but only of investible funds. Entire corpus is not investible funds. In our considered view the contention raised by ld. AR in this behalf is legally correct. Regulation 12(d)(i) requires investment of 66.67% of the investible funds. The words ‘investible funds’ are defined in definition 2(hh) of Regulation as above. It means corpus of the fund net of expenditure for administration and management of the fund. Sub-clause (i) of clause (B) of provision 5 in the trust deed provides that 80% of the corpus of the fund is required to be invested in the specified undertakings and the balance in cash and or in highly liquid form. Sub-clause (iii) of clause (B) of provision 5 of trust deed provides that 20% of the total sum will be kept aside as working capital. Thus the trust deed has empowered the assessee to invest 80% of the corpus in specified undertaking. Therefore, percentage 66.67% will be applied to 80% of corpus and not to 100% of the corpus. May be in the opinion of AO, 20% of the corpus is too high a sum for keeping apart for administration and management or as working capital, but so long as it is permitted by the trust deed and no mala fide is found, or no contravention of any provision of SEBI (VCF) Regulation 1996 is found, the AO cannot question why 20% was kept apart and why not 2 or 3% only which in his opinion could have been reasonable. There are clear stipulations in the SEBI (VCF) Regulation 1996 which put restriction on any other investment other than permitted under the regulation. Accordingly, when the claim of the assessee is that it has invested 66.67% of 80% of the corpus in specified undertaking, then no fault in investment pattern can be found. In our view the interpretation adopted by the AO that entire corpus should be treated as investible fund is not sustainable in law. It is for the assessee trust to decide how much should be investible fund out of the corpus of the fund, which is net of expenditure for administration and management. The copy of the trust deed is clearly submitted to the SEBI as per criteria contained in regulation 4(b)(i). If no fault is found by the SEBI while granting certificate of registration to the trust in keeping apart 20% of the corpus for management and administration then AO cannot bypass the judgment of SEBI and proceed to estimate as to how much should be kept apart for administration and management and how much should be the investible fund out of the corpus fund. Therefore, once the trust deed is registered under Registration Act, 1908 and certificate is granted by SEBI to this trust deed for carrying out activities, ear marking 80% of corpus as investible fund, then the AO cannot adopt a different measure. There is one point which requires special mention. It is mentioned by the AO that before Asst. Year 2004-05 i.e. before 31.3.2004 assessee trust was required to invest 75% of investible fund into equity of specified undertaking and the changes to 66.67% have come only w.e.f. 5.4.2005 If trust is required to invest @ 75% of the investible fund then assessee fund was required to invest a sum of Rs. 11.43 crores as against actual investment of 10.54 crores. There is a marginal short-fall. The claim of the assessee is that it has sanctioned for investment of sum of Rs. 14.54 crores which was in the pipe line for investment. In other words, it had identified the undertakings and sanctioned funds but actual investment was taking time due to the procedure and formalities.

28. In our considered view such marginal short-fall cannot be called to be an aberation in the investment norms as per SEBI (VCF) Regulations 1996. This minor short fall are not in any way the violation of investment norms laid down in SEBI Regulations. It could not have been practically possible to identify and invest the requisite percentage of investible fund in specified undertakings, in the very year of creation of Venture Capital Fund or even say within a couple of years thereafter, as it may be commercially hazardous to investment money into undertakings without their being any proper evaluation and satisfaction before making investment, therefore, the investment in specified undertaking is likely to take time. Keeping this difficulty in mind SEBI has inserted the explanation below sub-clause (e) in the Regulation 12(d)(ii). This explanation provides that investment conditions and restriction as contained in Regulation 12(d) shall be achieved by the Venture Capital Fund by the end of its life cycle. This explanation seems to have taken care of the difficulties of Venture Capital Fund in achieving investment norms within the very year of its creation or subsequently thereafter, on account of the fear of losing their capital by investing in wrong undertakings. This aspect will also be considered little later in the following paragraph. We, for the present, are of the considered view that, there is no violation of investment norms. Even if there is a short-fall then it could not be dubbed as non-fulfillment of the condition attracting sub‑clause (iii) of clause (b) of explanation-1 to section 10(23FB). As observed above, it is for the SEBI authorities to decide whether there is any violation of SEBI Regulation including the deficiency in investment pattern as per Regulation 12(d). Even if the AO thinks that there is a short-fall in investment in specified undertaking and hence there is violation of SEBI Regulation, he should have referred the matter to the SEBI authorities and waited for their decision and till then could have proceeded to frame a protective assessment. Having not done so and not referring the matter to the SEBI the AO cannot hold that there is violation of SEBI Regulations.

(7) Whether investment pattern can be achieved by the end of life cycle of the fund:

29. As observed above, there is an amendment in Regulation 12(d) w.e.f. 5.4.2004 thereby an explanation has been inserted below sub-clause (e) in Regulation 12(d)(ii). According to the explanation the investment pattern can be achieved by the Venture Capital Fund by the end of life cycle. In other words 66.67% of investment of investible fund in specified undertakings can be achieved by the end of life cycle of the Venture Capital Fund which in the present case is 10 years. The case of the AO is that this explanation will not be applicable to Asst. Year 2004- 05 i.e. F.Y.2003-04 and earlier years. It would be effective for FY 2004- 05 onwards. In our considered view the explanation so inserted, clarifies as to what legislators intended by the main provision. This explanation is clarificatory in nature and would be applicable to the existing trust deed/Venture Capital Fund also. It is not a case that this explanation would be applicable only to those venture capital funds which are created on or after 5.4.2004. No such intention emerges from the reading of the relevant regulation. On the other hand, what appears to us is that in order to remove the difficulties faced by the venture capital funds in not meeting the investment norms as per regulation 12(d) within the year of its inception or subsequent thereto, it was considered fit to introduce the explanation and enable the venture capital fund to meet out the target by the end of their life cycle. Therefore, this explanation would be applicable to existing trusts also which are to end their life cycle after 5.4.2004. In other words if a trust has not been able to meet the investment norms in initial years and there is a deficiency which continues to exist in subsequent years then it will not be treated as a default. If deficiency in years after 5.4.2004 is not treated as default then it does not stand to logic that deficiency in years prior to 5.4.2004 should be treated as default.

30. In our considered view by inserting this explanation SEBI has condoned the default of lack of adequate investment in specified undertakings as per regulation 12(d) and enabled the venture capital fund to achieve such target by the end of life cycle. In any case any perceived default has to be resolved by SEBI. Apparently SEBI does not find any fault by virtue of explanation in regulation 12(d) whereby deficiency in earlier years has been condoned by permitting the capital venture fund to fulfill the target by the end of their life cycle. Therefore, such deficiency in earlier years (prior to 5.4.2004) cannot be treated as default and violation. From that point of view also explanation would be retrospectively operative, though stated to be effective from 5.4.2004 only. Therefore, if we consider the explanation under regulation 12(d)(ii) we do not treat the deficiency, if any, as a default or violation of SEBI regulation and therefore, any violation of sub-clause (iii) of clause (b) under explanation-1 of section 10(23FB).

(8) What is the effect of amendment by Finance Act, 2007 w.e.f. 1.4.2008:

31. As observed above, there is a change in the pattern of income exempted u/s 10(23FB). As explained in the explanatory note referred to above while introducing the amendment in section 10(23FB), the exemption is now restricted to income from investment in specified undertaking. In other words, income from investment in other avenues other than investment in specified undertaking will not get exemption. From this it follows that if venture capital fund is investing not only in specified undertaking but also elsewhere then income from both the sources will get exemption upto 31.3.2008. After the amendment w.e.f. 1.4.2008 exemption is now restricted to one source only i.e. investment in specified undertakings. From this it follows that prior to 1.4.2008, if venture capital fund has invested in F.D. in bank and earned interest income therefrom, then such interest income would be exempt as per existing provision. ITAT Mumbai ‘A’ Bench in the case of ITAO vs. M/s Kshitij Venture Capital Fund in ITA No.2147/Mum/2010 Asst. Year 2006-07 pronounced on 9^th March, 2011 held on similar facts as under :-

“13. We heard both the parties. The issue is whether interest on temporary investments of Rs. 16,09,900/- and profit on sale Units of Mutual fund of Rs 1,00,91,000/- is entitled to exemption u/s. 10(23FB). Section 10(23FB) as applicable to the year under appeal is as under:

Any income of venture capital company or venture capital fund set up to raise funds for investment in a venture capital undertaking.

14. Thus the exemption in the case of Venture Capital Fund was in respect of any income. There is no restriction or requirement regarding the source of income for grant of exemption u/s. 10(23FB). It is only by Finance Act, 2007, w.e.f. 1^st April, 2008, an amendment to section 10(23FB) was brought about restricting the exemption under that section to income from Investment by the Venture Capital Fund in a venture capital undertaking. For this purpose, the said clause (c) of Explanation 1 has also been amended to define “Venture Capital Undertaking”. This amendment was made effective from 1 .4.2008. By no stretch of imagination can this amendment can be considered as clarificatory applicable to earlier Assessment Year. The memorandum explaining the amendment to the Finance Bill, 2007 as well as the CBDT circular explaining the provisions of the Finance Act, 2007 clarify that the amendment proposed to section 10(23FB) was to restrict the scope of income for which exemption under that section was available. Hence this amendment cannot be considered as clarificatory but must be considered as prospective in effect. It is not in dispute that the assessee is otherwise eligible for exemption u/s. 10(23FB). Hence for the year under appeal, as per the provisions of section 10(23FB) as applicable to the assessment year, any income of the venture capital Fund is exempt. Hence we confirm the order of the CIT(A) and uphold his direction that that interest on temporary investments of Rs. 16,09,900/- and profit on sale Units of Mutual fund of Rs 1,00,91,000/- is entitled to exemption u/s.10(23FB).

15. In the result, the appeal filed by the revenue is dismissed. Order pronounced on this 9^th day of March, 2011.”

32. The above view is also supported by CBDT Circular of 2008 which clarifies the position as under :-

The CBDT Circular No.3 of 2008 this case has been clarified.

Exemption for certain income of a venture capital company or venture capital fund.

14.2 Clause (23FB) of section 10 provides exemption in respect of any income of a venture capital company or venture capital fund set up to raise funds for investment in a venture capital undertaking. Such Venture capital undertaking has been defined in clause(c) of explanation 1 to clause (23FB) to mean a venture capital undertaking referred to in the Securities and Exchange Board of India (Venture Capital funds) Regulations, 1996, made under the Securities and Exchange Board of India Act, 1992, and notified as such in the Official gazette by the Board for the purposes of the clause.

With a view to make the tax benefit more focused and to channelize existing as well as future investments in key, risk prone thrust areas clause (23FB) has been amended whereby such exemption will now be available only in respect of income of a venture capital company or venture capital fund from investment in a venture capital undertaking

14.3. Applicability : This amendment will take effect from the 1^st day of April, 2008, and will accordingly apply in relation to the assessment year 2008-09 and subsequent assessment years.

33. The above view is also supported by the decision of Mumbai Tribunal India Value Fund vs. ACIT (2010) 129 TTJ (Mumbai) 611 wherein the issue of exemption of interest income from FDR was involved. The Tribunal in that case held as under :-

Held: The words “set up to raise funds for investment” have been substituted by the words “from investment” by the Finance Act, 2007 w.e.f. 1st April, 2008. By this substitution, the inference would be that any income of a venture capital company or venture capital fund would be exempt only if it is generated from investment in venture capital undertakings. But this restriction cannot be read in the earlier provision, where the expression used was “set up to raise funds for investment’. Whenever the legislature wanted to make particular items of income or sources of income to be exempt, then it has been clearly provided in various provisions. In this regard, the reading of s. 10(20), 10(2 1), 10(22), 10(23), 10(23FA) and 10(29) would make things clear. The reading of these provisions would make it clear that the legislature has either mentioned various incomes which are exempt; for example in the case of s. 10(20) income from house property, capital gains, income from other sources and income from trade or business is exempt. Alternatively, the legislature has given a blank exemption, for example in the case of s. 10(22) where any income in case of a university etc., was made fully exempt. In some cases, restrictive expression has been used, for example in case of s. 10(29) the income of an authority for marketing commodities only income derived from the letting of godowns or warehouses for storage, etc., has been provided to be exempt. Thus the legislature in its own wisdom has provided exemption in various formats and in some cases either whole of the income is provided to be exempt or income from particular sources is provided to be exempt or income derived from particular activity is provided to be exempt.

(Paras 20 & 21}

Thus, under s. 10(23BF) exemption is available on any income to a venture capital fund or venture capital company, which has been set up to raise funds for investment in venture capital undertakings. Perhaps the legislature has itself noted the situation that there may be circumstances where income may be earned from other activities for example income from interest and therefore, legislature has incorporated the restricted expression by substituting the words “set up to raise funds for investment” by the words “from investment” w.e.f. asst. yr. 2008-09, which means from that year the exemption would be available only from income generated from such investments in the venture capital

The contribution and the investment cannot be matched to a particular date. The venture capital fund may identify a particular investment and then he would issue draw down notice on contributors who have agreed to contribute but such contribution may come in staggered fashion and come on various dates. In the intervening period if such monies are kept temporarily in the FDRs no fault can be found. No investor would give money to the venture capital fund for just making investment in FDRs because ultimately even if such interest is distributed to such investors then “passed through” concept ‘would be applicable and such income becomes taxable in the hands of investor. Merely because FDRs are made for short duration of few months that too, to match contributions with the investment in the intervening period cannot lead to the conclusion that assessee venture capital fund was mainly engaged in the business of investing fund in FDRs.

34. Thus the effect of amendment of Finance Act, 2007 w.e.f. 1.4.2008 in section 10(23FB) is clear. Before Asst. Year 2007-08 income from venture capital fund from any source, (whether income from investment as per SEBI guidelines or from any other source) would be exempt including the interest income of F.D. It is only from Asst. Year 2008-09 onwards the income from investment in specified undertakings would be exempt and other income would be taxable. In this regard we may add that income which is exempt u/s 10(23FB) would be shared by the respective investors and would be taxable in their individual hands as per section 15(U) already referred above.

(9) Whether investment in FD is violation of SEBI Regulation or of trust deed:

35. In fact the trust-deed permits the investment of surplus funds into F.D. in the bank. Sub-clause (iv) of clause (B) of provision 5 in the trust deed reads as under :-

(iv) Investment of Temporary Surplus

Any surplus funds including funds lying in Working Capital account whether pending disbursement or distribution may be invested in risk free or lower risk investments e.g. bank deposits, units of debit/gift mutual funds, etc.

36. Therefore, the trust deed has clearly empowered the assessee to invest surplus into the fixed deposits. When we go through regulation 12(d) it provides a target of 75% upto 5.4.2004 and 66.67% thereafter of the investible fund to be invested in specified undertaking and upto 3 3.33% in other avenues as per clause (ii) of regulation 12(d). In other words there is likelihood of some surplus, if 33.33% is not invested in other avenues. Such surplus or surpluses arising out of working capital of 20% of investible funds can be parked in the F.D. as provided in the trust deed. Accordingly, in our considered view the investment in F.D. does not violate any of the provisions either under SEBI guidelines or of the trust-deed. In fact there is no express prohibition of investment in FD as per regulation 12(d). Therefore, as per above discussion, we hold that ld. CIT(A) was justified in granting exemption u/s 10(23FB) on interest income of Rs.75.56 lacs earned from bank deposits.

36.1 Accordingly, the order of ld. CIT(A) is upheld and appeal filed by the Revenue is dismissed.

ITA No.245/Ahd/2009 Asst. Year 2001-02 (Revenue’s appeal)

37. In this appeal the Revenue has raised the following ground :-

(1) The ld. CIT(A) has erred in facts and on law in deleting the addition made on account of violation of SEBI Regulation and Provisions contained in Section 10(23FB) by the assessee.

ITA No.246/Ahd/2009 Asst. Year 2004-05 (Revenue’s appeal)

38. In this appeal the Revenue has raised the following ground :-

(1) The ld. CIT(A) has erred in facts and on law in deleting the addition made on account of violation of SEBI Regulation and Provisions contained in Section 10(23FB) by the assessee.

ITA No.247/Ahd/2008 Asst. Year 2005-06 (Revenue’s appeal)

39. In this appeal the Revenue has raised the following ground :-

(1) The ld. CIT(A) has erred in facts and on law in deleting the addition made on account of violation of SEBI Regulation and Provisions contained in Section 10(23FB) by the assessee.

ITA No.2773/Ahd/2008 Asst. Year 2002-03 (Revenue’s appeal)

40. In this appeal the Revenue has raised the following ground :-

(1) The ld. CIT(A) has erred in facts and on law in deleting the addition made on account of violation of SEBI Regulation and Provisions contained in Section 10(23FB) by the assessee of Rs.76,39,300/-

41. As per discussion held by us in Asst. Year 2003-04 we hold that interest income earned on bank deposit is exempt u/s 10(23FB) and there is no decision of SEBI that there is any violation of SEBI (Venture Capital Funds) Regulation 1996 and, therefore, the AO cannot hold that there was such violation. In any case as per discussion held above in Asst. Year 2003-04 we do not consider that there is any violation as perceived by the AO. As a result, the appeals filed by Revenue are dismissed.

42. C.O.No.24/Ahd/2009 Asst. Year 2001-02, C.O. No.25/Ahd/2009 Asst. Year 2004-05, C.O. No.26/Ahd/2009 Asst. Year 2005-06 and C.O.No.222/Ahd/2009 Asst. Year 2002-03 are not pressed by the ld. AR and hence they are dismissed as not pressed.