The Indian government’s tax clarity for domestic venture capital funds in Budget 2025 has the potential to unlock more funding for start-ups by reducing regulatory complexities and increasing investor confidence. While the move promises to benefit early-stage and growth-stage start-ups, investors highlight lingering concerns.
The Centre’s move to address the ‘long-standing’ concerns of domestic venture capital (VC) industry by providing clarity on the taxation of Alternative Investment Funds (AIFs) in Budget 2025 could attract more funding for start-ups. Investors believe that the regulatory complexity and compliance challenges have long been a significant barrier to foreign investments in the start-up ecosystem.
“Many global investors prefer investing in Indian start-ups only after they flip to Delaware or Singapore because they find those jurisdictions easier to navigate. For them, India is not a favourable destination because of uncertain regulations and taxation complexities,” Ankit Anand, Founding Partner at Riceberg Ventures told Outlook Business.
However, the government had issues a clarification for foreign investors in 2014 and allowed proceeds from exits to be considered as capital gains. Now, the Budget 2025 has offered similar clarity to domestic investors about taxation on AIFs that could help accelerate funding in the long run.
The Government of India has classified all Category I and II AIFs gains as ‘capital gains’ under Section 2(14) rather than ‘business income’, taxing income generated by alternative funds at 12.5%. However, if the same income is categorized as business income, it would be taxed at 30% for residents and 39% for non-residents. Previously, the ambiguity in taxation led to higher burdens and potential litigations.
“It is proposed to amend the Act to provide that any security held by investment funds referred to in Section 115UB which has invested in such security in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 would be treated as capital asset only so that any income arising from transfer of such security would be in the nature of capital gains,” the budget documents read.
Budget 2025 also removed the TCS provision which could have been applied to the sale of securities. Siddarth Pai, Managing Partner of 3one4 Capital said this provision was ambiguously worded to bring AIFs under its ambit and led to friction and uncertainty around exits.
“Its removal will increase the pace of exits and give tax clarity. The government’s pledge to provide tax certainty and reduce litigation has given a major boost to the attractiveness of Indian AIFs and will help increase capital formation in India and for Indian entrepreneurs,” said Pai.
This tax amendment will take effect from April 1, 2026 and will apply from the assessment year 2026-27.
As the government has reduced arbitrary liabilities, it now has more confidence in funding early-stage and growth-stage start-ups. All In Capital founder Kushal Bhagia believes that tech start-ups and consumer brands will benefit the move because lower tax will make the adjusted returns more lucrative.
On the other hand, Anand stated that start-ups in sectors like deeptech, fintech, Software-as-a-Solution (SaaS), and electric mobility, which often require high-risk early-stage funding. “Growth-stage start-ups will also gain from the AIF capital gains tax clarity as it makes late-stage funding rounds more attractive to investors,” he added.
Given the increase in activities like secondary transactions, IPOs, and exits from new-age companies, the tax clarity also aims to reduce litigation risks and make the ecosystem more attractive for investors. Hence, India could become a more competitive destination for both global and domestic investors.
Despite positive impact on start-up funding, the question still arises: Are these measures enough to fuel growth in India’s start-up ecosystem. Investors say no! Challenges still exist for new-age businesses. From restrictions on secondary sales to taxation on start-up flipping, investors suggest that further adjustments are required to fully unlock domestic capital in India.
Bhagia said the latest reforms addressed asset sale taxation, but issues such as taxation of carried interest (the share of profits received by fund managers) remain a subject of debate. For him, another concern is whether the new classification will apply retroactively to deals that began before the amendment. In short, disputes over investments made under the previous tax treatment, could linger.
And global competition also remains fierce because continued vigilance is needed to ensure that other regulatory aspects like ease of fund repatriation and cross-border investments do not negate the benefits of the tax clarity, he added.
The list of challenges doesn’t end here. Anand mentioned other major barriers for Indian investors such as curbs on secondary sales to foreign funds and taxation on flipping.
“Currently, if an Indian angle investor sells shares to a foreign investor, they are forced to sell at or above the fair market value (FMV) and pay taxes accordingly. But in reality, secondary shares sale often happen at a discount, especially in start-ups where investors take a risk on future growth. This makes it harder for early investors and angels to exit,” the Riceberg Ventures founding partner explained.
In case of start-up domicile shifts, any share swap is treated as a taxable event which imposes taxes on unrealized gains. This forces investors to sell their shares before the flipping process as they may not have cash available to pay the tax on an illiquid asset. As a result, investors miss out on future growth as the company scales globally.
“Allowing investors to hold shares longer without triggering tax liabilities would enable them to benefit from the company’s success when it eventually goes public abroad. Addressing these concerns could significantly improve liquidity and attract more investment to India's start-up ecosystem,” said Anand.
While the tax clarity introduced in Budget 2025 offers a positive step towards stimulating investment in Indian start-up ecosystem, it’s important for industry stakeholders to monitor how these new rules are implemented and address remaining regulatory gaps. It not only aligns the domestic environment with the global norms but also signals a broader commitment by the government to nurture innovation-led start-up ecosystem.