In a significant judgment dated February 8, 2024, the Karnataka High Court ruled in favor of the India Advantage Fund-III and other appellants, determining that venture capital trusts are not subject to service tax under the Finance Act, 1994. This case, involving the appellant fund and the Commissioner of Central Tax, examined whether a venture capital trust should be considered a juridical person and if the appellant’s management activities fall under the scope of banking and financial services, thereby making it liable for service tax.
Background of the Case
The case centers around India Advantage Fund-III, a venture capital trust that pools investments from institutional investors and allocates them based on the guidance of an Investment Manager. The Anti-Evasion Unit argued that a portion of the income retained by the trust amounted to a service charge for fund management. According to the investigating team, this service charge falls under the taxable category of banking and other financial services under Section 65(105)(zm) of the Finance Act, 1994.
In response, the Appellant argued against the tax imposition, asserting that the trust acts solely as a pass-through entity, without rendering any taxable services to the investors. Furthermore, they argued that the Finance Act does not consider a trust a “person” for service tax purposes, as the entity only consolidates funds for the Investment Manager to administer.
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Court’s Key Rulings
The Court addressed several key questions to determine the trust’s tax liability:
- Is a Trust a Juridical Person?
The Court found that while the Securities and Exchange Board of India (SEBI) Act may recognize a trust as a juridical person, the Finance Act, 1994 does not. Therefore, the Court ruled that the Central Excise and Service Tax Appellate Tribunal (CESTAT) erred in interpreting the trust as a juridical person under the Finance Act and confirmed that the Finance Act’s scope does not cover trusts as taxable entities. - Does the Trust Provide a Taxable Service?
The Court agreed with the appellant that the trust merely functions as a pass-through vehicle, managing funds on behalf of investors under the guidance of the Investment Manager. The trust itself does not engage in profit-making activities or directly provide a service to contributors. Thus, the Court ruled that the trust is not liable for service tax, as it does not perform a taxable activity. - Application of Doctrine of Mutuality
The Court applied the doctrine of mutuality, observing that since the contributors and trust are inherently linked, there is no service rendered to an outside party. As a result, any service is provided by the trust to itself, further substantiating the pass-through nature of the fund.
Supreme Court’s Decision on the Special Leave Petition
Following the High Court’s decision, the Commissioner of Central Tax, Bangalore filed a Special Leave Petition (SLP) with the Supreme Court, seeking to challenge the ruling. However, on October 4, 2024, the Supreme Court dismissed the SLP, stating that it found no merit in the case. This dismissal effectively affirms the High Court’s decision and sets a precedent for similar cases involving venture capital trusts and their tax obligations.
Conclusion
The Karnataka High Court’s ruling reinforces the concept of pass-through status for venture capital trusts, exempting them from service tax under the Finance Act, 1994. This decision provides clarity for venture capital trusts, institutional investors, and fund managers regarding their tax obligations and emphasizes the need to evaluate the applicability of tax laws based on the purpose and scope of the relevant legislation.
