How VCFs & VCCs Earn Tax-Free Income in India: Section 10(23FB) Exposed

Investment appetite changes when taxes make or break returns. And somewhere in that decision-making matrix, Section 10(23FB) of Income Tax Act plays a quiet but powerful role, especially in India’s startup and venture investing ecosystem. Most people talk about funding rounds, valuations, and unicorns. Fewer talk about the foundation that helps these investments grow tax-efficiently. Section 10(23FB) is one of those building blocks.

This section specifically grants an income tax exemption on income earned by a Venture Capital Company (VCC) or a Venture Capital Fund (VCF) from investments in a Venture Capital Undertaking (VCU). In simpler words, when certain approved investment vehicles put money in eligible Indian startups, their profit from those investments can be tax-free. That statement alone explains why this section exists.

India needed more capital flowing into young, high-risk, high-innovation businesses. Investors needed higher post-tax returns to justify risk. The government needed innovation-driven companies to grow without being starved of funding. Section 10(23FB) became the bridge connecting all three.

Why Was Section 10(23FB) Introduced?

India’s startup economy did not always attract global or domestic venture investors, the way it does now. Early-stage investing is risky. The failure rate is high. Returns, when they happen, take years. So, taxing those returns on top of everything else? That would have slowed the entire ecosystem. To reduce friction, the government designed certain tax incentives. And Section 10(23FB) became one of the key ones.

The intent is clear:

✅ Encourage capital flow into innovative Indian companies"
✅ Ensure investment profit is not eroded through taxation
✅ Build a supportive environment for venture capital vehicles
✅ Boost sectors like tech, pharma, fintech, climate solutions, AI, deep tech, etc.

This section essentially whispers (loudly) to venture investors:
“Take the risk. We’ll at least handle the tax pressure.”

This is why the section Provides exemption for any income of venture capital companies from approved startup investments.

Also Read: Complete Guide to Exemption for Business Trusts

Who Can Claim This Exemption?

Not everyone can walk in & claim it. It is not open to angel investors, HNIs, retail investors, or unregistered funds.

Only these entities qualify:

1. Venture Capital Company (VCC) — A company registered under SEBI (Venture Capital Funds) Regulations.
2. Venture Capital Fund (VCF) — A registered fund operating under SEBI regulations.
3. Investments must be made into a Venture Capital Undertaking (VCU) — meaning a startup or business that fits SEBI and income tax eligibility conditions.

This is not a random exemption. It is a regulated one.

The government is saying:
“If you want tax benefits, invest through registered, compliant, India-focused venture structures. No loopholes. No shortcuts.”

What Kind of Income Gets the Tax Benefit?

The law covers income that arises from investments made into eligible startups — this may include:

• Dividend income
• Interest income
• Capital gains from sale of shares or units in VCU
• Other investment-linked earnings routed through approved VC structures

So when a VC exits a startup investment successfully — the gains flowing through the VCC/VCF structure can be completely tax exempt under this section.

That is huge. Because venture investing is all about the exit. No tax on gains = More capital recycled into new startups = Healthier funding ecosystem.

Conditions That Must Be Met

The exemption is not automatic. All boxes must be ticked:

✔ The investing entity must be a registered VCC or VCF
✔ The investee must qualify as a Venture Capital Undertaking (VCU)
✔ Income must arise specifically from eligible investments
✔ Compliance must be maintained under SEBI & Income Tax regulations
✔ The fund structure & activity must align with notified guidelines

Miss one condition — exemption can collapse.

This is why venture funds usually work closely with tax advisors even before they make their first investment.

Real-World Example to Understand It Better

Let’s say:

A registered Venture Capital Fund invests ₹10 crore into an Indian climate-tech startup (which qualifies as a VCU).
After 4 years, the startup gets acquired & the fund earns ₹25 crore from the exit.

So, ₹15 crore is the gain.

Under normal tax rules, capital gains tax would apply."

But because:

✔ The investment was made by a registered VCF
✔ The startup is an eligible VCU
✔ Income arose from the investment

This ₹15 crore gain becomes tax exempt under Section 10(23FB).

Result? More capital stays in the fund. More money gets reinvested into new startups. Everyone wins.

Also Read: The Tax Exemption That Keeps Religious and Charitable Boards Free from Tax Burden

Why This Matters for India’s Startup Economy

India now produces unicorns faster than ever. But unicorns don’t appear overnight. They are built through early capital, patient funding, and risk-absorbing investment structures. The tax system plays a quieter role in that story, but a very real one.

By protecting investor returns from tax leakage, this section contributes to:

• Higher investor participation
• More funding availability for startups
• Better risk appetite for early-stage investing
• Stronger innovation ecosystem
• Increased global VC interest in India

This section complements India’s growing role in global venture conversations.

Relation With Other Tax Sections (Common Queries)

Many investors & taxpayers confuse different exemptions. Here’s a quick distinction:

These sections operate in totally different universes. But taxpayers often search for them together. So it helps to understand context.

What If You Don’t Structure It Correctly?

This is where many investors make mistakes.

• Investing directly instead of through a registered VCF/VCC
• Backing a business that does not qualify as a VCU
• Receiving income outside the approved investment framework
• Missing compliance documentation
• Poor fund structuring

The outcome?

❌ Exemption denied
❌ Tax becomes payable"
❌ Returns shrink drastically
❌ Investor confidence drops

Tax efficiency in venture investing is 50% regulation, 50% structuring.

Also Read: Exemption on Pension Funds and Retirement Benefits

A Common Misunderstanding

Many think Section 10(23FB) means “all startup investing is tax-free.”

It does not. Only investment income routed through registered VCC or VCF into eligible VCUs gets this benefit.

If you are:

• An angel investor investing personally
• An unregistered fund
• A foreign fund not structured through the approved route

Then this section does not apply to you.

The Bigger Picture

Section 10(23FB) is not just about tax.

• It is about creating an environment where capital is not afraid to flow.
• It is about making India not just a consumer market — but an innovation market.
• It is about enabling bold founders & risk-taking investors to work together without heavy tax friction.

And honestly? It has worked. India has become one of the top startup funding destinations globally.

Final Thought

If your fund structure is right, your returns can stay largely intact. If your structure is wrong, even great investment wins can feel like losses after tax. VC investing is not just about picking the right company. It is also about picking the right investment vehicle.

Our CAs specialise in fund structuring, VC taxation, & tax-efficient investment planning. Don’t let taxes eat into your startup investment gains — Check your exemption the smart way. Visit Callmyca.com today. 🚀