When India’s startup ecosystem began to accelerate, the government realised that simply easing corporate tax wouldn’t be enough. Investment funds needed the right framework too. Enter Section 10(23FBB) of the Income Tax Act. On the face of it, it sounds technical. But when you peel it back, you’ll see a clear policy drive—to encourage capital flow into Indian innovation via investment vehicles like a VCF or VCC.
At its heart, this provision provides exemption for any income of venture capital companies or funds from investments in a Venture Capital Undertaking (VCU). That means when a fund invests in an Indian startup (a VCU) and earns income taxed by the fund as “business income,” the unit‐holders in that fund can enjoy an exemption under Section 10(23FBB). Read that again: the fund is taxed on business income, the unit‐holders get the benefit under this section.
Why Section 10(23FBB) Matters
Venture capital in India is risky. You invest in early‐stage companies, you hope for growth, but the timeline & returns aren’t guaranteed. By giving this tax exemption, the law helps align incentives. Investors in VCFs/VCCs know that if the fund successfully invests in a VCU, then the income remains exempt for them under Section 10(23FBB). That encourages fresh capital, supports innovation, and reduces some of the tax risk tied to growth‐oriented vehicles.
Moreover, the clause recognises that any income of the European Economic Community derived in India (or similar international funds) needs clarity when it flows to Indian unit‐holders. The section & accompanying rules ensure that these cross‐border investment flows are understood in the Indian tax context.
How It Works—In Practice
Imagine you are a unit-holder in a VCF registered in India. The fund invests ₹10 crore in a startup (VCU). The startup grows, exits, and the fund realises a gain of ₹3 crore, which the fund treats as business income under the Income Tax Act. Because of Section 10(23FBB), that income (when passed on to unit‐holders) is exempt in their hands, provided other conditions are met.
It’s vital to recognise key conditions:
- The fund must be a “venture capital fund” or “venture capital company” as defined under the Act & regulations.
- The income being exempt is that portion which the fund has taxed as business income from the VCU."
- The unit‐holder enjoys the benefit when the fund distributes the income or when accounting triggers under the fund’s structure.
Also Read: How VCFs & VCCs Earn Tax-Free Income in India
Key Terms and Conditions
- VCC/VCF: These are investment vehicles that pool capital to invest in VCUs.
- VCU (Venture Capital Undertaking): A startup or early‐stage business meeting criteria under Indian laws & regulations.
- Business Income: The return earned by the fund from its investment is treated as business income—not capital gains—in the hands of the fund.
- Unit‐Holder Benefit: Once the fund has earned and reported that business income, the unit‐holders (if eligible) can claim the exemption under Section 10(23FBB).
Why This is Smart Tax Policy
It’s not just about tax savings—it’s about creating a flow of investment. If funds know that unit‐holders will benefit from exemption, then more capital enters VCFs/VCCs, more startups get funded, more jobs get created, more innovation happens. That’s the economic logic behind Section 10(23FBB).
At the same time, it’s well‐targeted. This isn’t a blanket exemption for any fund. It works only when the fund invests in VCUs and earns business income. So the tax benefit is aligned with risk capital & growth‐oriented investment, not routine passive holdings.
Comparisons & Clarifications
It’s worth comparing this with other exemptions. Many tax provisions focus on salary, interest, capital gains, etc. Section 10(23FBB) is unique—it targets funds, unit‐holders and growth investment. In that sense it sits alongside other startup‐friendly provisions like Section 80IAC (tax on start-ups), but focused on the investment vehicle side rather than the company being invested in.
Practical Steps for Investors & Funds
- Check your fund’s status: Ensure your VCF or VCC is registered & qualifies under respective regulations.
- Ensure the fund treats investment returns as business income: Structuring matters. Gains must come from VCUs & be treated accordingly.
- Track distribution to unit‐holders: Exemption flows only when income is passed/distributed under fund structure.
- Filing & documentation: Maintain the fund’s audited accounts, distribution analysis, unit‐holder register. During ITR filing, the unit‐holder must report the income as exempt with suitable disclosure.
- Seek professional backup: Given the complexities, working with a tax advisor or CA (such as via CallMyCA.com) ensures you stay fully compliant and capture the benefit.
Also Read: Exemption for Sovereign Wealth Funds and Pension Funds
Key Takeaways
- Section 10(23FBB) of the Income Tax Act grants exemption for any income of investment funds & their unit‐holders, when the fund’s income is business income from VCUs.
- It’s a growth-capital friendly provision designed to encourage investment into Indian startups & innovation."
- Unit‐holders enjoy exemption only if the fund & investment meet prescribed criteria—so structure and documentation matter.
- This provision is a strategic lever for investors, funds, startups, and the broader ecosystem.
Final Thoughts
If you’re considering investing through a VCF or VCC, or you’re already a unit‐holder, Section 10(23FBB) opens up real tax‐efficient opportunities. It ensures your investment in innovation is backed by favourable tax treatment—rewarding both courage and vision.
For funds and unit‐holders alike: Don’t just focus on tax savings—focus on structuring for compliance, capturing exemptions & aligning investment strategy.
If you’re unsure whether your fund qualifies under Section 10(23FBB) or you need help with documentation, filing, or structuring—our expert team at CallMyCA.com is ready to assist.
Book a consultation now—ensure your investment in Indian innovation isn’t just smart, but tax-savvy too.
