The Karnataka High Court has ruled that venture capital funds' investment management activities are exempt from service tax.

The Karnataka High Court reversed the decision of the Customs Excise & Service Tax Appellate Tribunal, which previously ruled that service tax applied to the expenses incurred by Venture Capital Funds. The tribunal had reasoned that the fund was providing asset management services to contributors.

The court determined that the "carried interest" paid on Class 'C' units held by the investment manager should be regarded as an expense incurred by the fund. Consequently, the fund is deemed liable to pay tax on this expense.

In the case of ICICI Econet Internet and Technology Fund vs. The Commissioner of Central Tax, the court observed that the taxpayer functions as a "pass-through" entity. This means that funds contributed by investors are pooled together and managed by the investment manager. The taxpayer operates as a trustee, holding the contributed funds on behalf of the investors, with the intention of investing them according to the advice provided by the investment manager.

“The fund does not make any profit nor does it provide any service, and, therefore, the imposition of service tax is untenable,” the court said.