The case for rejig of tax norms for AIFs in India
The effects of the pandemic were short-lived on the markets – resulting in one of the most volatile years in history. With the great ruckus that 2020 had been, there was an eager anticipation in the Indian markets around the Union Budget for FY 2020-21. The budget laid major focus on seven sections to revive the hurt economy — Health and Wellbeing, Financial Capital and Infrastructure, Inclusive Development for Aspirational India, Reviving Human Capital, Innovation and R&D, and Minimum Government Maximum Governance.
Several regulations around the securities market are proposed to be merged as a single code — intends to consolidate the SEBI Act, Depositories Act, Securities Contracts (Regulation) Act and Government Securities Act. The amalgamation of these regulations might create a simpler and more effective regulatory environment in the country.
Impact on the markets and AIFs Sector?
The market quite clearly had a very positive sentiment toward the Union Budget mainly due to the higher capital expenditure allocation with major allocation to infrastructure and healthcare centric activities.
Another major call-out was the increase in FDI limits in the insurance sector from 49% to 71% with a clause that the management on the board would comprise many resident Indians.
Gujarat can be a preferred investment destination due to its pro-business policies and intrinsic entrepreneurial spirit backed by reliable resources adds to advantage factors in the Alternative Investment Fund space; the key highlight would be the promotion and incentivization on the Gujarat International Finance Tec (GIFT) City and international financial services center (IFSC). There are multiple global leaders in the fintech and banking who have already created a mark in GIFT City – Global banking major Hongkong and Shanghai Banking Corporation Limited (HSBC) has received an in-principle approval from the GIFT SEZ Authority to set up an IFSC Banking Unit (IBU) at GIFT- International Financial Services Centre (IFSC) as well as Bank of America has opened a Global Business Services Center.
About a quarter of the India-focused funds based in Singapore and Mauritius could theoretically migrate to the International Financial Services Centre (IFSC) at GIFT City, Gujarat, in the next course of a few years, due to the new guidelines for alternative investment funds (AIFs) operating out of the region. With phase 1 already completed and phase 2 ramping up – the city has great potential in the years to come.
One of the expectations from the current budget included a revamp on taxation especially for the Category III AIFs with the rationale that the product is currently a boon to investors and allows investors to hedge with positions while the markets are at such exorbitant valuations. A Category III fund typically has four types of income – Business income, Dividend income-, Short- and Long-Term Capital gains. Unlike Category I and II funds, Category III Funds will be taxed at the fund level itself.
The rate of tax, again, depends on the legal form of the fund (Company, LLP, trust etc.). Tax rules related to trust taxation are comparatively more complex compared to other forms such as Company or LLP. There needs to be specific guidance on the taxation of Category III AIF and their investors. Therefore, a separate tax regime should be implemented for investors of Category III AIF thereby bringing clarity and certainty on taxation of income from Category III AIF. An AIF usually incurs expenses such as fees payable to the investment manager, bankers, advisers, lawyers, and other service providers. Neither the AIF nor their investors can offset these expenses against income/gains that eventually result from the investment. A suitable amendment should be brought under the Income-tax Act allowing investors to claim the expenses incurred by the AIF, from the date of the investment to the…
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