Mar 3, 2015

AIFs vis-a-vis BUDGET 2015-16

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AIFs Vis-à-vis UNION BUDGET 2015-16


SEBI came out with Alternate Investment Fund Regulations in May 2012, though since then, no specific exemptions ever found placed under the Taxation provisions to promote these funds. By and large since the applicability of these Regulations close to 120 AIF were registered with SEBI within a span of short 2 years wherein majority of these funds had been in the nature of Trust to avail the benefit of Tax pass through following the advance ruling of AIG (in Re: Advance Ruling P. No. 10 of 1996). Though lately The Central Board of Direct Taxes (“CBDT”) issued a Circular No. 1 dated July 28, 2014 (“Circular”) to provide ‘clarity’ on the taxation of Alternative Investment Funds wherein it was provided that if ‘the names of the investors’ or their ‘beneficial interests’ are not specified in the trust deed on the ‘date of its creation’, the trust will be liable to be taxed at the ‘Maximum Marginal Rate’. This said circular created lots of hue and cry in the entire AIF industry as well as proved dampening to the domestic as well as foreign investors.

Having due regard to the large number of representation received from various Industry and Investor Association(s), the present budget 2015-16 has come up with special tax regime for Investment Fund (Alternative Investment Fund (AIF) Category I and II registered under SEBI (AIF) Regulations, 2012 to improve the investment climate in the Country and also to promote the domestic manufacturing.

The same is discussed herein below:
As per the budget 15-16, Tax Pass through has been extended to AIF Category-I and Category-II which covers the following nature of Investment Funds:

  • AIF Category – I : – Includes AIFs which invest in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the Government or regulators consider as socially or economically desirable.
  • AIF Category – II : – Includes private equity funds or debt funds which do not fall in AIF Cat-I and Cat III and undertake leverage or borrowing for meeting day to day operational requirements.

The Salient Features of the proposed regime are discussed hereunder:

  1. Applicability: Proposed regime to be applicable on “Investment Funds” (i.e. AIF Cat-I and Cat-II), and Cat –III AIFs (Hedge Funds) falls outside the purview of the proposed regime.
  2. Tax Pass Through to Investment Fund Income:
    • 2.1. The Income stream of an Investment Fund is broadly sub-categorized as Business Income; Capital Gains and Income from other Sources.
    • 2.2. The Tax Pass Through 1 is provided on Capital Gains and Income from other Sources though not on Business Income.
    • 2.3. Thus Business Income shall be taxable at the Fund level in accordance with the relevant provisions of the Income Tax Act (before distributing to unit holders).
    • 2.4. Investor is not required to pay tax on income accruing or arising to, or received by it out of Fund’s Business income
    • 2.5. The income received by the investor/unit holder from the Investment Fund, shall be deemed to be of the same nature and in the same proportion as if it had been received by, or had accrued or arisen to, the Investment Fund (i.e. proportion of Business Income; Capital Gain; Income from Other Sources shall remain same in hands of Investor/unit holders as originally held in Fund).
    • 2.6. Tax Pass Through shall be enjoyed by Investment Fund whether set up as Trust, Company, or Limited Liability Firm (LLP) etc.
  3. No Pass Through to losses:
    • 3.1. Loss of Investment Fund cannot be pass through to the Investor.
    • 3.2. Loss (current / previous) to be carried forward at the Fund level to be set off against the income of the next year in accordance with the provisions of Chapter VI of the Income Tax Act.
  4. Dividend Distribution Tax: Provisions of Chapter XII D (Dividend Distribution Tax) and Chapter XII E (Tax on distributed Income) shall not apply to the income paid by an Investment Fund to its investor/unit holder. This provision brings clarity w.r.t. Investment Funds incorporated in form of Company or other body Corporates.
  5. Provisions of TDS (withholding Tax):
    • 5.1. The income received by Investment Funds would be exempt from TDS requirement.
    • 5.2. TDS @10% shall be deducted by the Investment Fund from investor /unit holder on distribution of Income (other than Business Income) to its investor/unit holder.
  6. Other Disclosure Requirements
    • 6.1. Mandatory for Investment Fund to file return of its income.
    • 6.2. Fund to provide details of various components of income to investor/unit holder and Income Tax Authorities.
  • VFC/VCC which has been registered under SEBI (VCF) Regulations, 1996 and which are continuing without obtaining fresh registration under SEBI (AIF) Regulations, 2012; shall fall outside the jurisdiction of new regime (i.e. Existing regime shall be applicable on them).
  • The new Tax provisions are welcoming for the Fund Industry and intend to boost confidence of both domestic and foreign investors.
  • The removal of ambiguity with respect to taxability and providing pass through status for not only Trust structure but also for LLP and Body Corporate will see large number of new AIFs being registered and more money flowing in the economy.
  • Steps taken by the new government are positive in the direction of boosting Indian Economy and endow the Indian corporate with better avenues to channelize the idle funds of High Networth Individuals and Institutional Investors lying idle or unutilized.
  • The AIF has been made as double bonanza offer for the Corporate, being relatively relaxed with minimum restrictions and intervention of Regulators, and now with the special tax regime it looks even more lucrative from tax point of view.
  • As the provisions of Chapter XII D and XII E of the Act are not applicable, income distributed by an AIF registered as Company shall not be liable to deduct the dividend distribution tax under the provisions of the Act.
  • Though, over and above all the positives, in the exemptions so granted, a small issue with respect to “Business Income” remains unclear. The provision of Tax Pass through talks of Business Income to remain taxable at the Fund level, though what will tantamount to “Business Income” remains unclear and need to be elaborated upon. Since under SEBI AIF Regulations, 2012 Regulation 2(1) (b) which defines AIF clearly broaches that the object of AIF shall be make investments from the pooled money and thus entire income it earns from pool of money has to be its business income.  Some clarity in this respect ought to be received.
1 Income of Investment Fund (other than Business Income) shall be taxable in the hands of its investors/unit holders in the same manner as if it were the income accruing or arising to, or received by, such person had the investments, made by the Investment Fund, been directly made by him.

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