Budget 2024: AIFs seek tax parity with FPIs

Another clarification is needed to define whether profits made by AIFs are considered as capital gains or business income, say experts.

During a recent pre-budget consultation meeting with the government, the Indian Private Equity and Venture Capital Association (IVCA) proposed that Alternative Investment Funds (AIFs) should be granted tax parity with Foreign Portfolio Investors (FPIs).

Legal experts say that this tax parity is necessary because FPIs benefit from lower tax rates under Double Tax Avoidance Agreement (DTAA). They further add that foreign investors who wish to invest in Indian AIFs should also benefit from similarly reduced tax rates to make investments more attractive.

FPIs generally face lower tax liabilities in India due to the benefits of DTAA. However, in case of a foreign investor investing in an Indian AIF, the tax could be higher as the AIF fund is regarded as a taxable entity without having an access to DTAA, say experts. This makes the effective tax rates higher for foreign investors investing in AIFs.

"This arbitrage should be plugged and all AIFs should be brought at par with FPI so as to make AIFs equally attractive for foreign investors" said Dipesh Jain, partner at Economic Laws Practice.

Another clarification is needed to define whether profits made by AIFs are considered as capital gains or business income, say experts.

“Currently securities held by FPIs are considered as capital assets thereby plugging the controversy of business income versus capital gains and the litigation around that. Similar clarity could be brought out for AIFs as well; this would immensely help category III AIFs in particular,” said Jain.

There is some dispute whether the gains from investments should as taxed under capital gains or  business income.  For FPIs, the Income Tax Act says that investments are regarded as capital assets, and hence gains are regarded as capital gains. But for AIFs,  gains from investment are considered as business income

On Angel Tax
Another suggestion by the IVCA stated that exemptions from angel tax in genuine situations should be extended.

Section 56 (2)(viib) of the Income Tax Act,1961 applies to start-up companies when they issue shares to investors. The Central Board of Direct Taxes issued notification number 29 and 30 dated May 23, 2023. This provides exemptions to the start-up companies from the above tax rule.

Currently, tax on foreign investments made from 21 countries to Indian startups are exempted under the provisions of Section 56 (2) (viib) of the Income Tax Act, 1961 said Rubal Bansal Maini, Direct Tax Partner at Luthra and Luthra.

These 21 countries include United States, United Kingdom, Sweden, New Zealand, Denmark, Finland, France, and others.

However, she added, “If there are genuine investments in Indian startups made from other countries, apart from the 21 countries investments from which are already exempted, like Singapore or Mauritius, then, the income tax on these investments should also be exempted in the hands of the start-ups.”

Suggestions also included incentivizing global fund managers to set up in India versus in an overseas jurisdiction.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.​​​