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Last Updated : Jan 27, 2017 03:14 PM IST | Source:

Budget 2017: A possible power-play for Alternative Investment Funds

With the economy looking for strong investment led thrust in the forthcoming budget, one cannot ignore the importance of Alternative Investment Funds (AIFs) in the Indian economy.

Naresh Makhijani

The Union Finance Minister, Arun Jaitley, is all set to present the Union Budget 2017-18 on 1 February amid huge expectations from him  to introduce polices that can boost the economy, especially post the recent demonetisation.

With the economy looking for strong investment led thrust in the forthcoming budget, one cannot ignore the importance of Alternative Investment Funds (AIFs) in the Indian economy. This is so, as AIFs typically provide long-term, high-risk capital to a wide variety of ventures at all stages of their evolution. This includes risk capital in the form of equity capital for pre-revenue stage companies, early and late stage ventures, growth companies that wish to scale their future operations. In addition, AIFs also help incubate innovative ideas and invest in a broad array of sectors ranging from e-commerce, hospitals, tech ventures, education ventures, and industrial and infrastructure projects.

From the above, it could be said that AIFs are an important source of long-term capital for start-ups and other companies in India. This has been proved by the fact that AIF industry has been growing exponentially. As reported by SEBI on 30 September 2016, AIFs have invested nearly INR 25,000 crore in India. Nearly 60% of this amount is invested by Category II AIFs. Thus, considering its importance in the Indian economy, the government over the past couple of years, have addressed some of the tax and regulatory issues faced by AIF industry. Having said this, there are still some tax issues which need to be addressed and some of the key tax issues are as follows:

First, Section 194LLB of the Income-tax Act, 1961 (the Act) provides for withholding of tax at 10% by AIF in respect of any income (including exempt income) paid/credited by AIF to its resident investors, whereas for the non-resident investors it is at rates in force. Thus, for resident investors, tax withholding by AIF on exempt income leads to deferment of realisation of income as they will need to claim the tax withheld as refund in their income-tax return for that year. Also, the said withholding tax requirement on the exempt income relating to resident investors is not pari passu with the withholding tax requirement on the exempt income paid to Non-resident investors. Thus, in order to alleviate this genuine hardship faced by resident investors, it could be expected that the Union Budget 2017-18 may address the aforesaid issue by amending section 194LLB of the Act to provide for non-withholding of tax on payment of exempt income by AIFs to the resident investors.

Second, as per the provisions of the Act, Category I and II AIFs are accorded a pass-through status, i.e. such income shall be chargeable to tax directly in the hands of the investors, except where the income of the AIF is characterised as ‘business income’. However, income of Category III AIFs is to be taxed in the hands of the Trustee as a representative assessee. In order to streamline the taxation mechanism for all categories of AIFs, the government may address this inconsistency by extending the tax pass-through status to Category III AIFs, as well.

Third, similar to FPIs, one could hope that the income arising from transfer of securities held by AIFs is also clearly spelled out to be in the nature of ‘capital gains’. This can provide much needed clarity and mitigate avoidable litigation.

Last, Category I and II AIFs are typically close ended funds. The tenure of a fund / scheme is determined at the time of its launch. Typically, an AIF’s tenure does not exceed 10 years from its launch. Where Category I and II AIFs incur net losses on its investments towards the end of its lifecycle or has unabsorbed losses which cannot be utilised by the AIF, such losses would lapse. The investors would be taxed on an amount that would be greater than the ’real‘ income derived by them from investment in AIF, causing investments made through AIF to become unattractive vis-à-vis direct investments. This would be an unfair treatment that would be faced by the investors in an AIF. Accordingly, one could expect that the Union Budget 2017-18 may address this issue by amending Section 115UB of the Act, to provide that net losses incurred by AIFs should also be allowed to be passed on to the investors.

The above points represent a wish list relating to the AIF industry, but it is to be seen whether the FM considers the same while preparing the Finance Bill, 2017-18.

The author is  Partner and Head, BFSI, KPMG in India
(Views expressed are personal.)

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First Published on Jan 27, 2017 03:14 pm
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