“Dive into the world of Alternative Investment Funds (AIFs) with our comprehensive guide, exploring types, registration processes, compliance requirements, and taxation implications. Uncover the intricacies of Category I, II, and III AIFs, dissecting their focus areas, and regulatory frameworks. Understand the detailed registration process mandated by the Securities and Exchange Board of India (SEBI), compliance framework, and the tax treatment for each category. Stay informed about dematerialization requirements and gain insights into the constitution of Investment Committees, Investor Charters, and complaint disclosure. Navigate the complex landscape of AIFs with our detailed analysis and stay ahead in the dynamic investment arena.”
Introduction: Alternative Investment Funds (AIFs) have gained prominence as investment vehicles that cater to a niche segment of sophisticated investors. In this comprehensive guide, we’ll delve into the world of AIFs, exploring their types, registration process, compliance requirements, and taxation implications.
WHAT IS AN ALTERNATIVE INVESTMENT FUND?
An Alternative Investment Fund (AIF) is a type of investment vehicle that is distinct from traditional investment options like stocks, bonds, and mutual funds. AIFs are typically designed for sophisticated investors, both domestic and foreign, and they pool together funds to invest according to a specific investment strategy or policy. AIFs offer investors access to a wide range of alternative investments beyond the conventional asset classes.
TYPES OF AIFS
There are three main categories of AIFs in India, each with its own investment focus and regulatory framework:
1. Category I AIFs: These AIFs invest in sectors or areas that the government or regulators consider socially or economically desirable. They may invest in:
- Start-up or early-stage ventures
- Social ventures
- Small and Medium Enterprises (SMEs)
- Infrastructure projects
Examples of Category I AIFs include venture capital funds (including angel funds), SME funds, social venture funds, and infrastructure funds.
2. Category II AIFs: Category II AIFs primarily invest in equity and debt securities, and they do not fall under the Category I or III classification. These funds often focus on:
- Real estate investments
- Private equity investments
- Funds targeting distressed assets
Examples of Category II AIFs aim to provide diversification and alternative exposure to traditional asset classes.
3. Category III AIFs: Category III AIFs employ diverse or complex trading strategies, including the use of leverage, and may invest in both listed and unlisted derivatives. These funds are suitable for investors seeking exposure to more sophisticated and potentially higher-risk strategies.
Examples of Category III AIFs include hedge funds and Investment in Public Equity Funds (PIPE funds).
COMPARATIVE STUDY:
|
Criteria |
Category I | Category II | Category III |
| Categorization | 1. Venture capital funds (Including Angel Funds)
2. SME Funds 3. Social Venture Funds 4. Infrastructure Funds |
1. Real Estate Funds
2. Private Equity Funds 3. Funds for distressed assets |
1. Hedge Funds
2. Public Equity Fund (PIPE)
|
| Registration Fee | INR 5,00,000/- (For Angel Funds INR 2,00,000/-) | INR 10,00,000/- | INR 15,00,000/- |
| Continuing interest by Sponsor/ Manager | Lower of the following
1. 2.5% of corpus Or 2. INR 5 crores |
Lower of the following
1. 2.5% of corpus Or 2. INR 5 crores |
Lower of the following
1. 5% of corpus Or 2. INR 10 crores |
| Open ended/ Close ended | Close ended | Close ended | Open or Close ended |
| Ability to invest in Listed securities | Limited ability for listed investments.
Different norms across sub categories |
Upto 49.99% investments can technically be done in listed securities | Investments upto 100% can be made in listed securities |
| Investment Concentration Norm | Investment of not more than 25% of the investible funds in an investee company directly or through investment in the units of other AIFs | Investment of not more than 25% of the investible funds in an investee company directly or through investment in the units of other AIFs | Investment of not more than 10% of the investible funds in an investee company directly or through investment in the units of other AIFs.
For investment in listed equity of an Investee Company, the investment limit of 10% can be on investible funds or the net asset value. |
REGISTRATION PROCESS FOR AIFs:
The registration process for an Alternative Investment Fund (AIF) in India involves several steps and compliance with the regulations set forth by the Securities and Exchange Board of India (SEBI). Here is a summary of the registration process:
1. Online Application Submission: All applicants seeking registration as an AIF must submit their applications online through the SEBI Intermediary Portal. The portal’s URL for online application submission is https://siportal.sebi.gov.in.
2. Private Placement Memorandum (PPM): The Private Placement Memorandum is a critical document that provides detailed information about the AIF to prospective investors. SEBI has mandated a specific template for the PPM, which must be used. You can find the template for PPM for Category I & II AIFs at https://www.sebi.gov.in/sebi_data/commondocs/feb-2020/an_2_p.pdf and for Category III AIFs at https://www.sebi.gov.in/sebi_data/commondocs/feb-2020/an_2_p.pdf.
3. Scheme Launch and SEBI Registration: AIFs are required to launch their scheme(s) subject to filing the PPM with SEBI through a SEBI registered Merchant Banker. Additionally, a due diligence certificate should accompany the submission.
4. First Close of the Scheme: The AIF must declare the “First Close” of its scheme(s) within 12 months from the date of SEBI communication for taking the PPM of the scheme on record. The “First Close” signifies that the AIF has started attracting investors, and it must meet the minimum corpus requirement specified in the AIF Regulations for the respective category or sub-category of the AIF. This minimum corpus requirement ensures that the AIF has a sufficient pool of capital to operate effectively.
5. For Category III AIFs: In the case of open-ended schemes of Category III AIFs, the “First Close” refers to the close of their Initial Offer Period. This is when the initial subscription period for investors to participate in the AIF ends.
COMPLIANCE FRAMEWORK
To Investors: The manager is required to provide the following reports or disclosures to the investors of the AIF
| Sr. No | Particulars | Frequency | Submission date |
| 1 | Annual report to the investors including the following information:
a. Financial information of investee companies; b. Material risks and how they are managed, which may include i. Concentration risk at fund level; ii. Foreign exchange risk at fund level; iii. Leverage risk at fund and investee company levels; iv. Realization risk (i.e. change in exit environment) at fund and investee company levels; v. Strategy risk (i.e. change in or divergence from business strategy) at investee company level; vi. Reputation risk at investee company level; and Extra financial risks, including environmental, social and corporate governance risks, at fund and investee company level. |
Annually (For Category I and Category II AIF)
Quarterly (For Category III AIF) |
Within 180 days from the year end (For Category I and Category II AIF)
Within 60 days of the end of the quarter (For Category III AIF) |
| 2 | Description of valuation and methodology for valuing assets
a. Valuation to be undertaken by an independent valuer (For Category I and Category II AIF) Category III AIF to undertake NAV valuations and disclose NAV to the investors |
Half-yearly (Can be enhanced to 1 year on approval of 75% of investors by value of their investment)
Close ended fund –Quarterly Open ended fund – Monthly |
Half-yearly (Can be enhanced to 1 year on approval of 75% of investors by value of their investment)
Close ended fund – Quarterly Open ended fund – Monthly |
| 3 | As and when occurred: Any changes to the placement memorandum including modifications in terms or documents of the fund/scheme | Annually | Within one month from the end of the financial year |
| 4 | Reporting:
a. Financial, risk management, operational, portfolio, and transactional information regarding fund investments; b. Any fees paid to the manager or sponsor; and Any fees charged to the AIF or any investee company by an associate of the manager or sponsor |
Periodically | Periodically |
| 5 | The manager or sponsor is required to disclose their investment in the AIF to the investors | Periodically | Periodically |
To the Trustee and Sponsor:
|
Sr. No |
Particulars | Frequency | Submission date |
| 1 | Quarterly Compliance Report to Trustee | Quarterly | Within 15 days from the end of the quarter |
| 2 | a. Manager is required to prepare a compliance test report (CTR) and submit to the (i) trustee and the sponsor, in case the AIF is set up as a trust; or (ii) sponsor, in case of other AIFs
b. In case of observations on CTR, trustee/sponsor to intimate the same to manager. Manager to make necessary changes in CTR basis comments received from trustee/sponsor |
Annually | Within 30 days from the end of the financial year
Within 30 days from the end of the financial year Within 15 days from date of receipt of observations/ comments |
| 3 | Any findings of audit of compliance with terms of PPM along with Annually corrective steps, if any (in case of AIFs which have not raised any funds from their investors, they shall submit a Certificate from a Chartered Accountant to the effect that no funds have been raised) | Annually | Within six months from the end of the financial year |
To SEBI: Prior Approval/Intimation to SEBI
| Sr. No | Particulars | Frequency | Submission date |
| 1 | Prior SEBI approval if any change in control of AIF, sponsor or manager | Prior approval | As soon as possible |
| 2 | Submission of quarterly report (online) to SEBI relating to their Quarterly activity as an AIF | Quarterly | Within 10 days from the end of the quarter |
| 3 | Submission of report on leverage undertaken (For Category III AIF) | Quarterly | Quarterly |
| 4 | AIFs shall report the utilization of overseas investment limits on SEBI intermediary portal | Event Based | Within 5 working days of such utilization |
| 5 | In case the AIF has not utilised/partly utilised the overseas investment limits within a period of 6 months from the date of SEBI approval (validity period), the same shall be reported on the SEBI intermediary portal. | Event Based | Within 2 working days after expiry of the validity period |
| 6 | In case the AIF wishes to surrender the overseas limit at any point of time within the validity period, the same shall be reported on the SEBI intermediary portal | Event Based | Within 2 working days from the date of decision to surrender the limit |
| 7 | As and when occurred: Any changes to the placement memorandum, including modifications in terms or documents of the fund/scheme | Annually | Within one month from the end of the financial year |
| 8 | Any findings of audit of compliance with terms of PPM along with Annually corrective steps, if any (in case of AIFs which have not raised any funds from their investors, they shall submit a Certificate from a Chartered Accountant to the effect that no funds have been raised) | Annually | Within six months from the end of the financial year |
Direct Tax Compliances
| Sr. No | Particulars | Frequency | Submission date |
| 1 | Income tax return | Annually | 31 October of the Relevant assessment year |
| 2 | Advance tax payment | Quarterly | 15th day of June, September, December, and March of every tax year |
| 3 | Withholding taxes
a. Withholding tax payments b. Withholding tax returns c. Certification for withholding taxes on foreign remittances (Form 15CA/15CB) |
Monthly
Quarterly Per foreign remittance |
7th of the subsequent month except for March which is due by 30 April
31 July- first quarter 31 October – second quarter 31 January – third quarter 31 May – fourth quarter At the time of foreign remittance |
| 4 | Statement to be furnished (in Form No. 64C) by AIF to unitholders in respect of income distributed during the previous year (applicable for Category I/II AIF) | Annually | 30 June of the financial year following the previous year |
| 5 | Statement to be furnished (in Form No. 64D) by AIF to Income tax authorities in respect of income distributed during the previous year (applicable for Category I/II AIF) | Annually | 15 June of the financial year following the previous year |
FEMA and Other Regulatory Compliance
| Sr. No | Particulars | Frequency | Submission date |
| 1 | The AIF, which has issued units to a person resident outside India shall file the Form InVi with the RBI | Event Based | Within 30 days from date of issue of units |
| 2 | The AIF making downstream investment in another Indian entity which is regarded as indirect foreign investment (as sponsor or manager is not Indian owned and controlled), shall file Form DI | Event Based | Within 30 days from the date of allotment of equity instruments |
| 3 | Foreign Liabilities and Assets (FLA) return has to be filed with the RBI in lieu of all the foreign investments received and made in the previous year | Annually | 15 July of the financial year following the previous year. In case the financials are not audited then once the audited numbers are ready, request for approval to revise the previously filed return to RBI |
| 4 | Reporting of all cash and suspicious transactions with FIU | Immediate | Immediate |
Constitution of Investment Committee:
- Purpose: The Investment Committee is established to approve investment decisions made by the AIF. It plays a crucial role in the decision-making process regarding the allocation of funds and investment strategies.
- Composition: The Investment Committee may include both internal members, such as employees, directors, or partners of the AIF manager, as well as external members. The committee typically consists of individuals with expertise in finance, investments, and relevant sectors.
- Function: The Investment Committee’s primary function is to review and approve investment proposals, ensuring that they align with the AIF’s defined investment policy and objectives. Their decisions are vital in managing the AIF’s portfolio effectively.
Investor Charter and Disclosure of Complaints:
- Investor Charter: The Investor Charter is a concise document that outlines important information and services provided to investors. It includes details about the grievance redressal mechanism, investors’ responsibilities, and other relevant information. The goal is to provide investors with clear and easily accessible information.
- Inclusion in PPM: AIFs are required to include the Investor Charter in the Private Placement Memorandum (PPM). By doing so, investors receive essential information about the fund’s operations and their rights in a readily understandable format.
- Transparency in Investor Grievance Redressal: AIFs are also mandated to enhance transparency in their investor grievance redressal mechanism. They are required to maintain records of investor complaints and their resolutions. This data should be compiled and disclosed as a separate chapter in the PPM.
- Reporting Frequency: AIFs should update this information regularly, with data on investor complaints and their status compiled no later than seven days after the end of each quarter. This helps investors understand how grievances are being addressed by the AIF.
ISSUANCE OF UNITS OF AIFS IN DEMATERIALISED FORM
AIFs shall issue units in dematerialized form subject to the conditions specified by SEBI from time to time.
All schemes of AIFs shall dematerialize their units in the following time frame:
| Particulars | Schemes of AIFs with corpus ≥ Rs 500 Crore | Schemes of AIFs with corpus < Rs 500 Crore |
| Dematerialization of all the units issued | Latest by October 31, 2023 | Latest by April 30, 2024 |
| Issuance of units only in dematerialized form | November 01, 2023 onwards | May 01, 2024 onwards |
Taxation of Alternative Investment Funds (AIFs):
The taxation of Alternative Investment Funds (AIFs) in India is governed by specific provisions outlined in the Income Tax Act, 1961. These provisions provide for a “pass-through” status for Category I and Category II AIFs but not for Category III AIFs. Here’s a breakdown of the tax treatment for these categories:
i. Taxation of Category I and Category II AIFs:
-
- Pass-through Status: Category I and Category II AIFs that are registered with the Securities and Exchange Board of India (SEBI) enjoy a pass-through status for income tax purposes. This means that any income (other than business income) earned by the AIF is exempt from tax at the AIF level.
- Taxation at Investor Level: Instead of being taxed at the AIF level, the income earned by Category I and Category II AIFs is directly taxable in the hands of the investors of the AIF under Section 115UB of the Income Tax Act. Investors are liable to pay tax on their share of income in the same manner as if they had made the investments directly.
- No Dividend Distribution Tax (DDT): Category I and Category II AIFs are not liable to pay Dividend Distribution Tax (DDT) under Section 115-O of the Act on any income distributed to investors.
- TDS by Investment Fund: The AIF is required to deduct Tax Deducted at Source (TDS) at a rate of 10% under Section 194LBB of the Act on any income distributed to investors, except for business income.
- Treatment of Losses: In case there is a loss at the AIF level, such losses are not passed through to the investors. Instead, they are carried forward at the AIF level to be set off against future income in accordance with the provisions of the Income Tax Act.
- Filing of Tax Return: Investment funds that operate as Category I or Category II AIFs are required to file their tax returns under Section 139(4F) of the Income Tax Act.
ii. Taxation of Category III AIFs: Category III AIFs do not enjoy pass-through status for income tax purposes. This means that the income earned by Category III AIFs, particularly under the head “Profits or gains from business or profession,” is taxed at the investment fund level. The tax obligation does not pass through to unit holders.
Income earned by Category III AIFs is subject to tax at the fund level at the marginal rate of tax applicable to such income. The taxation is similar to the taxation of regular business income in India.
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Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement
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