Changeability of Income Tax on Source of Incomes of Family Investment Funds (Company/LLP)
International Financial Services Centres Authority’s ‘IFSCA’ Fund Management Regulations govern the registration of polling vehicles such as Alternative Investment Funds ‘AIF’, Real Estate Investment Trusts, Infrastructure Investment Trusts, Family Investment Funds ‘FIF’. These Regulations seek to regulate the Fund Management Entity instead of the existing approach of regulating the Funds. IFSCA specifically permits family offices to pool money and set up a FIF in International Financial Services Centres ‘IFSC’ who can then invest globally. The regime works as good as any other offshore structure, while at the same time it is closer to the ground in India.
FIF in IFSC can be set up in the form of a company, Trust, LLP with prior permission under Part C of IFSCA (Fund Management) Regulations, 2022 which defines FIF as “a self-managed fund pooling money only from a single family and has been set up in terms of these regulations”. It will need to have a corpus of USD 10 million within 3 years from the date of its registration. Through the FIF, families will be able to invest broadly in unlisted and listed securities (in India, IFSC, globally). Initially, FIF had to pool money only from individual family members of a singly family.
IFSCA has recently clarified to permit pooling of money from entities such as sole proprietorship firm, partnership firm, company, LLP, trust or a body corporate, in which an individual or a group of individuals of a family exercise control and directly or indirectly hold substantial economic interest. This clarification may enable resident entities to invest up to 50% of their net worth into the FIF, subject to complying with other conditions. In any case, for resident individuals, the limit of USD 2,50,000 per year would apply.
It is imperative to note that the FIF set up in IFSC will be considered as an Indian resident for tax purposes and an overseas resident/ offshore unit from an exchange control perspective. Conceptually, any investments flowing from India into the FIF will be regulated by the exchange control norms and any onward investments by FIF will be regulated by the FME Regulations. FIF would be entitled to 100% income tax exemption for a period of ten consecutive years out of fifteen years [Section 80LA of Income Tax Act] coupled with exemption from GST however, FIF may be subject to MAT/ AMT as the case may be, and the same so paid should be available as credit in later years. MAT / AMT shall be at 9% of book profits applies to Company / others setup as a unit in IFSC. MAT not applicable to companies in IFSC opting for new tax regime. From 01 April 2020, dividend income distributed by Company in IFSC to be taxed in the hands of the shareholder.
Also, while using LRS for investing in FIF would attract TCS at 20% w.e.f. July 1, 2023 while TCS is not an additional cost as it will be adjusted against the final taxes, however, the same is bound to impact the cash flows.
Tax Framework (As per Indian Income Tax Act, 1961) for a FIF as either a Company or a LLP
|Section 10(38)||Provides exemption from long term capital gain on transfer of equity shares or units of equity-oriented funds or units of business trust on which securities transaction tax is paid. Proviso provides that where the transaction is undertaken on a stock exchange situated in IFSC, the LTCG shall be exempt even though the Subject to Tax is not Paid.|
|Section 47 (vii)(ab)||Any transfer of Capital Asset being, i) bond or Global Depository Receipt ii) rupee denominated bond of an Indian company iii) derivative made by a non-resident on a recognized stock exchange located in any International Financial Services Centre and where the consideration for such transaction is paid or payable in foreign currency is not considered as a transfer and hence not liable to Capital Gain Tax.|
|Section 80 LA||Deductions in respect of certain incomes of Offshore Banking Units and International Financial Services Centre:
The exemption shall be
i) 100% deduction for the first five consecutive years beginning from the year in which permission from the respective regulatory authority was obtained
ii) 50% deduction for the next five consecutive financial years.
Provided that for the assessment year commencing on or after the 1st day of April, 2023, the deduction under this clause shall be one hundred per cent of such income.
|Section 111A||Tax on short term capital gains in certain cases: Proviso to section 111A provides that the where the transaction is undertaken on a stock exchange situated in an IFSC, the STCG shall be taxable at the rate of 15% even though Subject to Tax is not paid. One additional condition is that the consideration for such transaction shall be paid or payable in foreign currency.|
|Section 112A||Tax on long term capital gains in certain cases: Where the transfer takes place through a recognized stock exchange located in the IFSC, the provisions of section 112A shall not apply.|
|Section 115-JB||For a Company located in IFSC, the provisions of section 115JB shall be as follows: where the TAX on the total income is less than 9% of the Book Profit (as computed in accordance with the provisions of section 115JB), then the Company shall instead of paying tax as per the normal provision, pay tax at 9% of the Book Profit. Thus, for a Company located in IFSC, the rate of MAT is 9% instead of 18.5%.|
|Section 115-JC||For an Assessee other than a Company located in IFSC: where the TAX on the total income is less than 9% of the Adjusted total Income (as computed in accordance with the provisions of section 115JC), then the Assessee shall instead of paying tax as per the normal provision, pay tax at 9% of the Adjusted Total Income. Thus, for a unit other than a Company located in IFSC, the rate of AMT is 9% instead of 18.5%.|
|Section 115-O||Tax on distributed profits of domestic Companies: Section 115-O talks about charging Dividend Distribution Tax (DDT). Under this section, where a Domestic Company declares, distributes or pays dividend, it shall be chargeable to DDT at the rate of 15% plus 12% surcharge plus 4% Health and Education Cess. The rate comes up to 17.472% in aggregate. This rate is applied on 85% of the dividend amount (gross up concept applicable). Hence the effective rate would be 17.472% divided by 85% which comes to 20.555% of the Dividend amount.
However, the provisions shall not be applicable to units located in the IFSC. Effectively, the units located in IFSC enjoy tax concession to the extent of 20.555% on dividends distributed, declared or paid.
Effects on Dividend Distribution
Dividend usually refers to the distribution of profits by a company to its shareholders. But Section 2(22) of the Income-tax Act includes :
(a) Distribution of accumulated profits to shareholders entailing release of the company’s assets;
(b) Distribution of debentures or deposit certificates to shareholders out of the accumulated profits of the company and issue of bonus shares to preference shareholders out of accumulated profits;
(c) Distribution made to shareholders of the company on its liquidation out of accumulated profits;
(d) Distribution to shareholders out of accumulated profits on the reduction of capital by the company; and
(e) Loan or advance made by a closely held company to its shareholder out of accumulated profits.
However, by virtue of Finance Act of 2020: if the dividend is distributed on or after 01-04-2020 the domestic companies shall not liable to pay Dividend Distribution Tax. Shareholders are liable to pay tax on such dividend income. But, in a Limited Liability Partnership as per Section 10(2A), the profits are distributed to partners under the head of profits which not be taxed at the LLP’s level rather than at the Partner’s level. The Circular 8/2014 has previously clarified that includes income which is exempt or deductible under various provisions of the Act. It is, therefore, further clarified that the scope of such aspect includes the income of a LLP to be taxed in the hands of the firm only and the same can under no circumstances be taxed in the hands of its partners. Accordingly, the entire profit credited to the partners’ accounts in the firm would be exempt from tax in the hands of such partners, even if the income chargeable to tax becomes NIL in the hands of the firm on account of any exemption or deduction. It is imperative to highlight that such notification of non-applicability of 8/2014 for IFSC has not been made.
Hence, it can be construed that its still applicable for FIFs in IFSC.