Background of Alternate Investment Fund (AIF):
Alternative Investment Fund or AIF means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.
AIF does not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities. Further, certain exemptions from registration are provided under the AIF Regulations to family trusts set up for the benefit of ‘relatives‘ as defined under Companies Act, 2013, employee welfare trusts or gratuity trusts set up for the benefit of employees, ‘holding companies‘ within the meaning of Section 4 of the Companies Act, 2013 etc. [Ref. Regulation 2(1)(b)].
Categories of AIF:
AIF are categorised into category I, II & III.
Category I AIF – 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 and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified. [Ref. Regulation 3(4)(a)]
Category II AIF – AIFs which do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012. [Ref. Regulation 3(4)(b)]. Various types of funds such as real estate funds, private equity funds (PE funds), funds for distressed assets, etc. are registered as Category II AIFs.
Category III AIF – AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. [Ref. Regulation 3(4)(c)] Various types of funds such as hedge funds, PIPE Funds, etc. are registered as Category III AIFs.
An AIF under the SEBI (Alternative Investment Funds) Regulations, 2012 can be established or incorporated in the form of a trust or a company or a limited liability partnership (LLP) or a body corporate. AIF formed as Company or LLP must comply with provisions of Companies Act, 2013 and Limited Liability Partnership Act, 2008 respectively.
Salient features of Category II AIF:
a. An investor and his / her spouse
b. an investor and his/her parent
c. an investor and his/her daughter/son
Pls note above listed are key features / aspects of AIF II. For detailed compliance and adherence refer Securities and Exchange Board (Alternative Investment Funds) Regulations, 2012.
Amendment in FDI policy amid COVID-19 in April 2020
Under the previous FDI policy, investment by non-resident was permitted under automatic route in specified sectors. But amid COVID-19 pandemic, in April 2020 the Government of India wide press note by Department for Promotion of Industry and Internal Trade, in order to avoid opportunistic takeovers of domestic entities, have introduced government approval route for any and all entities which are investing in India and whose beneficial interest is directly or indirectly held by any entity sharing land border with India. To reiterate, any entity which shares land order with India will be required to obtain government approval in case it plans to invest in India in any form. Countries sharing land border with India are China, Bangladesh, Pakistan, Bhutan, Nepal, Myanmar and Afghanistan.
It is worthwhile to note that government approval route shall now be mandatory for any transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in beneficial ownership falling within the restriction specified above (i.e. beneficial ownership being acquired by any entity sharing land border with India).
The intent of introducing government route is to avoid hostile takeovers of domestic entities. Further, other provisions regarding prohibition of FDI in specified sectors remain unchanged.
Taxation on AIF Category II in India:
1. Sec 115UB – Pass through treatment to AIF:
AIF II has been provided pass through status under the Income Tax Act. Under this, any income except business income earned by the AIF II shall be taxable in the hands of investor in the same manner and under the same head as it would have been if the income had been earned by the investor directly and not through AIF. This is to avoid dual taxation since, income has been earned by AIF on behalf of the investor. The investor shall be liable to discharge tax due even if the income has not been received but credited to the investor by AIF and the same income shall not be taxable on receipt.
With respect to the losses incurred by the AIF except in the nature of business loss, the same could be passed on to the investors for claiming set-off or carrying forward. To avail this benefit, investors must have held the units for minimum period of 12 months. Also, the units must be held by the AIF as on 31 March 2019. And the losses shall be carried forward and set-off from the year in which it was first incurred subject to the period of limitation.
2. Sec 56(2)(viib):
The section provides that where a Company not being a Company in which public is substantially interested receives any consideration for issue of shares from a resident which exceeds the FMV shall be liable to tax. The provision does not apply to consideration received towards issuance of shares from venture capital fund and persons as notified by central government. W.e.f. 1 April 2020, issuance by Category II AIF has been excluded from applicability of section 56(2)(viib).
3. Taxability of non-residents:
With respect to non-resident, any income received, arising, deemed to be received or arising to a non-resident in India shall be subject to tax in India.
In case I above, income earned by non-resident shall be taxable in India considering it has been accrued / arisen in India – source-based taxation under ITA. But with respect to case II, since AIF is only a medium / intermediary i.e. overseas funds have been invested overseas only, the income so derived / earned will not be taxable in India. It is worthwhile to note that any losses incurred from such investments shall not be allowed to be set-off or carry forward against the income.