Alternate Investment Funds (AIFs)
An increase in the number of high net-worth individuals (HNIs) in India has led to enhancement of their willingness to grow and diversify their wealth by opting for certain personalised solutions, thereby making AIFs a preferred choice for many wealthy individuals. AIFs being a class product, it is essential to streamline the tax implications of investments in the AIF and consider the challenges that need to be resolved for AIFs in the upcoming Budget.
In the Finance Act, 2015, a special tax regime was introduced where pass-through status was granted to Category I and Category II AIFs. This resulted in the shifting of the payment of tax obligation on the income earned by AIFs (apart from business income) into the hands of the investors of the AIF. Consequently, the investors of AIFs are required to pay tax on the income received from AIFs as if the investors had earned the income directly by investing in the investee company.
Despite continuous discussions, such a pass-through status has not been extended to Category III AIFs under the income tax laws, resulting in disparity with the income earned by Category III AIFs that are subject to taxation at the fund level. Further, taxation of Category III AIF is dependent on the structure and incorporation status of AIFs, i.e. whether it is a Limited Liability Partnership (‘LLP’), a trust or a company having different tax treatment.
To give impetus to the International Financial Service Centre (‘IFSC’), pass-through status has already been granted to Category III AIFs incorporated in IFSC. It is important to bring tax parity among all the categories of AIFs. This extension will also enable aligning the tax treatment for the investors of Category III AIF with Category I and Category II AIFs since at the fund level, entire income is charged at the highest applicable rate of surcharge while different surcharge rates may be applicable to each investors if pass-through status is granted.
IFSC:
The Vibrant Gujarat Summit 2024 witnessed a remarkable success where a memorandum of understanding for 41,299 projects worth have been signed. Currently, a tax holiday of 100% on profits for a period of 10 out of 15 years is provided beginning from the year of operation of the IFSC unit. Though profits of IFSC units are eligible for 100% tax exemption for 10 out of 15 years, there has been no corresponding relaxation in the applicability of withholding tax provisions on the payments made to the IFSC-GIFT Units. Therefore, deduction of taxes at source on such exempt income puts forth a challenge for IFSC units in the GIFT city as this impacts cash flow and creates constraints on disposable working capital. To mitigate this dis-advantage, the IFSC units are required to make an application for a Nil withholding certificate to their respective Assessing Officer under section 197 of the Income-tax Act, 1961 (‘the Act’). This enhances the burden of compliance for the IFSC units and the income tax authorities. If application for aNil withholding certificate is not filed by the units, they have to claim refund of such withholding tax while filing of annual return of income which is again a time consuming and tedious task.
Today when different organisations are setting up their units in IFSC, there is a need to introduce a tax reform where any payment made to an IFSC unit in the GIFT city, whether by a resident or a non-resident, should not be subjected to withholding tax, where already the IFSC unit is claiming tax holiday. Such exemption can be granted by filing a declaration by the IFSC unit undertaking. This reform will assist in increasing liquidity while reducing compliance burden on IFSC units.
Such reform has already been introduced where payments are made in the nature of lease rent or supplemental lease rent, made by a person (lessee) to a unit of an IFSC (lessor) for lease of a ship. In such a case, no deduction of tax shall be made under section 194-I [relating to TDS on rent] of the Act. This can also be extended to other sectors on progressive basis.
Mutual Funds:
The mutual Fund industry is growing at a rapid pace. Unified Payments Interface (UPI) has enabled retail investors to invest in the stock market. Thus, this is an apt time for the government to bring in tax benefits that will further fuel the investments in the mutual funds.
One of the long-awaited suggestions in the Mutual Funds sector is introducing Debt Linked Saving Scheme (DLSS) on the lines of Equity Linked Saving Scheme (ELSS). This measure will help to channelise the long-term savings of retail investors into premium quality debt instruments with tax benefits. This will assist in deepening the Indian Bond market. Also, it will bring debt-oriented mutual funds at par with tax-saving bank fixed deposits that are eligible for tax deduction under section 80C of the Act. Mutual fund schemes investing in ‘specified infrastructure sub-sector’ as notified by the Central Government should be included in the specified long-term assets list under section 54EC of the Act.
Conclusion:
As we look back to 2023, the country has achieved several positive milestones and is on path to become the third largest economy in the next few years. For continuing the pace of the growth trajectory, it is essential to take the steps that will enhance the faith of foreign as well as Indian retail investors. Though the budget to be announced on February 1, 2024, will be an interim/vote on account Budget where the announcements on major tax changes will be restricted and more focus will be on fiscal numbers, the Budget recommendations can be prioritised in July, when a full-fledged Budget will be announced by the newly elected government.
(Manoj Purohit is Partner & Leader – Financial Services, Tax & Regulatory Services, BDO India. Views are own)
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