Guide to Investment Funds in IFSC | Overview of Tax Regime
- Blog|Company Law|
- 6 Min Read
- By Taxmann
- |
- Last Updated on 30 January, 2024
Latest from Taxmann
Table of Contents
- Introduction to IFSC
- Snapshot of the New Fund Regime in IFSC
- Fund Management Entity
- Taxation of Category I and II AIFs and Investors
- Category III AIF | Tax Nuance
- Relocation of Offshore Fund to IFSC
- Offshore Fund vs IFSC Fund
- Family Investment Fund
1. Introduction to IFSC
- GIFT City special economic zone is India’s maiden International Financial Services Centre (IFSC) introduced to act as a global financial hub
- IFSC caters to a wide plethora of financial services such as asset management, banking, insurance, capital market, etc. as well as family offices
- Deemed foreign territory for the purpose of foreign exchange laws in India. However, continues to be treated as Indian resident for the purposes of (Indian) Income Tax Act 1961
- Offshore Funds – both global and/or India centric pooling vehicles may be set up in IFSC. So far approx. 89 schemes have been launched in IFSC
- The new fund management regulations enables IFSC to compete well globally with other popular fund havens such as Cayman Islands, Mauritius, Luxembourg, Singapore etc
- IFSC’s competitive legal, regulatory and tax regime vis-à-vis other offshore financial services jurisdictions makes IFSC lucrative for domestic and Indian financial players
1.1 Gift City in the News!
2. Snapshot of the New Fund Regime in IFSC
- IFSC Funds are governed by IFSC Authority (Fund Management) Regulations, 2022 (FME Regulations)
- The FME Regulations have overhauled the previous fund regime in IFSC, which was based on the SEBI (Alternative Investment Funds) Regulations 2012
- FME Regulations seek to regulate the fund managers i.e., fund management entity (FME) while prescribing operating guidelines for the funds
- IFSCA has benchmarked the funds regime with the global best practices
- Consolidated registration and compliance requirements for FME while prescribing operating guidelines for funds/ancillary fund management activities
3. Fund Management Entity
3.1 Overview
- To engage in the fund management business, FME may seek registration under the following categories:
(a) Authorised FME: For investment in start-ups/early stage ventures through venture capital scheme
(b) Registered FME (Non-retail): To pool in funds from accredited investors, for investment in securities, financial products, undertake portfolio management service, private placement of REITs/InvITs, etc through restricted scheme.
(c) Registered FME (Retail): To pool in funds from all investors for investment in securities, financial products, etc. through retail or restricted scheme
- Venture capital scheme is filed as Category I AIF and Restricted scheme can be filed as Category I/II/III AIF depending on investment strategy. Retail schemes are not treated as AIF
- FME could be set up either as a company or an LLP or a branch thereof
3.2 Tax Considerations
|
Key parameters |
Company | LLP |
Branch |
| Corporate tax on management fee | Tax holiday for 10 years | ||
| Minimum Alternate Tax (MAT)/Alternative Minimum Tax (AMT) | MAT is payable at 9% unless it opts for concessional tax regime | AMT is applicable at 9% | Same as company/LLP |
| Distribution of profit by FME | Taxed as dividend in the hands of shareholders | Exempt from tax | Not taxable |
3.3 IFSC AIF | Classical Structure
4. Taxation of Category I and II AIFs and Investors
Pass Through Status and Levy of Tax
- Trusts, LLP and companies which are registered as a Category I or II AIF under FME Regulations are treated as ‘investment funds’ under Indian tax law
- Investment funds have been accorded partial tax pass through status – Investment income is taxable directly in the hands of investors on a pass through basis; Business income is taxable at AIF level
- Tax on investors is levied as if investment was made directly by such investors
- Characterization of income for the investor is same as that of AIF
- Obligation on AIF to withhold tax at (a) 10% for Indian resident investors; (b) applicable rate for non-resident investors
- Business income (if any): Taxable at ordinary rate for AIF (being a company/LLP) and maximum marginal rate for AIF being a trust; subject to tax holiday
- Business loss is carried forward at AIF level. Other losses allowed to be carried forward to investor holding units for at least 12 months
- Income on transfer of AIF units is taxable for investors at applicable capital gains tax rate
- Exemption for non-resident investors from obtaining Permanent Account Number and filing tax return (subject to certain conditions)
|
Income stream |
Indian resident investor |
Non-resident (NR) investor* |
| Dividend |
Ordinary rate (maximum 30%) |
20% |
| Interest |
Ordinary rate (maximum 30%) |
20% (on foreign currency debt) |
| Capital gain |
20% to 30% |
10% to 40% |
5. Category III AIF | Tax Nuance
| Parameter | Category III AIF
(determinate trust: Indian resident + NR Investors) |
Category III AIF
(All NR investors, except for units held by the sponsor/manager) |
| General tax regime | Income is taxed in the hands of the trustee as representative assessee of the investors | NR Investors are tax exempt whereas AIF is liable to pay tax on certain specified income discussed below |
| Income from India investments | Income attributable to NR Investors: Taxable at following rates (subject to tax treaty benefit)
|
1. Tax exemption for income arising on:
2. Interest and dividend is taxable @ 10%. Capital gain on equity shares is taxable at the rate ranging from 10% to 30% |
| Income from offshore investments | Income attributable to Indian resident investors:
Income attributable to NR Investors: Not taxable |
Exempt from tax |
| Transfer of AIF units | Taxable at the rates ranging from 10% to 40% | Exempt from tax |
| >Tax filings | No exemption | Exemption to NR Investors (subject to conditions) |
6. Relocation of Offshore Fund to IFSC
To encourage the Offshore Funds to shift their base to IFSC, the relocation has been made tax neutral subject to certain conditions:
- Offshore Fund should be tax resident of a country with which India has a tax treaty
- Activities of Offshore Fund should be subject to applicable investor protection regulations in the domicile country
- Relocation should be undertaken by 31 March 2025
- IFSC Fund to discharge consideration by issuing shares/units to the Offshore Fund or investors
Effect of Relocation
- Tax implications for income earned by the IFSC Fund – same as mentioned in the preceding slides
- Cost of acquisition and period of holding of the assets is continued
- Losses are allowed to be carried forward
- In case of IFSC Fund being Category I/II AIF, tax will be paid at respective investor level whereas for Category III AIF, tax will continue to be paid at Fund level
- Investors are exempt from obtaining PAN and filing tax return (subject to certain conditions)
7. Offshore Fund vs IFSC Fund
|
Key parameters |
Offshore Fund | IFSC Fund (Category I/II AIF) |
IFSC Fund (Category III AIF with only NR Investors) |
| Tax regime | Tax is paid at Fund level | Tax is paid at Investor level | Tax is paid at Fund level and Investors are tax exempt |
| Tax liability (subject to tax treaty benefit) | (a) Interest (on foreign currency debt) and dividend is taxable at 20%
(b) Capital gain is taxable at 10% to 40% |
Same as Offshore Fund | (a) Interest and dividend is taxable at 10%
(b) Capital gain (on shares of Indian company) is taxable at 10% to 30% (c) Capital gain on other assets is tax exempt |
| Tax credit (subject to domestic tax law) | Taxes paid by the Fund may not be creditable for Investors | Tax paid at Investor level and hence, credit should be allowed | Tax paid at Fund level and hence, may not be creditable for Investors |
| Distributions by Fund to NR Investors | (a) Dividend distribution: Not taxable
(b) Redemption: Taxable if Fund derives at least 50% value from India (subject to certain exceptions) |
Subject to withholding of tax payable by the Investors | Exempt from tax |
8. Family Investment Fund
8.1 Overview
- FIFs are self-managed pooling vehicles for the family and Indian entities wherein the family members hold substantial economic interest
- FIF may be set up either as a contributory trust or company or an LLP. In case of a trust, the beneficiaries and their respective beneficial interest must be fixed and identifiable at all times
- Capital can be pooled only from a single family (defined to include group of individuals who are the lineal descendants of a common ancestor and includes their spouses and entities owned and controlled by them)
- Exchange control regulations allows 50% of net worth of Indian entity to remit funds to GIFT City entity
- An FIF is required to maintain a minimum corpus of USD 10 Million within a period of 3 (three) years from date of registration as an FIF
- An FIF may borrow or engage in leveraging activities as per its defined risk management policy
8.2 Tax Considerations
|
Key parameters |
Trust | LLP |
Company |
| Tax regime | Trustee liable to tax as representative assessee of the beneficiaries | Tax payable at LLP. Distribution of profit is exempt from tax | Tax to be paid by Company as well as on subsequent distribution to shareholders |
| Capital gain | Taxable at 20% to 30% | Taxable at 20% to 30% | Taxable at 20% to 30% |
| Dividend and Interest Income | Taxable at maximum of 30% | Taxable at 30% | Taxable at 22% to 30% |
| Distribution of profit by FIF to beneficiaries/partners/shareholders | Not taxable | Not taxable | Dividend distribution is taxable at 30% in the hands of shareholders |
| Business Income | Tax holiday for 10 years. However, potential risk of other income being taxed at maximum marginal rate | Tax holiday for 10 years | Tax holiday for 10 years |
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