AIF industry bats for tax parity with mutual funds
Industry players met finance ministry officials a few days AGO, lobbying for a pass-through status to losses incurred by alternative investment funds (AIFs), and and clarity on levy of the goods and services tax (GST) on management fees and expenses. They also want fees and expenses to be included in the AIF’s cost of investment, giving tax relief to investors.
The industry wants losses on investments to be available to investors for set-off, rather than letting it lapse. According to the Finance Act, 2015, unit holders cannot offset losses from the fund against other profits and gains.
For Category I and II AIFs, any loss at a fund level is not allowed to be passed through to the investors but would be carried over at the fund level to be set off against income of the next year. “This could lead to a potential anomaly of investors facing tax leakage for some deals that have seen profitable exits, despite the fund not performing well at an overall portfolio level,” said Richie Sancheti, partner — investment funds practice group, Nishith Desai Associates.
Lobby groups want fees and expenses to be included in the cost of investment of the AIF. In the case of Category III AIFs, the investors are generally taxed in the same manner as they would have been if they had directly made the underlying investments depending on the nature of AIF structure. So, typically investors don’t get the benefit of deduction for management fees paid by the AIF to the investment manager against the capital gains earned.
“In a mutual fund, the management fee is reduced from the net asset value (NAV), so the investor indirectly benefits because his capital gains are lower. A similar benefit is currently not available in an AIF because the fund will not be able to get a deduction for management fees when capital gains are calculated, and so will have to give the same treatment to the investor,” said Rajesh Gandhi, partner, Deloitte Haskins & Sells. The cost component in AIFs can be significant, as these funds typically deploy 15-20 per cent of capital towards management fees and other miscellaneous charges paid to service providers such as bankers, accountants and lawyers.
Industry players want clarity on GST on management fees and expenses to be borne by foreign investors of domestic AIFs.
AIFs that pool capital from overseas investors at an offshore location to invest in India do not pay GST. However, AIFs managed by India-domiciled asset managers are considered taxable for GST purposes, even if they pool the same overseas money. This effectively adds 18 per cent to the cost of management. “There is no ‘pass through’ for the GST, as is the case for direct taxes and this could discourage managers from setting up India-based funds. We could consider GST remission for approved funds (AIFs), as is in practice in some other countries such as Singapore,” said Sancheti.
The GST paid by an AIF on management fee is not available as an input tax credit because the AIF does not have any output GST liability. “This becomes a cost for investors because the AIF will normally recover the GST from the investors. The other issue is whether the GST applies on all components of revenue earned by a manager from the AIF,” said Gandhi.
The other longstanding demand is for Category III AIFs to get a passthrough status, similar to what the government had provided for Category I and Category II AIFs in 2015. No pass-through status means that income from such funds will be taxed at the fund level and the tax obligation will not pass through to the unit holders.
According to Securities and Exchange Board of India (Sebi) data, investment commitments of AIFs reached ~1.16 lakh crore as of September 2017, more than a fourfold jump from ~27,484 crore two years ago. The surge in assets is a function of the easing regulatory framework, options for customisation and robust returns.
Besides providing for a pass-through to Category I and II AIFs, the government has effected several other changes as well in the past three years. For instance, the holding period for availing of long-term capital gains in the investments made by AIFs in the unlisted space was reduced to two years from three years. The one-year lock-in period for AIFs after initial public offerings has been done away with.