Hidden Jewels & Comparables of the Indian AIF Regulations, Taxes and GIFT IFSC Ecosystem


The Indian Alternative Investment Fund (AIF) regulations were issued in 2012 by Securities and Exchange Board of India (SEBI) with major amendments in 2015 and the International Financial Services Centre (IFSC) versions of the 2012 and 2015 regulations were issued in 2018.

The regulation as one would expect met with a lot of criticism mainly for its rigidity. The law then was compared to the ones existing in Singapore, Hong Kong, Mauritius and Cayman Islands; with a large number of people commenting adversely about the Indian law. What was not realised is that the background situation in those countries were different when compared to this new law that was being used for regulation in India. To give the criticisers credit, there were some portions of the regulation that needed to reflect the state of the market which has been reasonably ironed out in subsequent regulation.

One thing is however clear that even though the investors are private and seek to invest into a private fund, for an orderly growth of the market and until the market becomes mature, there is a need for moderate regulation. In this background as one compares comparative regulations for the alternative fund industry globally ,it appears clearly that the alternative fund industry in India, has certain unique, comparable and forward looking features.

In this article, I shall try to dwell on these features with respect to India’s only IFSC now,The Gujarat International Fin-Tec (GIFT) city, the regulations and to an extent, the domestic AIF region.

  1. There is a customary practice that the sponsor and the manager need to be the same. The regulation per se does not mandate it to be so. The regulation provides an optional separation between these two participants. Structured correctly, this offers young, intelligent managers with skills and history to create a fund without necessarily having access to large amounts in their personal bank accounts. Thus merit is over money. One needs to read the definition of sponsor in clause (w) and clause (q) Sebi (Alternative Investment Fund) Regulations, 2012).
  2. The Indian regulations have been criticised for quite a bit on extensive disclosure requirements in the case of private alternative funds structured as private companies or limited liability partnerships. This criticism presents only one side of the story. Where a Trust is the common pooled vehicle, then there is no no need to disclose the names of the investors as the accounting standards do not require one to do so. I believe eventually the regulators, namely the Ministry of Corporate Affairs of the Indian Government, may exempt upon representation the need for investor reporting even for these two entities, if they are regulated by SEBI.
  3. Not many of us realise that private fund managers are not directly regulated in India so far. This cuts both ways. However, it allows a skilled fund manager to manage other people’s money without having to invest his own capital. The flip side is that every fund floated by the manager needs to be licensed. Here skills are more important than the capital or ease of administration.A via media could be to get the fund manager licensed eventually and remove the licensing requirements for the fund. Then not the common pool, but the manager becomes open to regulation.It is worth the debate. Both models are prevalent around the world. For example,Luxembourg, Singapore and Mauritius subject the manager to regulation while Cayman Islands regulates the fund. One solution could be fund level regulation at low levels of capital and manager level when there is a track record and and the volume of capital going up.
  4. Variable Capital Company (VCC) is an emerging trend in many parts of the world now. VCC helps in managing the cost of the fund by helping it to reuse a platform already created. Singapore is one of the latest domiciles to have approved this model. Such models have existed in Mauritius, Jersey and Cayman. It also exists in Luxembourg and is called co- domiciliation and executed through the Specialised Limited Partnership (ScSP), an equivalent of the Anglo Saxon LLP. It is not well known that Indian alternative fund and mutual fund regulations have always allowed this. In India, it is known popularly as the scheme. It is an entity that is similar to a subsidiary. Each scheme has it's independent set of investors. Each of these schemes are separately licensed under the alternative fund regulations. They need separate audit and financial reporting. Interestingly they have the same Permanent Account Number for or Tax Identification Number for Indian Income Tax purposes. This works well for Category 1 and Category 2 funds where there is a pass through. Unless the nature of gains versus the income is not disputed by the tax authorities, to my mind there is no taxation risk. The structure has been very well used by the retail mutual funds as well.
  5. 5. Alternative Investment Fund Managers Directive (AIFMD) is the European regulation that regulates private funds. A study of AIFMD reveals that the principal cornerstone of the legislation is as follows.
    • a. Authorisation of the fund manager
    • b. Defined oversight
    • c. Independent depository
    • d. Independent valuation of assets
    • e. Liquidity & Risk management procedures
    • f. Detailed investor disclosures
    • g. Passporting
    Based on the above framework, Indian AIF is comparable in regulation except that it is not mandatory to have independent valuation and does not have passporting at the moment. Thus more or less, we offer the same framework or flexibility.
  6. International investors and International investments: The Central Board of Direct Taxes (CBDT), in India,BDT issued a circular on July 3, 2019, which clarifies that investments made outside of India by non-resident investors using a Category 1 or Category 2 alternative investment fund domiciled in India, shall not attract any provisions of section 5 (2) of the income tax act in India. A provision under Chapter XII-FB, section 115 UB, which relates to pass through, in effect considers that the investments were made directly by the non-resident investors in an entity outside India. As this is popularized, one will note that India which is known for its availability of skilled resources and intellectual capability will be used as a pure third party service domicile while structuring funds. Not only is this cost, the ability to service with a large resource pool. Remember, this is a very unique preposition in the Indian context to global investors.
  7. IFSC Exchange Listed entities- Latest amendment: An additional feature of Capital Gains Exemption is available from April 1, 2020, as a result of amendment to Section 47 of Income Act 1961. One needs to read Section 47, Section 10(38)(4), 115U, and Section 112 (A3), of Income Tax Act together, for better clarity. In effect as a result of amendment to Section 47, transfer of units of a security listed in IFSC exchange is out of the definition of transfer. Not a transfer , means no capital gains under Section 45. However there are pass through benefits given to Category I and II funds under section 115U. There is a need for clarity, when the underlying investments are sold produce Capital Gain and pass through to the investors. Does Section 115U apply or does Sec 45 apply?
    This will have a major impact on structuring of funds both for inbound India AIF investing in India by listing it in INX Exchange or other IFSC Exchanges.It will provide GIFT IFSC and advantage over Alternative funds structured in Mauritius, Singapore, HongKong or Dubai investing into India and investors subscribing in Dollars.
  8. Segregated Nominee Account Services or SNAP: There is a provision under SEBI regulations which provides for non-resident investors to authorise a service provider like Stock Holding Corporation of India (SHCIL) to be their representative for tax purposes. This is based on the provisions of the income tax law which provides for a representative assessee. Currently this is allowed only for an investor who invests in public markets. This should be extended to non- resident investors in AIF category 1 and category 2. Further it is now accepted that non-resident investors need only to procure a Permanent Account Number (PAN) or tax identification number. No returns need to be filed. Things may even be better if a provision through an investors identification number could be issued by National Securities Depository Limited (NSDL) at the time of the KYC of the Investor. Such identification numbers may then be shared between the regulators,without necessarily having to register with every regulator. The number would work like a National Identity Number.
  9. There exists a limitation of benefits clause in the India Singapore DTA. The amount is SGD 200,000. This is an amount that needs to be spent to get tax residency and substance. However in GIFT IFSC India, this is not needed.
  10. Recently, The regulators have allowed IFSC Exchanges to offer listings of INR-USD. This is a major benefit to non resident managers and investors. They can now cover their portfolio to ensure protected return due to foreign exchange fluctuations on the India portfolios. It is estimated that India INX will be able to offer the Currency Pairs of INR-USD at reasonable costs of SGX and DGCX which is 65 cents and 50 cents respectively.
  11. India's only IFSC, GIFT, has a unique advantage not found in other domiciles. Any manager in GIFT can walk to invest, live, enjoy tax substance, work and play all within the 800 acre GIFT ecosystem which boasts of concealed underground wiring within the city, solar power generation, recycled grey water, residential complexes, top rated schools,universities and hospitals to be, hotels, shopping promenades, heliport, metro etc. Further ample pool of professionals and human resources are available at reasonable costs.
  12. Unlike other domiciles, in case of GIFT, the Government of Gujarat bears the cost of provident fund contribution of fund managers in GIFT for five years. Besides there are other incentives given by the Government of India and the Government of Gujarat which are detailed below:
    • a. Capex subsidy to the extent of 25% of capital costs for set up
    • b. Rental subsidy for five years through a partial credit
    • c.Subsidies on electricity for five years
    • d. Marketing subsidy for exhibitions of Rs. 200,000 twice in five years
    • e. Patent application subsidy of Rs. 200,000 once in five years
    • f. No stamp duty on trust deeds, rental agreements or lease agreements,subsidised by the Government of Gujarat
  13. Other Well known features of GIFT IFSC AIF
    • a. No Dividend distribution tax on dividends like other domiciles
    • b. Capital gains treatment for an unlisted fund is the same as per the DTAA with jurisdictions like Singapore and Mauritius in the hands of the investor based on DTAA, other than a Cat 3 fund, where it is on the fund. Of course this is different from Ireland, Luxembourg, UK, Singapore where these gains are exempt. This is applicable for all unlisted entities including unlisted AIF.
    • c. Exemptions from many clauses of Companies Act 2013
    • d. No GST on Management Fees. It is to be noted in GIFT, it is not charged
    • e. 15 % Minimum Alternate Tax (MAT;after the current ordinance) on the income of the AIF fund manager to be set off over the income to be paid in future. There is a 10 year tax holiday in a block of 15 years.This mainly benefits the AMC. This is not only lower than Singapore, but also is actually an advance to be set off. Further it is pretty close to Ireland 12.5% tax rate and much lower than the UK, France or USA for the management company.
    • f. Pass through status of category 1 and 2 funds

There are some comparable and unique features of the Indian alternative fund regulations. The government has done what it needs to do. It is up to practitioners and service providers to highlight these benefits.

I am happy to explain because through our global experience; we already have a comparative listing of benefits across domiciles Vs India’s only IFSC now GIFT. Clearly Indian IFSC for non resident investors, will turnout to be a winner as the years go by.

Jai Hind.