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Ease On Taxation Norms For Category – II AIFs To Encourage Funds For SMEs

AIFs have become an important cog in the wheels of Indian economy and its contribution will be critical for India’s growth story.

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Post the introduction of AIF Regulation in August 2012, the Alternative Investment Funds (AIFs) have grown significantly with FY-19 being the best year. The Capital commitment to AIFs in FY-19 was close to US$ 17 billion which is almost same as the capital committed in the previous three fiscal years. We are witnessing huge latent demand as well and the growth is expected to continue. AIFs have a been a success story and are fast becoming the preferred instrument to invest in private enterprises in India. 

The regulators and Indian government have done their part by gradually enhancing the ease of doing business for AIFs and bringing out tax reforms. It was necessary and critical for the industry as they were competing against overseas funds based out of tax havens, which could offer better post tax returns to investors.

The Indian government through a series of regulatory reforms have eased out the tax burden. The tax pass through status was given to category I and category II AIFs in the 2015 budget. This proved to be a critical reform for increasing the acceptability of AIF among investors. The holding period for unlisted shares to be considered under the more favourable long-term capital gains was decreased from three years to two years. 

Another major development, which increased the competitiveness of AIFs, was the renegotiation of Double Taxation Avoidance Agreements with Mauritius and Singapore. Under the previous regime, the companies based out of Mauritius were exempted from any capital gains tax on selling shares of Indian companies. But it has been plugged under the new treaty. The two-year transition period, during which the half rate applied has been over and from this fiscal year the full capital gain tax is going to be applicable.

The recent budget has provided further impetus to AIFs. The angel tax provisions were revised to exempt category II AIFs in addition to category I AIFs, which were exempted earlier. It’s a major relief, since majority of the AIFs come under the definition of category II. There was also a long-standing demand of the industry to extend the pass-through treatment to losses of AIFs as well. This has been met now, which gives investors the right to set off such losses against their income.

AIFs have come a long way in last 7 years. But there are still a few demands and clarifications which the industry expects the government to take up. The most critical one is to consider the cost of operating and managing AIFs while calculating capital gains for the investor since typically about 20% of the funds are not actually used for investment but for operating expenses.  Investors should be allowed to deduct these expenses from the capital gains.  

The government has been quite receptive to the demands of industry and we believe that this will continue to be the case going forward as well. AIFs have become an important cog in the wheels of Indian economy and its contribution will be critical for India’s growth story.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Mohit Ralhan

The author is Managing Partner & CIO – TIW Private Equity

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