 "AIFs seek tax passthrough to compete with emerging 'new asset class'")
Worried about competition from the ‘new asset class’, the alternative investment fund (AIF) industry plans to request the Ministry of Finance for passthrough status or parity on taxation.
At present, Category III AIFs — funds that invest in listed as well as unlisted companies, derivatives, and structured products — must pay tax at the fund level, leading to effective rates as high as 39 per cent for those in the high-income bracket.
On the other hand, mutual fund (MF) investments are taxed in the hands of the investor, giving them a competitive advantage.
The AIF industry is concerned that if the soon-to-be-rolled-out new asset class gets MF-like tax treatment, it will distort the competitive landscape for the Rs 5 trillion industry.
Industry players said they have had internal discussions and will soon make representations to both the Securities and Exchange Board of India and the finance ministry, seeking a more level playing field. The suggestions may be submitted before the next Union Budget, they added.
“Currently, AIFs pay 39 per cent tax on derivatives transactions, and this is payable annually. If a new asset class gets the same treatment as an MF — where the fund doesn’t pay tax, but the client pays on redemption — it will be a huge disadvantage to the AIF industry and could lead to substantial outflows,” said the head of equities alternatives business at a major AIF player.
“MF players do not have to pay tax on each churn or trade in the fund, which AIFs have to. Further, the MF manager is not liable to pay dividend tax. In AIFs, there is a tax on every transaction, such as short-term or long-term, and on dividends,” said Nimesh Mehta, director and head of sales and products at ASK Investment Managers.
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“Our request is to allow us the same flexibility as MFs, as it creates a big arbitrage and is detrimental to investor choices. It should be a level playing field,” he added.
Emailed queries sent to the industry association regarding the possible timeline for submissions remained unanswered until the time of going to press.
Termed ‘Investment Strategies’, the product design for the new asset class is in line with some Category III AIFs but comes with a low investment barrier of just Rs 10 lakh, as opposed to Rs 1 crore for AIFs.
“The potential new asset class in MFs investing in derivatives will likely follow MF taxation rules. This could attract investors by offering tax-efficient structures combined with derivatives exposure — a capability currently dominated by Category III AIFs,” said Punit Shah, partner at Dhruva Advisors.
The funds raised by AIFs had crossed Rs 5 trillion as of September, while Category III AIFs have invested over Rs 1.23 trillion. Category III AIFs have seen over a 50 per cent jump year-on-year in terms of investments and fundraises.
The total commitments by AIFs have crossed Rs 12 trillion.
“According to Indian tax laws, Category III AIFs are taxed at the fund level and must discharge taxes every year as they earn income. Hence, the periodic tax payments by such funds negatively impact the return on investments of the funds,” said Riaz Thingna, partner at Grant Thornton Bharat.
Thingna added that if the new asset class is accorded a tax regime similar to that for equity-oriented MFs, the tax for Category III AIFs may be relatively higher, placing them at a disadvantage.
Bridging the arbitrage
- AIF players say current tax regime disadvantageous to compete with the product class in MF- New asset class to have similar investment strategies as category III AIFs but lower minimum investment
- Firming up final suggestions with the industry players to submit to the government
- Tax levied at fund level in AIFs while MF returns taxed in the hands of the investors
- Higher outgo as tax paid with each transaction, dividend in AIFs