AIFs pin hopes on passthrough status for Category-III funds: IVCA

Industry body requests removal of 25 per cent limit for IFSC-based retail funds' investment in unlisted assets

The alternative investment funds (AIFs) have requested the regulators to allow a tax-pass through for category-III AIFs to ensure tax parity for investors, the Indian Venture and Alternate Capital Association (IVCA) said in a report on Thursday. 

Category-III funds include AIFs that employ complex trading strategies and may invest in listed and unlisted derivatives. These include hedge funds and private investment in public equity deals.

A pass-through status is given to avoid double taxation. An entity usually pays tax twice — one for the income generated by the firm's shareholders and another at a corporate level, which is corporation tax.

 

Under the pass-through status, the income generated is taxed in the hands of the investor, and the fund does not have to pay tax on the same.

The other categories of AIFs already enjoy this status. 

“This will align with global best practices where commingled funds have an EET (investors pay tax on distribution) or ETE (investors pay tax when fund earns income) regime, with taxation at the investor level,” IVCA said. 

The association has suggested the introduction of attribution rules to tax income attributable to non-resident investors at the fund level while limiting their participation to up to 10 per cent of the corpus at the same time to avail the pass-through status.

It has also suggested providing the pass-through to long-only funds. 

“This will promote growth of long-only funds and attract domestic institutional capital from insurance companies, pension funds, and banks into long short hedged strategies,” the report notes. 

According to the estimate of the AIF industry, category III AIFs are expected to grow to Rs 2.5 trillion commitments by 2028 with top players planning to cumulatively raise at least Rs 60,000 crore over the next two years.

As of March 2024, the commitments raised for category III AIFs stood at Rs 1.45 trillion. 

The industry association has also batted for the removal of 25 per cent limit for investment in unlisted securities for retail funds launched by registered fund management entities in GIFT-IFSC. 

“While these restrictions are intended to mitigate liquidity risk, they may also act as a roadblock, specifically in cases where IFSC funds are proposed to be set up as feeder funds for global funds. For greater flexibility and broader investment potential, the IFSCA should explore options such as removing this cap entirely or exempting investments in unlisted securities where the underlying asset is listed from the 25 per cent limit,” submitted IVCA. 

ICVA has also advocated for adopting the concept of passporting for funds. It allows fund managers to freely offer their financial products in other jurisdictions, facilitating cross-border marketing and distribution. 

The number of funds registered in Gift-IFSC has doubled in a year to 124 as of March 2024.