Alternate funds’ woes to continue as CBDT turns down plea

Alternate Investment Funds (AIFs) have clearly failed to win the confidence of the income-tax authorities going by the latest CBDT circular on the matter.

The fund industry’s demand that an automatic tax pass-through be granted for all categories of AIFs at the fund level on registration with SEBI, while maintaining taxation at the investor level, has not been accepted. The latest CBDT circular, while not handing out a favourable tax treatment to the 100-odd SEBI registered AIFs (most set up as non-charitable trust), runs the risk of impacting investor interest in such investment vehicles in the coming days, say tax experts.

Some even argue that the AIF industry could have got a favourable tax treatment had SEBI put its weight behind AIFs and pushed for tax breaks, just as it recently did for real investment trusts (REITs).

The silver lining for the over a decade-old AIF industry — which had faced several tax uncertainty — is the fact that there is now clarity that the tax incidence will fall on the trustees as representative assesses, although at a maximum marginal rate of 30 per cent.

This, however, is a sore point for AIFs (other than VCF) having status of a non-charitable trust.

Even after the latest CBDT circular, a pass-through tax status will be available only for a small segment of the AIF industry.

Only those AIFs that are registered with SEBI under the venture capital fund (VCF) sub-category of Category 1 AIFs and those VCFs registered under the SEBI (VCF) regulations 1999 will be entitled for tax pass-through.

However, the much desired tax pass-through will not be available to other category I AIFs (small and medium enterprises, social venture funds and infrastructure funds), Category II AIFs and Category III AIFs.

Unless alternative forms of vehicles such as LLPs are encouraged, the immediate hesitancy in according favourable tax treatment to AIFs may act as a dampener in attracting savings to the financial sector, said Aseem Chawla, Partner, MPC Legal, a law firm.

Subramaniam Krishnan, Tax Partner, EY, said the circular could be prone to misuse.

There is a clear risk that the taxman — armed with this circular — regard AIFs as not being specific trusts and tax their incomes at maximum marginal rate (MMR), leading to avoidable litigation, he said.

Post this CBDT move, taxman can cite this circular to characterise the whole of AIF’s incomes as business income and tax them at MMR even in cases where there are gains from sale of shares, according to Krishnan.