As the pandemic hit, a huge section of the crowd progressed in their investing journey. Many people routed themselves towards private investment. In recent years AIFs have been one such investment that gained momentum. It helped in economic stability by providing new emerging entrepreneurs with the right financial support. Due to its large initial investment and divergence from traditional investment, investors investing in AIFs were rightly termed as “sophisticated investors” by SEBI.
An alternativeInvestment Fund is a privately pooled investment fund established or incorporated in India. It collects funds from foreign or Indian investors and invests by the investment policies that benefit the investors.
AIF can be invested in the form of
- Limited liability partnership
- Or a body corporate.
Who can make the Investments?
Investments can be made by any investor whether they are:
- Resident Indians
- Foreign Nationals
AIFs can be categorised as follows:
Venture Capital Funds
Social Venture Funds
|Private Equity Funds
Structured Credit Funds
Real Estate Funds
|Long only Funds
Long short Funds
Other funds with diverse and complex trading strategies.
|These AIFs invest in start-ups, SMEs, or socially and economically desirable areas.
|They do undertake leverage or borrowing.
Exists to meet day-to-day operational requirements permitted by SEBI
|They employ diverse or complex trading strategies and also include leverage.
Now, that we are well acquainted with the term AIF and its categories, we need to analyse how it affects a US resident and the various compliances that wheels in with it.
Investing in Indian AIFs parks money in offshore tax havens, which initially deferred tax liability in the U.S. To encourage investment in U.S based establishments rather than foreign establishments, the U.S IRS enacted the tax reform regime and insisted on additional reporting on all such Passive Foreign Investment Companies (PFIC). Being a private equity fund established in India, AIFs are one such PFIC.
In this article, we will try to structure the favourable tax position of a U.S resident investing in Indian AIF.
RESTRICTIONS AND GUIDELINES FOR US RESIDENT INVESTING IN AIFs
A US resident can invest in AIFs in India but must fulfil the following criteria
- A minimum corpus of 20 crore rupees is required.
- Minimum investment for an individual is 1 crore rupees except in the case of employees who are directors, employees and fund managers then the minimum value of investment shall be 25 lakh rupees.
- Each scheme must have a minimum of 1000 investors.
- Category I and II AIF can be close-ended with 3 years lock-in whereas, category III can be both open and close-ended.
- Previously, ID proof such as a PAN card was required to be obtained by foreign investors in Indian AIFs operating in International Finance Service Centre (IFSC), however, the same has been done away with, If TDS has been deducted from their income by the fund.
- Funds shall be collected and solicited only by way of private placements.
Other guidelines for investment for managers and sponsors
|Manager or sponsor
|Shall have interest in the continuing AIF
|-2.5% of corpus or
– 5 crore rupees
whichever is less.
|Manager or sponsor
|Shall disclose their AIF
|To the investors of AIF
INDIAN TAX IMPLICATIONS FOR A US RESIDENT INVESTING IN AIF
The Income-tax Act 1961 provides a pass-through tax regime in respect of income other than business income earned by category I and category II AIFs.
Under the said regime:
- Income of the AIFs is taxable in the hands of the investors in the same manner as if the income were accruing or arising to the investors, had the investments made by AIF been made directly by the investors.
- However, while distributing the said income to the non-resident investors, the AIF is required to withhold taxes applicable at a specific rate and remit the same to the government.
- Since the tax on the above-mentioned income has already been collected by the government on behalf of the non-resident investors, additional tax should not be paidconcerning the income distributed by such AIF.
A Category III AIF does not enjoy the pass-through regime provided to category I and II AIFs. Tax implications for category III are:
- The income of an AIF is taxable in the hands of the AIF itself and exempt in the hands of the investor u/s 10 (23FBC) of the Act.
- Category II AIF under ‘Specific funds’ are exempted under section 10 (4D) of the Act.
- No exemption is granted to non-resident investors of AIF under specific fund AIF from obtaining the PAN even though the income is exempted under section 10 (23FBC) of the Act.
- A non-resident being a foreign investor shall not be required to obtain PAN if he has made a transaction only in a capital asset referred to in section 47(viiab) which is listed on a recognized stock exchange located in any IFSC and the consideration is payable in foreign currency.
- Such foreign investors shall be exempted from filing Income Tax returns subject to the conditions.
To obtain the exemption mentioned above a non-resident must fulfil certain conditions:
- Such foreign investor (not a company) does not earn any income in India, other than the income from the transfer of a capital asset referred to in section 47(viiab) of the Act.
- Such non-resident should furnish the following details to the stock broker through which the transaction is made:
- Name, e-mail id, contact number
- Address in the country or specified territory outside India of which he is a resident
- A declaration that he is a resident of a country or specified territory outside India; and
- Tax identification number (TIN) of the investor’s residence country.
- If such TIN is not available the unique number based on which such non-resident is identified in his country.
U.S TAX COMPLIANCES AND REPORTING
AIFs differ from operational corporations in many aspects as they are both legal entities and financial products. Several global guidelines have been issued to monitor the funds. There are similar compliances to be considered by AIFs.
As per FATCA and CRS, every entity established as a private equity fund pool(AIF) must ascertain if it’s
-a financial institution
-or non-financial entity (NFE)
- If the above-mentioned establishment is a financial institution, it should be examined whether it is reporting financial institution or a non-reporting financial institution.
- If it’s a non-reporting financial institution, it does not require registering or reporting its financial accounts.
- If the establishment is a non-financial entity (NFE) then it needs to identify if such an institution is an active or passive NFE. Being a passive NFE details of the controlling person must be provided.
If the AIF is reporting financial institutions:
- It should register with US IRS and obtain a Global Intermediary Identification Number (GIIN).
- Must register with Indian Taxation Authorities as well for reporting.
- AIF must identify financial accounts that are reportable under CRS or FATCA.
- If AIF is a passive non-financial entity, it is required to identify the controlling persons and collect their information like tax residency and classification with TIN.
- FATCA/ CRS compliance is the utmost statutory compliance that must be duly complied with failing which attracts a penalty.
- Form 61B has been introduced as a reporting platform by CBDT for easier mechanisms.
Reporting such passive income from Indian AIF by US Citizen
US IRS defines PFIC as a non-US entity that earns
-75% or more of its gross income from non-business operational activities.
-or, if at least 50% of the assets are held for generating passive income.
Such income must be reported in the IRS form 8621 and newly introduced form 8938. as PCIF income which can be studied in detail here.
This article exhibits a broad paradigm setting the tone for AIF compliances for a US citizen which may factor out differently as per individual adjustments.
Investing in AIFs provides investors flexibility in terms of structure, sector, instruments etc which is otherwise not available in traditional investments like Mutual Funds. People within and outside India have been major contributors to infusing capital into various sectors of the economy.