Although the category is the second largest under the categories for alternative investment fund (AIF), with £1.29 trillion on so far collected investor funds, the tax rules are not clear.
“In contrast to other investment products, which clearly fall under a certain tax regime, the III AIF category does not yet have a well -defined tax framework. These AIFs are usually set up as trusts and are therefore taxed under trust rules,” explained Tushar Sachade, partner at Waterhouse & Co. Price. Llp.
Here is a look at some of these tax issues and problems that already influence the declarations of investors after taxes due to the lack of a tax regime at investor level.
No transit status
Category III AIFs do not have transit status, which means that all taxes are levied at the long -term level instead of at investor level.
As mentioned earlier, category III AIFs have been set up as trusts. That is why the different rules that regulate the tax treatment of trusts also apply to category III AIFs. There is also some blurness, in which the court is stated that these AIFs can be treated as ‘determining’ trusts. At the same time, the strict interpretation of tax rules implies that the open structure of category III AIF is ‘indefinite’.
More about that later.
Returning to the lack of transit status, why is this a problem for investors?
The investor may not always benefit from the long -term tax rate on power gains (12.5% on listed shares) despite the fact that the fund is held for more than one year, which is the threshold period to be eligible for long -term profit. Simply because the investor’s own retention period does not matter due to the lack of pass through, but the detention period of the fund is the decisive factor.
For example, if the fund buys and sells a share within a year, profit of the shares will be taxed at a tax rate of 20% short -term capital wins (STCG). This will affect the NAV of the Fund (net asset value) and thus the exposure of investors. An investor who holds the fund for more than a year will also be influenced by the same STCG rate.
Similarly, any profit from the derivative strategies are dealt with as business income, and the fund is taxed at the maximum marginal rate of 39%. It is possible that the investor’s own plate rate is lower, but because the fund will be taxed at the maximum marginal rate, the investor will be taxed as standard at the same rate.
The investor cannot benefit from the lighting or wearing losses. “Because the losses are booked at the long -term level, the capital losses (if present) are not available to the investor,” be Nalin Moniz, Chief Executive Officer at IONIC Asset Management.
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Likewise, capital losses on other investments are not available for deposition against the profit on category III AIF investments.
With other investments, an investor can book capital losses and use these to remedy profits from other investments – shares, real estate, bonds, etc. – and then pay taxes on the net power profits after this deduction. The losses of non -ignored – if capital loss is more than capital gain – can be transferred during eight following financial years; After the year in which the capital loss is originally made.
Trust
The problem is not so much that the AIFs are set up as trusts for operational convenience, but the lack of clear tax rules for category III AIFs.
“Mutual Funds (MFS) are also set up as trusts, but they have a well-defined tax framework, wherein no taxes are payable by the mutual fund on the transfer of underlying securities (as the income is mf housses exte … The time of transfer of MF units, Depding Upon the Holding Period of the Said Units by Each Investor, “Pointed Out Riaz Thingna, partner at Grant Thornton Bharat LLP.
“The first level of uncertainty stems from the question of whether an open category III AIF should be considered as a certain or indefinite trust. According to the legal definition of certain trust, the trust is determined whether the beneficiaries are mentioned in the trust deed, and the share of the beneficiaries is also prescribed in the trust department placed in the formation of the formation,” pointing to the formation of the formation, “pointing to the formation of the formation.”
However, the statements from the past have stated that a trust can be considered, as long as the beneficiary and their percentage share can be identified at any time. Advance Authority of Rulings (AAR) made this observation in 1996.
The Central Board of Direct Taxes (CBDT) published a circular in 2014, thereby restoring the original definition of ‘decisive’ trust. However, the statement of Karnataka High Court in 2017 was again the position of Aar. More recently, Madras High Court had the same position in an order that was published in 2020.
AIF’s rely on these statements from the past and the industrial practice AIF regards as a certain trust.
The certain rules of trust state that it should be taxed at the same rate if the beneficiary would be taxed on their income. So if the income is in the power gain, the tax rates of the power gain apply. The only condition is that if the fund has business income, ie income from the derivatives strategy, the maximum marginal tax rate of 39% applies.
For ‘indefinite’ trusts, all income categories are taxed at the maximum marginal tax rate of 39%.
“There is also a risk of double taxation, since the units are now classified as separate ‘security’ under Scra – Securities Contracts Regulation Act,” Sachade said. The Finance Bill 2021 included AIF units as ‘effects’.
This has therefore created another gray area about whether an investor can be taxed on power gain on reducing units after the fund is already taxed on power gains on underlying effects.
The industry is looking for clarity
“As an industry, we have bone seeking clarity on these things – Clarity on Considering Cat III AIFS AS ‘DETERMINATE’ Trusts, Once It is ‘determine’ clarity on maximum marginal rate and special rates. It should also be the taxed that leg Level, “Said Rahul Shah, Executive Vice President of the Industry Body – Indian Venture and Alternate Capital Association (IVCA). Special rates refer to the tax rates for capital gain-the tax rate in the short term capital gain of 20% and a long-term capital gain tax rate of 12.5%.
“We also went looking for pass-throughstatus, so that taxes are at the investor level,” he added.
“To repeat, the industry is not looking for tax concessions; it requires clarity and the right amount of taxes that are recovered from the right beneficiaries,” Sachade said.
Industry participants are of the opinion that the legal security will stimulate the next growth phase of the industry. “Clarity about the various tax issues and more regulatory certainty will also encourage more innovation in the AIF category, attract global investors and lead to more job creation and development for industry,” said Vaibhav Sanghavi, Chief Executive Officer of Ask Hede Solutions.
Important collection restaurants
- Although they were founded in 2012 and managing important investor funds, category III AIFs work without a dedicated, well -defined tax regime, in contrast to other investment products such as investment funds.
- Taxes are levied at the long -term level instead of the level of investors.
- Tax at fund level means that investors may not benefit from lower long-term capital profit rates, even if they possess the long-term fund, derivatives income is taxed at a maximum margin rate within the fund and investors cannot use losses that are generated by their other capital winsts within the fund.
- Clarity needed when treating these AIFs as ‘determining’ trusts.
