Key tax proposal - Certain reliefs for category I & II AIFs
There were some recent reforms to the tax pass-through regime applicable to Category I and II Alternative Investment Funds (“AIFs”), which are as follows:
permitting the set-off of unabsorbed losses (other than business losses) of such AIFs, in the hands of the AIF’s investors who have held the units of the AIF for at least 12 months; and clarifying that the income arising to non-resident investors of such AIFs, derived from their overseas portfolio investments, are not subject to tax in India. It is also clarified that the losses arising from investments in overseas portfolio investments, corresponding to the non-resident investors of such AIFs, cannot be set off against the income of the AIF.
Author: Kulin Dave, Associate at King Stubb & Kasiva Advocates & Attorneys.
Currently, the domestic funds registered with the Securities and Exchange Board of India (“SEBI”) as Category I or Category II AIFs are eligible for the tax pass through regime under Section 115UB of the Income Tax Act, 1961 (“ITA”).
Accordingly, the income arising to investors of AIFs from their investments in such AIFs, other than income from business or profession, is deemed to be arising to their investors, as if the investments made by the AIF were held by the investors directly.
However, the said ‘tax pass through’ regime for AIFs had certain oddities associated with it when compared to the tax pass-through treatment accorded to funds globally. The ITA does not permit investors of an AIF to carry forward or set off the unabsorbed losses arising to the AIF against their individual income. Separately, in respect of the non-resident investors of AIFs, since the investors would typically receive income as distributions from or against redemption of their interest in, the Fund; there was a lack of clarity as to whether the income of an AIF’s non-resident investors from overseas portfolio investments of the AIF could be taxed in India.
The Finance Bill, 2019, which has been introduced before the Parliament as a part of the Union Budget, proposes to amend Section 115UB of the ITA such that the unabsorbed losses of Category I and II AIFs (other than business losses), may be set off by the AIF’s investors against their own income, provided that they hold the units of the AIF for at least 12 months. Further, as per Finance Bill proposal, unabsorbed losses arising to Category I and Category II AIFs, not being business losses, as on 31 March, 2019, will be deemed to be the losses of investors who hold units of such AIFs as on the said date and will be allowed to be carried forward and set off by the investors as per the provisions of the ITA.
The Central Board of Direct Taxes has vide a recent Circular clarified that any income earned by non-resident investors of Category I and Category II AIFs registered with SEBI, from overseas investments of such AIFs, is at par with the income of such non-resident investors from direct investments made outside India; and thus not liable to taxation in India. The Circular further clarifies that losses arising to non-resident investors of Category I and Category II AIFs, from the offshore investments of the AIFs, will not be allowed to be set-off or carried forward and set-off, against the income of such AIFs. Notably, this clarification applies to Category I and Category II AIFs which enjoy a tax pass-through status under the India tax laws in respect of income, other than business income.
The clarification comes in the backdrop of Section 5(2) of the ITA, which provides that any income of a person who is a non-resident investor is liable to be taxed in India, if it is received or is deemed to be received in India in such year by or on behalf of such person, or accrues or arises or is deemed to accrue or arise to him in India. Since the investors of an AIF receive distributions and income from the AIF situated in India, it could be argued that such income is taxable in India as income received, accrued, or accruing in India. However, the Circular clarifies that the income arising to non-resident investors from overseas investments of Category I and II AIF is at par with the income earned by such non-residents from their direct investments outside India, and hence not liable to be taxed in India.
 CBDT Circular No 14/2019 dated 3 July 2019.