Indian government’s decision to hike surcharge on income tax paid by super-rich individuals may put AIFs at a disadvantage.
In the Union Budget, the government has proposed higher taxes for individuals who earn more than Rs. 2 crore a year. For individuals with taxable income between Rs.2 crore and Rs.5 crore, the surcharge (charged on top of the applicable income tax rate) is proposed to increase from 15% to 25%. The government has proposed to increase surcharge on individuals with taxable income of over Rs.5 crore a year. With this, the effective tax rate for these two groups stand at 39% and 42.74%, respectively.
Tax experts believe that the proposed changes will not only apply to an individual but also HUFs, trusts and association of persons (AOPs). Since AIFs are trusts and its category III variant (which includes long only funds and long short funds) will have to pay tax at marginal rate i.e. 42.7% on gains made. Further, after an investor receives redemption proceeds, he will have to pay capital gains tax.
Kenneth Andrade, CIO, Old Bridge Capital Management said that the proposed changes would affect net return of investors. This may make this category a little uncompetitive from a tax point of view, he said.
Harsh Agarwal, Head – Alternative Strategies, Tata Asset Management said, “As most of the AIFs are constituted as business trusts, the higher surcharges and maximum marginal rate (MMR) will apply to a portion of their income streams. The income stream qualifying as LTCG will also attract a higher than earlier tax rate of tax 14.25%. Industry has raised these concerns with the government. It is possible that changes in the finance bill are made to exclude AIFs from these enhanced surcharges as they act as pooled investment vehicles.”
Since category I funds such as venture capital funds and infrastructure funds and category II funds like private equity, private debt, structured debt, pre-IPO focussed funds and so on have pass through status, the impact on investors of these categories is limited. However, investors in these categories will be allowed to set off their losses against the gains they made through investments.
Here are the possible impact of surcharge on AIFs across all categories
- Since AIFs investors are HNIs, inflows into such funds would be affected due to higher tax outgo.
- Investors investing in AIFs pay tax at a marginal rate on their return, which before Budget was already higher than LTCG or STCG tax applicable on stocks and mutual funds. Post the Union Budget 2019, the difference between LTCG/STCG and marginal rate has widened further. For an individual earning more than Rs.5 crore, the effective rate of LTCG and STCG will be 14.25% and 21.37%, respectively. Currently, such peak rates are 11.96% and 17.94%, respectively.
