In the recent Union Budget 2019, finance minister announced multiple proposals related to the alternatives funds. Let us analyse their impact on the alternative space.
Category 1 and 2 AIF:
Key proposal: Allowing setting off against losses
Since Category I and Category II have pass through status, any gains are taxed in the hand of investors. However, setting off against the losses in AIFs Category I and II is not allowed. With this, investors will be able to set off their losses against the gains they made on such investments, which would decline their tax outgo.
The rules will be applicable provided:
They are not business losses
Units are held for more than 12 months (applicable after April 1, 2019)
Impact
Pankaj Murarka, CIO, Renaissance Investment Managers, said that AIFs are essentially pooled investments. The move will bring a degree of parity between AIFs and other investment options making them more attractive to investors, he feels.
Category 2 key proposal:
There will be no tax scrutiny in AIF category II. This means, the tax authority would not question the rationale for arriving at a particular valuation of security in which deal is done. Currently, AIF category 1 are also exempted from such a scrutiny.
Impact:
Pankaj believes that the move is positive as it will make the tax and operational compliance easier as start-ups will not need to obtain valuation report while issuing shares.
Category 3 key proposals
• 100% tax holiday to IFSC units for a period of 10 consecutive years out of 15 years from approval
• Capital gains arising on sale of specified securities traded on a recognized stock exchange located in IFSC by Category III AIFs shall be exempt from tax, subject to conditions
• DDT exemption on distribution made by a unit in IFSC from accumulated profits derived from operations in IFSC
• Increase in surcharge
Impact
Harsh Agarwal, Head - Alternative Strategies, Tata Asset Management believes that the proposals announced for category 3 AIF in IFSC are likely to be positive in long term as they allow both the investment management firm and the investors (monies raised from offshore clients) to avail taxation benefits.
Elaborating further, Agarwal said, “For AIFs and offshore investors to see full benefit of these announcements, the stock exchange located in IFSC will need to have higher liquidity, which is some time away. In near/medium term, we may not see any meaningful business (foreign inflows) coming from IFSC due to these measures. The benefits of 100% tax holiday for the AMCs established in IFSC though will act as an attraction for AMCs to establish their mutual fund business to attract foreign investors in their long only schemes.”
Talking about the increase in surcharge he said, "As most of the AIFs are constituted as Business Trusts, the higher surcharges (tax rate 42.74%) and MMR (maximum marginal rate) 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 shared their 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.”