Budget 2020: Tax recommendations for AIFs
The much-awaited Union Budget 2020, to be presented by Finance Minister (FM) Smt. Nirmala Sitharaman, has caught everyone's attention. This comes in the backdrop of reduction in the corporate tax rates by the Finance Minister towards the end of 2019, in order to provide much needed stimulus to corporates for making investments into the Indian economy.
This announcement has now increased hope amongst the tax fraternity that the Government in its forthcoming Budget, may make certain announcements to address some of the other long pending direct tax issues which will boost the economy. The expectation is also supported by the fact that in August 2019, the Government received recommendations from the Direct Tax Task Force. The Task Force was constituted to provide suggestions and to address and update the six-decade old direct tax law in the country.
As per media reports, the Direct Tax Task Force had amongst various recommendations, made certain important suggestions in relation to the Alternate Investment Fund (AIF) industry. This is because of the increasing importance of the AIFs to the Indian economy as can be gauged by the increase in number of AIFs in the last few years.
Some of the key asks of the AIF industry which could be addressed in the forthcoming Budget, are as follows:
1. Pass through status to Category III AIFs
Currently, under the provision of the Income-tax Act, 1961 (the Act), a tax pass through status is granted to Category I and II AIF i.e. income earned by these AIFs shall be chargeable to tax directly in the hands of investors, except where the income of AIF is characterized as 'business income'. However, currently the income of Category III AIFs is taxed in the hands of the Trustee as a representative assessee.
In order to streamline the taxation mechanism for all the categories of AIFs, the Government should address this inconsistency by extending the tax pass-through status to Category III AIFs, as well.
2. Tax deduction with respect to exempt income earned and distributed by Category I/II AIFs
An AIF is required to withheld tax at the rate of 10% from any income (including exempt income, like dividend income) paid / credited by it to its resident investors. Similarly, for non-residents, the tax is required to be withheld at the rates in force.
Thus, for resident investors, tax withholding by AIF on exempt income leads to deferment of realisation of income as they will need to claim the tax withheld as refund in their income-tax return for that year. Also, the said withholding tax requirement on the exempt income relating to resident investors is not pari-passu with that for the non-resident investors.
Thus, in order to alleviate this genuine hardship faced by resident investors, the 2020 should address the aforesaid issue by amending the relevant section of the Act to remove withholding tax liability on payment of exempt income by AIFs to the resident investors.
3. Deduction of expenses passed on to investors
In the absence of clarity with respect to availability of deduction in relation to various expenses (including the management fees) incurred by AIF, diverse practices are followed by the investors / AIFs across the industry. Thus, the Union Budget 2020 should address the issue and clarify on the deductibility of expenses incurred by AIFs (Category I, II and III) to the investors / AIF, as the case may be.
CA Amit Kedia (with inputs from CA Raghav Aggarwal and CA Mansi Shah)