Alternative investment funds explore conversion to LLPs over tax surcharge

Compliance burden may, however, make conversion difficult to execute

Sophisticated vehicles meant for the ultra-rich are facing issues with higher taxation, following changes in the Budget earlier this month. Alternative structures that are being explored could throw up challenges such as cumbersome compliance requirements, and disclosures, which may affect commercial confidentiality, say experts.
 
The increase in surcharge for earnings exceeding Rs 5 crore applies to trusts as well. Many alternative investment funds (AIFs) function as trusts. The new rules will, thus, require Category-III AIFs to pay up to 42.7 per cent of their income as tax, up from 35.9 per cent earlier.
 
An AIF is a pooled investment vehicle, targeted at the wealthy, and requires a minimum investment of Rs 1 crore.
 
Experts say that AIFs are now exploring the Limited Liability Partnership (LLP) structure. An LLP is a structure that combines the flexibility of a partnership and advantages of a limited liability company.
 
However, in the context of investment vehicles, they may come with their own set of complications, such as the need to make the entire list of investors public and fresh filings every time there is a change in the investor base.
 
Subramaniam Krishnan, Tax Partner (Private Equity & Financial Services), EY India, said implementation of the LLP option is challenging, especially for open-ended funds.
 
These will need to refile their partnership deeds every time there is a change in the partnership constitution — which could be investment or redemption — and get all partners (other investors) to sign off on the amended agreement.
 
Open-ended funds are estimated to account for at least half, if not more, of the assets under management for Category-III AIFs. There is also a confidentiality issue that comes into play given that the investor (admitted as partners) details are publicly available, which a fund manager may not be comfortable with.
 

“There is a confidentiality issue. Closed-ended funds may still consider it when they raise capital in one go rather than in stages since the investor base is typically locked-in, in such funds," he said. 
 
The LLP structure may also exclude certain kinds of investors. “There are restrictions on non-banking financial companies (NBFCs) investing in LLPs. This could create issues since many family offices (often large investors) have an NBFC structure,” said Tushar Sachade, Partner (Tax and Regulatory Services), at PwC.
 
FPIs face a similar issue as well. They are exploring coming in as corporate entities. However, domestic laws make it difficult for AIFs to structure themselves as firms. Compliance requirements are significantly higher, and the structure involves difficulties in executing routine activities such as returning capital to investors.
 
Category-III AIFs have already made investments worth Rs 30,802 crore as of March-end, according to data from the Securities and Exchange Board of India. The funds raised are Rs 36,866 crore, while they have total commitments of Rs 43,255 crore.