AIFs explore limited liability partnerships to bypass high taxes

Dolat Capital has been the first off the block in setting up such a structure for its Category-III fund

Alternative investment funds (AIFs) may be looking to set up in the form of a limited liability partnership (LLP) instead of a trust structure, given the favourable tax treatment to the former.

The business income earned by the funds constituted as LLPs will be taxed at the fund level at applicable tax rates of 34.94 per cent, against 42.74 per cent that is otherwise applicable to a trust (taking into consideration the highest income bracket).

Further, any distributions made to the investors/partners out of the tax-paid income will be exempt in the hands of investors/partners.

Dolat Capital has been the first off the block in setting up an LLP structure for its Category III AIF, which recently received the nod from the Securities and Exchange Board of India.

The hedge fund will aim at generating consistent absolute returns while minimising capital risk, and use sub-strategies such as derivatives trading, options-based strategies, and cash calls.

Private equity firm Gaja Capital has filed for a Category II AIF Gaja Capital India Fund 2020, which has an LLP structure. This is yet to get the regulator’s nod.

“Globally, LLPs are the most suitable and preferable option for alternatives and hedge funds. This was not the case in India so far since the taxation for LLPs and trust structures were similar. More AIFs structured as LLPs may be launched in the future as they provide for a tax-efficient structure,” said Amit Saxena, director and head–AIFs, Dolat Capital.

The LLP structure comes with its own restrictions. These include curbs on non-banking financial companies investing in them. Other issues include confidentiality since the LLP structure requires investor details (once admitted as partners) to be made public.

The route was explored after the Union Budget sought to raise taxes on the wealthy. The Budget had raised the surcharge on those earning between Rs 2 crore and Rs 5 crore from 15 per cent to 25 per cent. It increased it for those earning over Rs 5 crore from 15 per cent to 37 per cent.

Category III AIFs saw their tax rate increase from 35.9 per cent to 42.7 per cent.

“An LLP structure is primarily aimed at achieving tax efficiencies. Right now, we have not yet decided on such a structure since there are operational issues and concerns around client confidentiality,” said Vaibhav Sanghavi, co-chief executive officer, Avendus Capital Public Markets Alternate Strategies LLP.

Category III AIFs have seen their investments rise by over 16x over the past five years to Rs 36,963 crore as of September 30. It makes them the fastest-growing of the three categories of AIFs.