Lower taxes may help home-grown hedge funds attract corporate money

An additional layer of taxes has been removed for companies opting to come under the new corporation regime

The recent cut in corporation tax rates could help open a door to more capital for the beleaguered domestic hedge fund industry.

Companies under the minimum alternate tax (MAT) regime earlier had to pay a tax on gains on investments in such hedge funds. Those shifting to the lower non-MAT regime would no longer have to pay this additional tax on gains through investment in such funds, potentially making it a more attractive route for corporate capital, according to experts.

“The new tax regime has removed the MAT hurdle for companies that would have invested in category-III AIFs (alternative investment funds). Such funds could now attract some corporate money which they had not been able to earlier," said Umang Papneja, senior managing partner, IIFL Wealth Management

Hedge funds look to make returns irrespective of market direction. They make use of derivatives and sophisticated strategies, which allow them to benefit from falling stock prices as well as position themselves to profit when markets rise. Such funds come under category-III AIFs.

Companies which were taxable under MAT earlier had to also pay MAT on any gains through investment in category-III AIFs even if the AIF had already paid capital gains tax but did not pay the MAT. For such companies which opt for the lower non-MAT tax regime now, it would also mean that they wouldn't have to pay this additional MAT after the AIF has paid capital gains taxes.

"To that extent the new regime makes it easier for AIFs and its corporate clients," said Rajesh H Gandhi, partner, Deloitte India.

Finance Minister Nirmala Sitharaman reduced corporation tax for companies with effect from October 1. New domestic manufacturing companies face taxation at the rate of 17.16 per cent. This includes a base rate of 15 per cent with an additional surcharge and cess.

Category-III AIFs have faced headwinds since the Budget. This is because a surcharge was raised, meaning any domestic fund with exposure to derivatives in their funds would face a tax rate of up to 42.7 per cent. A similar tax rate for foreign portfolio investors (FPIs) was rolled back after the Budget.

FPIs had been net sellers to the tune of over Rs 30,000 crore following the announcement of higher taxes in the Budget.

“In order to stabilise the flow of funds into the capital market, it is provided that enhanced surcharge introduced by the Finance (No 2) Act, 2019 shall not apply on capital gains arising on sale of equity share in a company or a unit of an equity-oriented fund or a unit of a business trust liable for securities transaction tax...,” said a government statement exempting surcharge on capital gains on sale of shares.

Foreign investors’ derivative exposure also got an exemption.

“The enhanced surcharge shall also not apply to capital gains arising on sale of any security including derivatives, in the hands of FPIs,” it said.

Category-III AIFs have total investments of Rs 33,208.4 crore, according to June data from the Securities and Exchange Board of India.