Foreign investment in AIF, tax 'pass-through' to boost PE funds

Alternative Investment Funds are established or incorporated for pooling in capital from Indian investors

The announcement by Finance Minister Arun Jaitley to allow foreign investment in Alternative Investment Funds (AIFs), a category of pooled-in investment vehicles for real estate, private equity and hedge funds, is expected to give a boost for private equity industry in India.

Furthermore, Jaitley proposed to allow tax pass-through for alternate investment funds.

AIFs are basically funds established or incorporated in India for the purpose of pooling in capital from Indian investors. In presentation of Budget for 2015-16, FM has also said that the government would do away with different categories like Foreign Portfolio Investors (FPI) and Foreign Direct Investment (FDI) for such investments with a view to making it easier for overseas investors to invest in AIFs. 

Harish HV, Partner, Grant Thornton India LLP said, “This is a welcome budget for the PE industry as it addresses some of the key pain points of the industry which is the Permanent Establishment issue, the pass-through issue of AIFs and clubs FPI and FDI together in terms of terms of investment. Overall a positive budget for PEs. This together with the other measures which promise predictability and non-aggressive tax regime should see a significant growth in PE investments in India.”

A pass-through status allows the fund to pass on the tax liability to the end-investor. Currently, specific tax ‘pass through’ is applicable only to AIF Category I - VCF and erstwhile VCFs. Other AIFs are taxed as per trust taxation framework. 

About $80 billion plus investment was made in Indian companies by PE/VC over last 10 years.

Ajay Garg, managing director at investment banking firm Equirus Capital said, "Foreign investment in AIF Will help NRI and institution participation which constitutes a big segment of investors being targeted by the AIF. But the big challenge on tax treatment to avoid double taxation for investors in AIF hasn’t been addressed."

The clubbing of definition between FIIs, FDIs and FPIs is also welcome as reduce administrative aspect for investment into the country, Garg added.

Kalpana Jain, senior director, Deloitte India said, “The removal of distinction between FPI and FDI is welcome as it is not really possible to differentiate between the two and has been a pain point for investors. Also, we expect to see a stimulated environment of foreign investment and private equity interest in India given that foreign investment is proposed to be allowed in alternative investment funds.”

PE industry had demanded for encouraging insurance companies, EPFO, pension funds and charitable trusts to invest in Alternative Investment Funds (AIFs). In India, regulations governing pension funds and charitable trust do not permit investment in AIFs.

Zulfiqar Shivji, International Liaison Partner & Head of Transaction Advisory Services, BDO India LLP said, " These changes are expected to allow free flow of long term foreign capital into all categories of AIF without the need to seek specific approvals. This will definitely boost the global investors’ confidence, ease the procedural aspects and increase the pace of foreign capital in PE sector."

There are 200 plus active fund managers operate in India while 100 are domestic fund managers. The PE industry claims over 12% employment growth in PE/VC backed companies against 3% employment growth in non PE-backed companies.