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Alternative Investment Funds (AIF) Overview

Alternative Investment Funds (AIF’s) are investment funds that are targeted at more sophisticated & wealthy investors (require a minimum investment of Rs. 1 cr). These funds offer wealthy investors an ability to invest their money in more sophisticated investment products, whose risk-reward can differ materially from traditional mutual funds. 

AIF’s are broadly categorized into 3 different types

Cat 1 AIF

  • Invest in early-stage ventures, start-ups, social ventures, SMEs, infrastructure and other sectors considered by the government as socially desirable
  • Typical Funds: SME Funds, Venture Capital Funds, Infrastructure Funds, Social Venture

Cat 2 AIF

  • AIF’s that do not fall under Cat 1 or 3
  • Typical funds: Real Estate, Private Equity, Debt Funds

Cat 3 AIF

  • AIF’s that employ complex or diverse trading strategies, employ leverage, invest in derivatives or listed equities
  • Typical funds: Listed Equities, Long-short, 
  • Can be both close-ended or open-ended

Suitability of AIF's for Investors

AIF’s are more complex investment vehicles, and the suitability of an AIF for an investor is highly dependent on the type of AIF and the unique requirements of the individual investor. 

We provide below some of the main pros & cons of different types of some of the major AIF fund categories:

Start-up Funds (Angle/Venture)

Private Equity (Traditional PE/Late-Stage/Pre-IPO)

Real Estate Equity Funds

Debt AIF's

Long-Short AIF's

Listed Equity AIF's

AIF Taxation

Cat 1 & 2 AIF

  • Non-business income: pass-through status. Non-business income is taxed in the hands of the investor, as if this investments had been made directly by the investor. 
  • Business Income: Taxed at the AIF level, based on the structure of the AIF (25% company, 30% LLP, maximum marginal rate or 41.1% in case of a trust)

Cat 3 AIF

  • Taxed at the fund Level
  • Taxation depends on the type of income & the structure of the AIF.
  • Taxation based on type of Income
    • ST Capital Gains (Equity): 15%
    • LT Capital Gains (Equity): 10%
    • LT Capital Gain (Non-Equity): 20% with indexation benefits
    • Business Income/Dividends/non-Equity ST gains: based on AIF structure. 25% company, 30% LLP, 41.1% Trust

Note

  • Tax rates indicated are pre-cess and based on FY21 Budget
  • Nuances & complexities in Cat-3 Taxation
    • Nature of Investments: investments have to be categorised as held for trading or investments. Gains arising from the trading book are considered as business income (and not capital gains)
    • Trust Structure: If the fund is structured as an indeterminate/discretionary trust, fund pay tax based on MMT (41.1%). If the fund is structured as a determinate/specific trust, fund pays tax at the rate applicable to each beneficiary based on his share of income. 
    • Applicability of MMT on Capital Gains: An income tax circular has clarified that gains from investments held in the investment book are subject to Capital Gains tax (and not MMT). While this has been clarified, there is still some gray areas around the risk of a tax-official insisting on applicability of MMT (based on the general tax treatment of indeterminate trusts). 

AIF FAQ's

An AIF can be structured as either a private limited company, an LLP or a trust. 

An AIF is established by a Sponsor, who is mandated to maintain a certain continuing interest in the AIF in the form of the sponsors contribution. The sponsors contribution is the lower of 2.5% of AUM or Rs. 5 cr (Cat 1 & 2) or 5% of AUM or Rs. 10 cr (Cat 3). 

The typical minimum investment required for an AIF is Rs. 1 cr. There are however certain exceptions to this minimum for Accredited Investors, Directors/Employees/FM of AIF (25 lakhs) and Angel Investors (25 lakhs). 

AIF’s are open for investments for Resident Indians, NRI’s and foreign nationals as well. 

Joint investments in AIF’s are allowed, but subject to certain specific criteria:

  • Only 2 joint investors allowed (not more than 2)
  • Joint investors have to be from the immediate family (the investor’s spouse, parents or children)