Taxation
Tax obligations
Would a private equity fund vehicle formed in your jurisdiction be subject to taxation there with respect to its income or gains? Would the fund be required to withhold taxes with respect to distributions to investors? Describe what conditions, if any, apply to a private equity fund to qualify for applicable tax exemptions.
Indian tax law provides for a special tax regime with respect to Category I and Category II alternative investment funds (AIFs). Any income other than profits and gains from business or profession is exempt from tax in the hands of a Category I and Category II AIF but taxed in the hands of investors of Category I and Category II AIFs on a pass-through basis, as if such investments were directly made by the investors.
However, the income in the nature of profits and gains from business or profession is taxed in the hands of Category I and Category II AIFs and exempt from tax in the hands of investors.
There are comprehensive withholding tax provisions applicable with respect to certain specified payments to Indian tax residents and on all payments to non-residents. As per the specific provisions, income (other than profits and gains from business and profession) receivable by a Category I and II AIF is exempt from withholding of tax by the payor. On the distribution of income (other than profits and gains from business or profession) by Category I and II AIFs to the investors, Category I and II AIFs are required to withhold tax at 10 per cent in the case of Indian resident investors and at the rates in force for the non-resident investors.
In the case of a Category III AIF, the tax implications would differ depending on whether such AIF is in the form of a company or limited liability partnership (LLP) or a trust. In the case of a company, the income arising on investments will be taxed at the applicable corporate tax rate and subsequent distribution of profits as a dividend will be taxed in the hands of the shareholder (investors). The company would be required to withhold applicable taxes prior to the distribution of dividends. An LLP will be taxed on entire income at the applicable rate and any distribution to the partners (as a share of profit) is exempt from tax in the hands of LLP as well as the partners.
However, a Category III AIF is typically set up in the form of a trust with a share of each investor being defined under the investment documents. The income earned by a determinate trust could be taxed either in the hands of the trustee as a representative assessee of the investors or in the hands of the investors directly. Where the trustee is assessed as representative assessee of the investor, it should be taxed in the same manner as if the income was taxed directly in the hands of investors. There is though one exception to this principle: if the income includes profits and gains from business or profession, the entire income in respect of which the trustee is liable as representative assessee of the investor could be taxed at maximum marginal rate.
Further, there is a special tax regime with respect to a Category III AIF set up in the Gujarat International Finance Tec-City (GIFT City), the units of which are held by non-resident investors except for the sponsor and manager. Interest and dividend income earned by and in the hands of such AIF is taxed at 10 per cent. Capital gains on the sale of securities (other than shares held in an Indian company) are exempt from tax. The non-resident investors in such AIF are exempt from taxation.
Local taxation of non-resident investors
Would non-resident investors in a private equity fund be subject to taxation or return-filing requirements in your jurisdiction?
Yes, in the case of investment in a Category I or II AIF, income (other than profits and gains from business or profession) attributable to non-resident investors will be taxed directly in their hands. The tax rate would vary depending on the nature of income (ie, capital gains, dividend or interest income) and eligibility to tax treaty benefit, if any. Further, all the non-resident investors earning income from India need to file their annual income tax returns in India.
For non-resident investors in a Category III AIF being a trust, an income tax return is to be filed in India unless the trustee pays tax as representative assessee.
If the Category III AIF is a company and the non-resident investors have only earned dividend income from India, the income tax return is to be filed in India unless the tax on such dividend is withheld as per the rates provided under Indian tax law. However, if the Category III AIF is an LLP and investors has only received a share of profit, investors should not be required to file their tax return in India.
Further, where the AIF is situated in GIFT City, the non-resident investors in such AIF should not be required to obtain a Permanent Account Number (an Indian tax registration) and file an income tax return, provided such investor has earned income during the relevant financial year solely from the AIF in GIFT City and the AIF has withheld applicable taxes on income payable to the investor.
Local tax authority ruling
Is it necessary or desirable to obtain a ruling from local tax authorities with respect to the tax treatment of a private equity fund vehicle formed in your jurisdiction? Are there any special tax rules relating to investors that are residents of your jurisdiction?
At the outset, there is an option available for the taxpayers to approach the Board of Advance Ruling to determine the tax treatment of any particular transaction. However, it is not necessary for a private equity fund in India to obtain a ruling from the local tax authorities. Further, it is not generally desired as there is clarity on the tax treatment of income earned by a private equity fund and the process is time-consuming,
On the question of tax rules for Indian tax resident investors, such investors are liable to tax on their global income in India. In terms of differentiation, distribution by a Category I and II AIF to Indian resident investors is subject to withholding of tax at 10 per cent (in all cases) as against non-resident investors (for whom the applicable rate is to be applied).
Organisational taxes
Must any significant organisational taxes be paid with respect to private equity funds organised in your jurisdiction?
From an income tax perspective, Category I and II AIFs are subject to tax on the profits and gains from business or profession. Further, stamp duty will be payable on the setup of the fund vehicle as well as the issue of units by the AIF. While the stamp duty on the setup of a trust and LLP is insignificant, the stamp duty payable for the incorporation of a company would depend on the authorised share capital of the company. Additionally, the stamp duty payable on the issue of units will be 0.005 per cent of the value of the units (ie, stamp duty of 500 Indian rupees will be payable if units are issued for 10 million Indian rupees).
Special tax considerations
Describe briefly what special tax considerations, if any, apply with respect to a private equity fund’s sponsor.
Generally, the sponsor would subscribe to the units for minimum capital commitment. The return on such units will be taxed as if the sponsor is a regular investor.
Additionally, the sponsor may be entitled to received carried interest. The tax implication for carried interest would primarily depend on whether such carried interest is in the nature of a performance fee or incentive, in which case it could be treated as business income or ordinary income or a return on investment that is taxable as a capital gain.
With respect to the management fee, the Indian manager would be taxed in India at an ordinary rate.
Tax treaties
List any relevant tax treaties to which your jurisdiction is a party and how such treaties apply to the fund vehicle.
To date, India has tax treaties in place with more than 80 countries. As a principle, if a taxpayer is a non-resident in India and tax resident of a country with which India has a tax treaty, such taxpayer could be taxed as per the beneficial provisions under the applicable tax treaty. Therefore, if the non-resident investors in the fund are eligible for any tax treaty benefit, income attributable to such investor will be taxed in India as per those beneficial provisions. The eligibility to tax treaty benefit is a mixed question of law and fact and needs to be assessed appropriately.
Other significant tax issues
Are there any other significant tax issues relating to private equity funds organised in your jurisdiction?
Under Indian tax law, where any person acquires shares or securities at a price lower than its fair value computed as per tax rules, the difference between such fair value and actual purchase price, is taxed as ordinary income for the recipient. The units in an AIF fall within the definition of securities and therefore, if the price paid by the investors for the purchase of units is lower than its fair value (open market value), the difference between such fair value and purchase price is taxable in the hands of investors.
