In India’s rapidly evolving investment landscape, fund managers are capitalizing on opportunities presented by a burgeoning market, with alternative investment funds (AIFs) leading the charge. According to SEBI’s annual report for FY24, a total of 195 new AIFs were registered during the year, bringing the cumulative total to 1,283 as of March 2024. Simultaneously, the Gujarat International Finance Tec-City (GIFT City) has seen GIFT AIFs gaining momentum, with nearly 104 funds registered with the International Financial Services Centres Authority (IFSCA) as of March 2024.
As the fund landscape expands, first-time fund managers often face a crucial question: how should their fund be structured? This article aims to provide insights into the available options and key considerations involved in the process.
Traditionally, Mauritius and Singapore have been the preferred jurisdictions for Indian fund managers establishing investment funds. These countries offer streamlined registration processes, investor-friendly regulations, and a robust financial infrastructure. Notably, before April 2017, investments made in India were exempt from capital gains tax, thanks to favourable Double Taxation Avoidance Agreements (DTAAs) signed between India and these jurisdictions.
Recognizing the potential of foreign investment in India and the growing sophistication of Indian fund managers, the Indian government sought to create a domestic framework that could rival offshore structures. This initiative resulted in the introduction of the SEBI (Alternative Investment Funds) Regulations in 2012, which facilitated the establishment of AIFs. These AIFs provide a mechanism for pooling funds from both Indian and foreign investors under a single structure. Importantly, these benefit from pass-through tax status, which means that income such as interest, dividends, and capital gains is not taxed at the fund level, but directly in the hands of investors.
However, a significant drawback of the domestic AIF regime has been the imposition of the goods and services tax (GST) on management fees earned by fund managers. In contrast, offshore fund managers are not subject to indirect taxes on similar fees. This disparity has placed domestic fund managers at a competitive disadvantage when vying for foreign capital. The issue gained prominence following the GST advance ruling in the case of Multiples Alternate Asset Management Pvt Ltd, where authorities determined that GST would apply to management fees collected from non-resident investors. This prompted repeated industry representations to the government, seeking relief for domestic fund managers.
To address these concerns and enhance India's global competitiveness, the government introduced GIFT City in April 2015. This Special Economic Zone (SEZ), near Gandhinagar, was specifically designed to merge the advantages of both offshore fund structures and domestic AIFs. GIFT City is regarded as a jurisdiction outside India for regulatory purposes and is governed by IFSCA.
Since its inception, GIFT City has experienced rapid growth. The GIFT AIF regime has been crafted to reflect global best practices and offers substantial flexibility for fund managers. Like domestic AIFs, GIFT AIFs also enjoy pass-through status under Indian tax laws, meaning significant income such as interest, dividends, and capital gains is taxed solely in the hands of investors. However, unlike domestic AIFs, GIFT fund managers are exempt from GST on management fees and carried interest. Additionally, fund managers in GIFT City benefit from tax exemption on their income for any 10 consecutive years within a 15-year window. Furthermore, while GIFT AIFs are structured similarly to offshore funds, they are still recognized as regulated entities under Indian law and enjoy certain advantages not available to unregulated foreign funds.
One of the primary concerns for new fund managers is the mandatory sponsor contribution. Under current AIF regulations, fund managers must contribute at least 2.5% of the fund corpus, or Rs 5 crore ($0.5 million), whichever is lower. This requirement can pose challenges for first-time managers, who often seek loans or structured arrangements to fulfil it. GIFT AIFs mitigate this issue by offering an exemption from the sponsor contribution requirement, provided the fund raises capital from accredited investors or meets other specified conditions. This makes GIFT City particularly appealing for emerging fund managers.
While GIFT City provides an excellent platform for attracting foreign capital, it is essential to note that there are certain restrictions on pooling domestic capital through GIFT AIFs. Consequently, fund managers looking to raise funds from Indian investors must still consider establishing a domestic AIF under SEBI regulations.
To conclude, GIFT City has emerged as a strategic and tax-efficient jurisdiction for Indian fund managers. It effectively bridges the gap between domestic and offshore structures, offering regulatory flexibility, tax neutrality, and enhanced global competitiveness. For new fund managers, particularly those focused on attracting foreign capital, GIFT City presents a compelling and practical alternative to traditional offshore jurisdictions.
Hiren Bhatt is a tax partner and Amit J Revankar is director-tax at EY India
