Onshoring of investment funds -- The GST conundrum

By Smita Bhandari

  • 27 Jul 2021
Onshoring of investment funds -- The GST conundrum

Attracting foreign investment has been a continued goal for India, as it is known to be a catalyst for triggering a positive transformation in the economy through the development of local industry, generation of employment and transfer of technical know-how. 

Alternative investment funds or AIFs (whether private equity, venture capital funds, or others) are widely acknowledged as an important conduit for deploying foreign investment in India. 

With their long term investment strategy and healthy risk appetite, they are well recognised for investing in non-traditional businesses, early stage ventures, and innovation-oriented startups. 


Over the years, India has worked continually to present a more attractive investment proposition to the foreign investors, yet has faced challenges in rising to become the most favoured investment destination when compared with neighbouring countries like Singapore, Hong Kong or some other tax havens like Cayman, Mauritius, etc. 

The Foreign Direct Investment (FDI) equity inflows for 2020-21 from such preferred tax jurisdictions accounts for approximately 65% of the total FDI equity inflows into India. 

As India endeavours to attract more FDI, it is necessary that one of the aspects of ease of doing business translates through in some of the current tax framework applicable to funds and Indian fund managers, including under the Goods and Services Tax regime. 


The GST conundrum 

One of the deterrents of bringing in foreign investment through onshore funds in India is on account of GST being applicable on all costs that are charged to the Indian onshore fund, including fund management fees. 

For instance, presently, fund management services provided to onshore funds attract GST at the rate of 18%. This GST is a cost to the funds’ investors/contributors since typically funds do not have the ability to offset such tax. 


This tax cost is borne by all investors alike irrespective of whether they are local or foreign. To the contrary, GST being a destination-based tax, when the same fund management services are exported to offshore funds (located outside India), GST is zero-rated, that is, not applicable with export refund/rebate benefits being available to the Indian manager. 

With the increased burden of 18% cost on all services including the fund management fees for all onshore funds, it is more cost efficient for investors to maintain pooling vehicles outside of India. The overall impact of these costs could approximate to 0.5% of the assets under management (AUM). 

An important aspect that the policymakers need to consider is that though the management fees for fund management services are contractually charged to the fund, in substance funds are merely pooling vehicles. That is to say, the fund managers’ services are effectively used or consumed by the investors to the funds. 


So essentially the GST charged on management fee of offshore capital invested in onshore funds leads to export of taxes, which has never been the intent of the law. 

Fund managers in significant offshore financial hubs are not similarly disadvantaged since such countries either exempt fund management services entirely or grant specific rebates/exemptions on management of foreign capital. 

In fact, even under the Indian income tax laws, specified categories of AIFs have been given a special pass through status. This means that the tax applicable is determined based on the contributors/investors to the AIFs. 


The law achieves this through a legal presumption that the investor is directly making such an investment and hence the income received by the AIF is taxed in the hands of the investor. 

Similarly, it is important to recognise and extend this principle even under GST; that is, an onshore fund having foreign investors needs to be extended the same GST status as and when the same foreign investor invests through an offshore fund. 

Towards this, a zero rating status to fund manager fees attributable to the foreign capital invested in an onshore fund needs to be granted. The industry is aggrieved by this disparity and has sought intervention and clarification from the relevant GST policy making bodies. 

Bringing in such tax and regulatory amendments will help in maximising the potential of foreign investment for India which will surely contribute to creating a strong and mature asset management ecosystem in the country. 

Smita Bhandari is a partner (indirect tax and regulatory services) with Ernst & Young, India LLP. Views are personal.

Share article on