The relocation of Alternative Investment Funds (AIFs) to India's GIFT City has emerged as a significant trend, offering fund sponsors the opportunity to onshore fund management operations while maintaining tax neutrality. The Direct Tax Code (DTC) 2025 provides a specific framework for such relocations under Section 70(2) read with Rule 51 of the Income-tax Rules, 2026, with particular conditions applicable to Category III AIFs.
The Relocation Framework Under the DTC
Section 70 — Transactions Not Regarded as Transfer
Under Section 70(1)(t), the transfer of a capital asset by the original fund to the resulting fund in a relocation is not regarded as a transfer for capital gains purposes. Similarly, Section 70(1)(u) provides that transfer by a shareholder, unit holder, or interest holder in a relocation of a capital asset being shares, units, or interest held in the original fund in consideration for shares, units, or interest in the resultant fund is not regarded as a transfer.
The conditions for "original fund," "relocation," and "resultant fund" are defined in Section 70(2) (Table: Sl. No. 5) .
Original Fund — Definition
The original fund means a fund established or incorporated or registered outside India, which collects funds from its members for investing it for their benefit, and fulfils the following conditions:
- The fund is not a person resident in India
- The fund is a resident of a country with which India has a Double Taxation Avoidance Agreement (DTAA), or is established in a notified country
- The fund and its activities are subject to applicable investor protection regulations
- The fund fulfils other conditions as may be prescribed
Resultant Fund — Definition
The resultant fund means a fund established or incorporated in India in the form of a trust or a company or a limited liability partnership, which:
- Is located in an International Financial Services Centre (IFSC) (GIFT City)
- Has been granted a certificate of registration as a Category I or Category II or Category III Alternative Investment Fund under the SEBI (AIF) Regulations, 2012, or a certificate as a retail scheme or an Exchange Traded Fund under the IFSCA (Fund Management) Regulations, 2022
- Is regulated under the SEBI (AIF) Regulations, 2012 or IFSCA (Fund Management) Regulations, 2022
Relocation — Definition
Relocation means transfer of assets of the original fund, or of its wholly owned special purpose vehicle, to a resultant fund on or before 31st March, 2030, where consideration for such transfer is discharged in the form of shares, units, or interest in the resultant fund to:
- A shareholder, unit holder, or interest holder of the original fund in the same proportion as held in the original fund; or
- The original fund in the same proportion (where shares, units, or interest are not issued to the shareholder or unit holder directly)
The Resident Participation Test — Rule 51
The Condition
For a Category III Alternative Investment Fund, the relocation provisions under Section 70(1)(t) and (u) are subject to the condition that the aggregate participation or investment in the original fund, either directly or indirectly, by persons resident in India does not exceed 5% of the corpus of such fund at the time of such transfer.
This condition is prescribed under Rule 51 of the Income-tax Rules, 2026, which states: "For the purposes of section 70(2) [Table: Sl. No. 5, C(a)(A)(iv)], the original fund, in a case where a capital asset is transferred to a resultant fund being a Category III Alternative Investment Fund, shall fulfil the condition that the aggregate participation or investment in the original fund, either directly or indirectly, by persons resident in India does not exceed 5% of the corpus of such fund at the time of such transfer."
Rationale
The 5% resident participation test ensures that the relocation benefit is not used by funds that are substantially Indian in character. If a Category III AIF has significant participation from Indian residents, the relocation would effectively onshore an Indian fund without appropriate tax consequences. The 5% threshold maintains the integrity of the relocation framework.
Interpretation and Application
- "Directly or indirectly": The test applies to all forms of participation or investment, whether direct (e.g., units held directly by resident Indians) or indirect (e.g., through intermediaries, structures, or nominees)
- "At the time of such transfer": The condition must be satisfied at the moment of transfer of assets from the original fund to the resultant fund
- "Corpus of such fund": The 5% is calculated as a percentage of the total corpus of the original fund as on the date of transfer
Consequences of Non-Compliance
If the resident participation exceeds 5% at the time of transfer:
- The transfer of assets from the original fund to the resultant fund will be regarded as a transfer for capital gains purposes
- Capital gains tax may be triggered on the transfer
- The tax neutrality of the relocation may be lost
Compliance and Documentation Requirements
Pre-Transfer Diligence
Before initiating a relocation, the fund sponsor must:
- Conduct a comprehensive review of the investor base of the original fund
- Determine the exact percentage of resident Indian participation
- Identify any indirect participation that might affect the 5% calculation
Certifications
The fund should obtain appropriate certifications regarding resident participation, including:
- Certifications from investors regarding their residency status
- Certifications from intermediaries regarding the ultimate beneficial ownership of units
Reporting
The resultant fund (Category III AIF in GIFT City) must:
- Maintain records of the resident participation in the original fund
- Furnish the annual statement of exempt income in the prescribed form
Broader Relocation Conditions
Original Fund Conditions
In addition to the resident participation test for Category III AIFs, the original fund must also satisfy the general conditions under Section 70(2) (Table: Sl. No. 5):
- The fund must be established or incorporated or registered outside India
- The fund must not be a person resident in India
- The fund must be a resident of a country with which India has a DTAA or established in a notified country
- The fund's activities must be subject to applicable investor protection regulations
Resultant Fund Conditions
The resultant fund (Category III AIF in GIFT City) must:
- Be located in an IFSC (GIFT City)
- Have a certificate of registration as a Category III AIF
- Be regulated under the SEBI (AIF) Regulations, 2012 or IFSCA (Fund Management) Regulations, 2022
Timing
The relocation must be completed on or before 31st March, 2030.
Tax Implications of Relocation
Capital Gains Tax Neutrality
If the relocation conditions are satisfied (including the 5% resident participation test for Category III AIFs), the transfer of assets from the original fund to the resultant fund is not regarded as a transfer for capital gains purposes. This provides tax neutrality for the relocation.
Subsequent Taxation
Once the assets are transferred to the resultant fund in GIFT City, the income from those assets may be eligible for the tax benefits available to IFSC units:
- 100% deduction for ten consecutive years out of fifteen years (or twenty years under the amended provisions)
- Exemption from capital gains on transfer of certain assets
Investor Taxation
The taxation of investors in the resultant fund will be governed by the provisions applicable to AIFs in India, including the pass-through taxation regime for Category I and II AIFs, and the taxation at the fund level for Category III AIFs.
Practical Considerations
Structuring the Relocation
- Timing: The relocation must be planned well in advance to ensure compliance with all conditions
- Investor Communication: Resident Indian investors must be informed of the implications of the relocation
- Regulatory Approvals: Approvals from SEBI and IFSCA may be required
Managing the 5% Limit
- Monitoring: Continuous monitoring of resident participation before the transfer
- Redemption: Consider redemption or buyback of units held by resident Indian investors before the transfer
- Restructuring: Consider restructuring the fund to reduce resident participation
Documentation
- Legal Documentation: The relocation must be documented through proper legal instruments
- Tax Documentation: Tax opinions and certifications should be obtained
- Regulatory Filings: Appropriate filings with SEBI and IFSCA must be made
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on AIF relocation to GIFT City. Our direct tax experts help fund sponsors navigate the relocation framework, comply with the resident participation test, and structure defensible relocation transactions. We assist in due diligence, documentation, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on AIF relocation or any other direct tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the complex relocation framework for Category III AIFs requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:
- Relocation Structuring: Guidance on compliant relocation structures
- Resident Participation Analysis: Assistance with the 5% test
- Documentation: Assistance with legal and tax documentation
- Representation: Representation before income-tax authorities
Contact us for expert legal guidance on your AIF relocation matters.