Category III Alternative Investment Funds seeking to relocate to IFSC face a specific condition: the aggregate participation or investment in the original fund by persons resident in India must not exceed 5% of the corpus at the time of transfer. Understanding this condition is essential for AIFs considering relocation.
The Statutory Framework
Rule 51
Rule 51 provides that 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.
Understanding Category III AIFs
Definition
Category III Alternative Investment Funds are funds that employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.
Relevance to Relocation
When an original fund relocates to a resultant fund that is a Category III AIF, the 5% resident participation cap applies. This ensures that the relocation benefit is not used by funds with significant Indian participation.
The 5% Cap
Calculation of Participation
The aggregate participation or investment in the original fund by persons resident in India shall be calculated as a percentage of the corpus of such fund at the time of transfer.
Corpus of the Fund
"Corpus" means the total amount of funds raised for the purpose of investment by the fund as on a particular date.
Direct and Indirect Participation
The 5% cap applies to both direct and indirect participation or investment by persons resident in India.
Compliance Requirements
Monitoring
The original fund must:
- Monitor resident participation regularly
- Calculate the percentage of resident participation
- Ensure compliance with the 5% cap at the time of transfer
Documentation
Maintain records of:
- Participation by persons resident in India
- Calculation of the percentage
- Compliance with the 5% cap
Certification
The fund may need to obtain certification from an accountant confirming compliance.
Consequences of Non-Compliance
Loss of Tax-Neutral Treatment
If the original fund does not comply with the 5% resident participation cap:
- The relocation may not be eligible for tax-neutral treatment
- The transfer of capital assets may be regarded as a transfer for tax purposes
- Capital gains may be chargeable to tax
Penalties
Non-compliance may also attract penalties under the Act.
Expert Legal Guidance
Understanding the 5% resident participation condition is essential for Category III AIFs considering relocation. Anuj Desai & Associates provides expert advisory services on IFSC tax compliance, helping AIFs navigate the relocation process.