Alternative Investment Funds (AIFs) and their managers operate in an increasingly complex tax environment. The Direct Tax Code (DTC) 2025, which came into force on 1st April 2026, brings significant clarity — and heightened compliance obligations — for AIF manager fee arrangements under the transfer pricing regime. Understanding when and how the arm's length rules apply is critical for fund managers, trustees, and sponsors.
The Foundation: Section 161 and the Arm's Length Principle
Section 161(1) of the DTC provides that "Any income arising from an international transaction or a specified domestic transaction shall be determined having regard to the arm's length price". This is not limited to income alone. Section 161(2) extends the requirement to "Any allowance for any expense or interest arising from an international transaction or a specified domestic transaction".
In practical terms for AIF managers, this means:
- Management fees paid to an associated enterprise must be at arm's length
- Performance fees or carried interest allocated across related entities must withstand ALP scrutiny
- Cost-sharing arrangements for research, administration, or investment services must be priced as between independent parties
The provision applies to any fee paid to an Associated Enterprise (AE) that exceeds the ALP, or if the taxpayer fails to demonstrate receipt of actual services, the excess amount may be disallowed. The non-application clause in Section 161(4) is critical: the provisions shall not apply if the ALP determination has the effect of reducing the income chargeable to tax or increasing the loss — ensuring that transfer pricing cannot be used to artificially reduce tax liability.
When Does an AIF Manager Become an "Associated Enterprise"?
The definition of "associated enterprise" under Section 162 is exhaustive. An AIF manager becomes an AE of the fund, the sponsor, or portfolio companies when any of the following tests are met:
Voting Power Test
Section 162(1)(a)(ii) treats enterprises as associated if one holds, directly or indirectly, shares carrying not less than 26% of the voting power in the other. For AIF structures, this applies where the manager holds equity or voting rights in the fund's investment vehicle or in portfolio companies.
Debt and Guarantee Tests
- Loan Test: Where one enterprise has advanced a loan constituting not less than 51% of the book value of total assets of the other enterprise
- Guarantee Test: Where one enterprise guarantees not less than 10% of the total borrowings of the other enterprise
Control and Management Tests
Section 162(1)(d) and (e) cover cases where:
- More than half of the board of directors or members of the governing board are appointed by the other enterprise
- More than half of the directors or members are appointed by the same person or persons
Specified Domestic Transactions — Extended Scope
For specified domestic transactions, Section 162(2) extends the associated enterprise definition to include:
- Other units, undertakings, or businesses of the same assessee (relevant for AIF with multiple schemes or funds under common management)
- Any other person referred to in Section 140(13) (applicable to eligible start-ups and specified businesses)
What AIF Transactions Are Covered?
International Transactions
An AIF manager fee arrangement constitutes an international transaction under Section 163 if the manager and the fund (or its investors) are resident in different jurisdictions. This includes:
- Management fees paid by an offshore fund to an Indian manager
- Management fees paid by an Indian AIF to an offshore sponsor or sub-manager
- Performance fees or carried interest allocated across borders
Specified Domestic Transactions
Even purely domestic AIF structures may be caught by transfer pricing rules through specified domestic transactions under Section 164. The threshold is aggregate value exceeding ₹20 crore in a tax year. This includes:
- Fee arrangements between a Category III AIF and its manager where both are resident in India but related
- Cost allocation arrangements between multiple schemes managed by the same entity
- Transactions between different units or undertakings of the same assessee
Determining the Arm's Length Price for Management Fees
Applicable Methods
Section 165(1) prescribes six methods for determining the ALP:
- Comparable Uncontrolled Price Method (CUP)
- Resale Price Method
- Cost Plus Method
- Profit Split Method
- Transactional Net Margin Method (TNMM)
- Such other method as may be prescribed
For AIF management fees, the most appropriate method is typically TNMM or CUP, depending on the nature of services provided and the availability of comparable data.
Most Appropriate Method Selection
Section 165(2) requires selection of the most appropriate method having regard to:
- The nature of transaction or class of transaction
- The functions performed by the enterprises
- The assets employed or to be employed
- The risks assumed
- Availability, coverage, and reliability of data
Benchmarking Considerations for AIF Managers
- Functional Analysis: What functions does the manager perform? Investment management, administration, compliance, marketing, or all of these?
- Asset Analysis: What assets are employed? Intellectual property, reputation, proprietary systems?
- Risk Analysis: What risks are assumed? Market risk, credit risk, operational risk, regulatory risk?
Documentation Requirements
Section 171 — Maintenance of Information and Documents
Every person who has entered into an international transaction or specified domestic transaction shall keep and maintain prescribed information and documents. This includes:
- Description of the ownership structure
- Profile of the multinational group
- Description of the business and industry
- Nature and terms of the international transaction or specified domestic transaction
- Description of functions performed, risks assumed, and assets employed
- Record of uncontrolled transactions taken into account for comparability analysis
- Description of the methods considered and selected
Section 172 — Report from an Accountant
Every person who has entered into an international transaction or specified domestic transaction shall obtain a report from an accountant and furnish it on or before the specified date. The report must set forth prescribed particulars in the prescribed form.
Penalties for Non-Compliance
- Failure to maintain documentation: penalty equal to 2% of the value of the transaction
- Failure to furnish information or documents when required: penalty equal to 2% of the value of the transaction
Safe Harbour Relief for AIF Managers?
Under Section 167, the Board may make safe harbour rules providing circumstances where income-tax authorities shall accept the transfer price declared by the assessee. However, the safe harbour framework under Rules 86–102 of the Income-tax Rules, 2026 primarily covers:
- Information technology services
- Intra-group loans
- Corporate guarantees
- Contract research and development services
- Manufacture and export of auto components
- Low value-adding intra-group services
- Data centre services
AIF management fee arrangements are not explicitly covered by the safe harbour rules. This means AIF managers must typically undertake a full transfer pricing study and documentation exercise.
Advance Pricing Agreement — An Alternative?
Sections 168–169 provide for Advance Pricing Agreements (APAs) with the Board. An APA can provide certainty on the arm's length price or specify the manner in which it shall be determined for an international transaction to be entered into.
For AIF managers with significant and recurring cross-border fee arrangements, an APA may be a worthwhile investment despite the ₹20 lakh filing fee.
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on transfer pricing compliance for AIF managers. Our direct tax experts help fund managers understand their obligations, document fee arrangements, and navigate the regulatory framework. We assist in TP study preparation, report filing, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on transfer pricing compliance or any other direct tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the complex transfer pricing framework for AIF manager fee arrangements requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:
- TP Study Preparation: Assistance with transfer pricing documentation
- Report Filing: Assistance with Form 3CEB filing
- Benchmarking: Guidance on comparable selection and analysis
- Representation: Representation before Transfer Pricing Officers
Contact us for expert legal guidance on your transfer pricing matters.