The General Anti-Avoidance Rule (GAAR) framework under the Direct Tax Code (DTC) 2025 includes a specific carve-out for Foreign Institutional Investors (FIIs) and certain investments made before 1st April 2017. This carve-out has significant relevance for FPI-AIF dual structures. This guide analyses the FII GAAR carve-out and its implications for FPI-AIF structures.
The GAAR Framework
Section 178 — Applicability of GAAR
Section 178(1) provides that "an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement". Section 178(2) clarifies that GAAR "may be applied to any step in, or a part of, the arrangement".
Section 179 — The Impermissible Avoidance Arrangement Test
An arrangement qualifies as an impermissible avoidance arrangement where the main purpose is to obtain a tax benefit, and it:
- Creates rights or obligations not ordinarily created between persons dealing at arm's length
- Results in misuse or abuse of the provisions of the Act
- Lacks commercial substance or is deemed to lack commercial substance under Section 180
- Is entered into by means not ordinarily employed for bona fide purposes
The FII GAAR Carve-Out
Rule 128 — GAAR Not to Apply in Certain Cases
Rule 128 of the Income-tax Rules, 2026 provides that the provisions of Chapter XI (GAAR) shall not apply to:
Rule 128(1)(b) : A Foreign Institutional Investor:
- Who is an assessee under the Act
- Who has not taken benefit of an agreement referred to in Section 159 (DTAA)
- Who has invested in listed securities, or unlisted securities, with the prior permission of the competent authority, in accordance with the SEBI (Foreign Institutional Investors) Regulations, 1995 (or 2019), in relation to such investments
Rule 128(1)(c) : A person, being a non-resident, in relation to investment made by him by way of offshore derivative instruments or otherwise, directly or indirectly, in a Foreign Institutional Investor
Rule 128(1)(d) : Any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received by, any person from transfer of such investments which were made before the 1st April, 2017 by such person
Rule 128(2) — Applicability to Arrangements
The provisions of Chapter XI shall apply to any arrangement, irrespective of the date on which it has been entered into, in respect of the tax benefit obtained from the arrangement on or after the 1st April, 2017, except for that income which accrues or arises to, or is received or deemed to be received by, any person from transfer of such investments which were made before the 1st April, 2017 by such person.
Key Elements of the FII Carve-Out
- FII Status: The investor must be a Foreign Institutional Investor (FII) as defined under SEBI regulations
- No DTAA Benefit: The FII must not have taken benefit of a DTAA
- Investment in Securities: The investment must be in listed securities or unlisted securities with prior permission
- Pre-1st April 2017 Investments: Investments made before 1st April 2017 are protected
FPI-AIF Dual Structures
What are FPI-AIF Dual Structures?
FPI-AIF dual structures typically involve:
- A foreign portfolio investor (FPI) investing in an Indian AIF
- The AIF investing in portfolio companies
- The structure providing access to Indian markets for foreign investors
How FPI-AIF Structures Work
- FPI: A foreign portfolio investor registered with SEBI
- AIF: An Indian AIF (Category I, II, or III)
- Investment: The FPI invests in the AIF
- Deployment: The AIF invests in portfolio companies
Relevance of FII GAAR Carve-Out to FPI-AIF Structures
1. FII Status
The FII GAAR carve-out applies to FIIs, not FPIs. However, FPIs may be treated similarly for certain purposes. The key question is whether the FPI qualifies as an "FII" under the carve-out provisions.
2. Pre-1st April 2017 Investments
Investments made before 1st April 2017 are protected from GAAR. For FPI-AIF structures established after 1st April 2017, the carve-out may not apply.
3. DTAA Benefit
If the FPI takes benefit of a DTAA, the carve-out does not apply. This is a critical consideration for FPI-AIF structures.
4. Investment in Securities
The carve-out applies to investments in listed securities or unlisted securities with prior permission. AIF investments are typically in unlisted securities, which may require prior permission.
Practical Implications
For FPI-AIF Structures
- Pre-2017 Structures: Investments made before 1st April 2017 are protected from GAAR
- Post-2017 Structures: GAAR may apply to post-1st April 2017 investments
- DTAA Benefit: If the FPI claims DTAA benefits, the carve-out does not apply
For New FPI-AIF Structures
- GAAR Risk: New FPI-AIF structures may be subject to GAAR
- Commercial Substance: Ensure the structure has commercial substance
- Documentation: Document the commercial rationale
For Existing FPI-AIF Structures
- Review: Review existing structures for GAAR risk
- Protection: Pre-1st April 2017 investments are protected
- Changes: Changes to the structure after 1st April 2017 may trigger GAAR
Defensible Structuring Strategies
1. Ensure Commercial Substance
- Ensure the FPI-AIF structure has genuine commercial substance
- Document the commercial rationale
2. Avoid DTAA Benefit
- If relying on the FII carve-out, avoid claiming DTAA benefits
- This may be a trade-off: DTAA benefits vs GAAR protection
3. Maintain Records
- Maintain records of investments
- Document the pre-1st April 2017 status
- Maintain records of compliance with SEBI regulations
4. Seek Expert Advice
- Given the complexity, seek expert legal and tax advice
- Obtain tax opinions on the GAAR implications
Consequences of GAAR Invocation
Section 181 — Consequences
If the FPI-AIF structure is declared to be an impermissible avoidance arrangement, Section 181 empowers the tax authorities to:
- Disregard, combine, or recharacterise any step in the arrangement
- Treat the arrangement as if it had not been entered into or carried out
- Reallocate income, expenditure, deduction, relief, or rebate among parties
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on GAAR compliance for FPI-AIF dual structures. Our international tax experts help FPIs and AIF managers understand the GAAR implications, structure defensible arrangements, and navigate the regulatory framework. We assist in structure review, documentation, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on GAAR compliance or any other international tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the complex GAAR framework for FPI-AIF dual structures requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive international tax advisory services, including:
- Structure Review: GAAR risk assessment for FPI-AIF structures
- Documentation: Assistance with commercial rationale documentation
- Advisory: Guidance on defensible structuring strategies
- Representation: Representation before income-tax authorities
Contact us for expert legal guidance on your FPI-AIF structuring matters.