The relocation of funds from an original fund located outside India to a resultant fund located in India is a complex transaction with significant tax implications. Section 70(1)(t) and (u) of the Income Tax Act, 2025 provide that the transfer of capital assets in a relocation shall not be regarded as a transfer【70†L0】. Rule 51 of the Income Tax Rules, 2026 specifies additional conditions for Category III Alternative Investment Funds【51†L0】.
The Statutory Framework
Section 70(1)(t) and (u)
Section 70(1)(t) provides that the provisions of Section 67 shall not apply to a transfer in a relocation, of a capital asset by the original fund to the resulting fund【70†L0】. Section 70(1)(u) provides that the provisions shall not apply to a transfer by a shareholder or unit holder or interest holder, in a relocation, of a capital asset being share or unit or interest held by him in the original fund in consideration for the share or unit or interest in the resultant fund【70†L0】.
Section 70(2) - Definitions
"Original fund" means a fund established or incorporated or registered outside India which collects funds from its members for investing it for their benefit【70†L0】. "Resultant fund" means a fund established or incorporated in India in the form of a trust or a company or a limited liability partnership, located in an International Financial Services Centre【70†L0】.
Rule 51: The 5% Resident Participation Cap
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【51†L0】.
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【70†L0】.
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 and Compliance
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【70†L0】.
Compliance Requirements
The original fund must:
- Maintain records of participation or investment by persons resident in India
- Calculate the percentage of resident participation
- Ensure compliance with the 5% cap at the time of transfer
Consequences of Non-Compliance
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
Practical Considerations
For Original Funds
- Monitor resident participation regularly
- Ensure compliance with the 5% cap at the time of transfer
- Maintain proper documentation
For Resultant Funds
- Verify compliance with the 5% cap
- Maintain records of the relocation
- Ensure proper reporting
Expert Legal Guidance
Understanding the 5% resident participation cap for Category III AIFs in fund relocation is essential for funds contemplating relocation. Anuj Desai & Associates provides expert advisory services on Direct Tax Code compliance, helping funds navigate the relocation provisions and ensure compliance with the participation cap.