Sebi to take up NR Narayana Murthy panel suggestions

The much-awaited tax reforms for Alternative Investment Funds (AIFs), which were to be addressed by the markets regulator, would take a few more months as the Securities and Exchange Board of India (Sebi) might forward the tax proposals of an expert panel headed by Infosys founder NR Narayana Murthy to the finance ministry.

The report suggested several tax reforms, including tweaking of safe harbour rules, promoting onshore fund management by providing tax incentives for funds managed from India and a Securities Transaction Tax (STT) regime for AIFs. The final decision of sending the recommendation to the North Block is likely to be taken in Sebi’s board meeting on May 20.

However, Sebi is likely to approve structural recommendations by the committee, including reduction in the minimum ticket size and issuing clarity on sub-categorisation of AIFs. According to current regulations, the minimum ticket for investing in AIFs is `1 crore. Market participants expect this to be reduced to `50 lakh which would improve liquidity in AIFs.

In terms of sub-categorisation, the committee had suggested measures such as introduction of new category of AIFs for angel investors and allowing foreign venture capital institutions (FVCI) to invest in all categories of AIFs. Currently, FVCIs are eligible to invest only as Category-I AIFs.

“According to the law, Sebi doesn’t have a complete jurisdiction over taxation issues. Currently, Category-I and Category-II AIFs are treated as pass-through entities for taxation purposes, while Category-III is subject to tax at the maximum marginal rate. These issues can be addressed only by finance ministry. Even for introduction of STT regime, the Income Tax Act need to be ammended,” said a former Sebi official on condition of anonymity.

The Narayana Murthy committee in its report had suggested that the taxation on AIFs should not be higher than that paid by foreign portfolio investors (FPIs) and domestic institutional investors (DIIs). The panel had recommended a 10% tax rate on long-term capital gains (LTCG) to be applicable on transfers of shares of private limited companies.

AIFs are special investment vehicles established to pool in funds for investing in real estate, private equity and hedge funds. Sebi had released regulations for AIFs in 2012.

According to the regulations, there are three categories of AIFs. Category-I comprises infrastructure, social venture and SME funds. These funds attract special concessions, including tax breaks for investors and were designed to fund the capital intensive sectors such as infrastructure. Despite the special incentives, Category-I AIFs have witnessed a lukewarm response from investors so far. As on September 2015, these funds constituted only 23% of total funds raised via AIFs.

Category-II consists of private and equity funds that are allowed to invest anywhere in any combination. However, these funds cannot invest in debt except for the purpose of day-to-day operations. These funds are the most popular among investors and account for more than half of total AIF inflows. Category-III consists of funds that make short-term investments and then sell. This category includes hedge funds.

AIFs have witnessed a significant jump in inflows in the last two years. The cumulative funds raised via AIFs was `14,031.39 crore in Q3FY16 — triple the value of `5,874.5 in Q1FY15, data compiled by Sebi showed.