Why Category III AIFs Still Battle Tax Ambiguity, Investor Concerns

Investors are wary of tax implications and legal uncertainties, despite rising popularity, trillions in investments

- Jash Kriplani

Category III AIF, which was established as an investment category in 2012, continues to be entangled in a maze of tax issues. Even though the category is the second largest among the alternate investment fund (AIF) categories, with 1.29 trillion worth of investor funds raised so far, the tax rules are not clear.

Unlike other investment products, which clearly fall under a specified tax regime, the category III AIF does not have a well-defined tax framework yet. These AIFs are mostly set up as trusts and therefore get taxed under trust rules," explained Tushar Sachade, partner at Price Waterhouse & Co. LLP.

Here is a look at some of these tax issues and issues that already affect investors' post-tax returns due to the lack of an investor-level tax regime.

No pass-through status

"Category III AIFs do not have a pass-through status, which means that all taxes are levied at the fund level rather than the investor level," said Bibek Sengupta, director-sales at WhiteOak Capital Management.

As mentioned earlier, category III AIFs are set up as trusts. Hence, the various rules that govern the tax treatment of trusts also apply to category III AIFs. There is also some haziness with the court ruling that these AIFs can be treated as 'determinate' trusts. At the same time, the strict interpretation of tax rules implies that the open-ended structure of category III AIF is 'indeterminate'.

More on that later.

Now, returning to the lack of pass-through status: why is this an issue for investors?