Taxation for Non-Resident Investors, Withholding Rules, and Statutory Compliances (Part 3)
This installment (Part 3 of 6) focuses on the taxation of non-resident investors in Category I and II AIFs, specific withholding tax (TDS) mandates, anti-avoidance provisions, and the reporting obligations of the fund under the Income Tax Act (ITA), 1961, based on the NISM Series XIX-C Alternative Investment Fund Managers Workbook.
16.1.3 Taxation in the Hands of Non-Resident Investors
Non-resident investors (including FPIs and NRIs) are subject to the same pass-through status as resident investors for Category I and II AIFs. The tax liability is determined by the nature of the income generated by the fund and the specific provisions applicable to non-residents under the ITA or applicable Double Taxation Avoidance Agreements (DTAA).
Taxation of Capital Gains for Non-Residents
The tax rates for non-residents depend on the type of asset and whether the transaction was subject to Securities Transaction Tax (STT):
| Nature of Income | Effective Tax Rate (Non-Resident Corporates) | Effective Tax Rate (Other Offshore Investors) |
|---|---|---|
| STCG (Listed Equity/Equity MF with STT) | 21.84% | 23.296% |
| LTCG (Listed Equity/Equity MF with STT) | 13.65% (on gains > INR 1.25 lakh) | 14.56% (on gains > INR 1.25 lakh) |
| Other LTCG (Unlisted Shares/LLP Interest) | 13.65% | 14.56% |
| STCG (Unlisted Debentures) | 30% (for FPIs) or applicable slab rates | 30% (for FPIs) or applicable slab rates |
- Treaty Benefits: Non-resident unitholders can opt to be taxed as per the provisions of the ITA or the applicable DTAA between India and their country of residence, whichever is more beneficial.
- Character of Income: The characterization of income (e.g., Capital Gains vs. Business Income) remains the same for the non-resident unitholder as it was for the AIF.
16.1.5 Withholding Tax (TDS) by the Investment Fund
Since Category I and II AIFs are pass-through vehicles, the responsibility for collecting and depositing tax lies with the fund at the time of distributing or crediting income to unitholders.
Section 194LBB: The Primary Withholding Provision
Under Section 194LBB of the ITA, an Investment Fund is required to deduct tax at source on any income (other than business income) paid or credited to its unitholders.
- For Resident Investors: Tax must be deducted at a flat rate of 10%.
- For Non-Resident Investors: Tax is deducted at the "rates in force" as specified in the Finance Act or the relevant DTAA rates.
- Timing of Deduction: The tax must be withheld at the earlier of:
- Crediting of income to the account of the unitholder.
- Actual payment of the income to the unitholder.
Withholding by Portfolio Companies
As per Section 197A(1F) of the ITA, Indian investee companies are not required to withhold tax when paying income (other than business income) to a Category I or II AIF. This ensures that the pass-through mechanism operates without unnecessary tax leakage at the portfolio level.
16.1.7 Reporting Compliances for AIFs under the ITA
Investment funds have strict statutory reporting requirements to ensure the tax authorities can track the income passed through to unitholders.
1. Filing of Income Tax Returns
It is mandatory for the AIF (the Investment Fund) to file its return of income annually as per the provisions of the ITA.
2. Issuance of Form 64C (To Unitholders)
The fund must provide a statement of income paid or credited to every unitholder.
- Format: Form No. 64C.
- Deadline: On or before 30th June of the following financial year.
- Purpose: This form allows unitholders to include the correct amount and nature of income in their personal tax filings.
3. Filing of Form 64D (To the IT Department)
The fund must electronically file a consolidated statement of all income distributed or credited during the year.
- Format: Form No. 64D.
- Deadline: On or before 15th June of the following financial year.
- Verification: Must be verified by a practicing Chartered Accountant.
16.1.4 Other Relevant Provisions: Anti-Avoidance Rules
AIF managers must navigate complex anti-avoidance rules to ensure tax efficiency.
- Deemed Sale Consideration (Section 50CA): If unlisted shares are transferred at a value lower than their Fair Market Value (FMV), the FMV is deemed to be the full value of consideration for computing capital gains.
- Bonus Stripping: If an investor buys units within 3 months prior to a record date, receives bonus units, and sells the original units within 9 months, any loss on the sale is ignored and instead added to the cost of the bonus units.
- Dividend Stripping: Similar to bonus stripping, losses incurred on units sold within 9 months of a "record date" (after receiving tax-exempt dividends) are ignored to the extent of the dividend received.
Key Takeaways
- Pass-through Neutrality: Non-residents can leverage DTAA benefits to optimize their tax outgo on AIF distributions.
- Withholding Burden: The AIF acts as a tax collector for the government, deducting 10% for residents and rates in force for non-residents.
- Compliance Deadlines: June 15th (Form 64D) and June 30th (Form 64C) are critical dates for AIF tax managers.
Important Terms
- Form 64C: The annual certificate issued by the AIF to unitholders detailing the income passed through.
- Section 194LBB: The specific section of the ITA governing TDS on payments made by investment funds.
- Rates in Force: The tax rates (including surcharge and cess) as defined by the Finance Act of the relevant year.
- DTAA (Double Taxation Avoidance Agreement): A treaty between two countries to avoid taxing the same income twice.
Note on Formulas: Net Distribution to Investor = Gross Realized Income - Withholding Tax (TDS) [Simple line format].
This concludes Part 3 of 6. Part 4 will move into the complex world of Category III AIF taxation, exploring why they do not have pass-through status and how the trust structure (Determinate vs. Indeterminate) changes the tax liability.