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Earlier there were only the conventional ways to invest in instruments like equities, bonds, real estate, FDs, etc. With the increase in high-net-worth individuals, the demand for unconventional financial instruments arose. The Securities Exchange Board of India (SEBI) came up with Alternate Investment Fund (AIF) which accumulates money from wealthy private investors. AIF is an apt option for wealthy investors who want to diversify their portfolios.
The money accumulated by AIF is invested as per the investment policy of the AIF. AIF in India is governed by SEBI (Alternative Investment Fund) Regulation, 2012. As per this regulation, an AIF can be set up as a Company, trust, LLP or body corporate. AIF has witnessed rapid growth in India and the most significant portion among AIF is Category II AIF.
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Prior to the introduction of Venture Capital and Private Equity funds, investors primarily relied upon public offerings, private placements and raise capital from lendings by financial institutions. Venture capital funds manage the money of investors who invest in personal equity shares in start-ups and small-to-medium-sized enterprises with growth potential but with high-risk and high-return. The enactment of SEBI (Venture Capital Funds) Regulations, 1996 provided the much-needed risk capital and entrepreneur’s mentorship, improved stability and quality of companies in the capital markets. Thereafter, the SEBI (AIF) Regulations, 2012 was introduced, which loosened the rules for foreign investments by way of AIF and Venture Capital Funds (VCF). As per the guidelines on overseas investment, a prospective AIF or VCF must obtain a No objection certificate (NOC) from SEBI and allocate the proposed amount of investment from the maximum limit of USD 1,500,000,000 for every AIF and VCF. For better understanding, let’s discuss the development of the regulatory framework of AIF in a tabular form:
As per the SEBI (AIF) Regulations, 2012, an AIF can be established as a Company, Trust, LLP or Body Corporate. Among these structures, Trust is the most preferred mode of AIF. So let’s understand the major aspects of an AIF setup as Trust. The parties involved in an AIF set up as a Trust is the Fund itself, the Trustee, the Sponsor and the Investment Manager. Some of the documents executed by an AIF set up as a Trust are as follows:
There are certain prerequisites prescribed under the SEBI (AIF) Regulation, 2012 for the establishment of an AIF. These pre-requisites have been discussed below:
A prospective investor has to register with SEBI before making investments. It can seek registration under different categories of AIF such as:
While applying for the registration of an AIF in India, the following registration fee has to be paid by the AIF:
The qualified investors as per the SEBI (AIF) Regulations, 2012 can be Resident Indians, non-resident Indians and foreign investors. In addition to this, AIF can have joint investors by making an investment of at least Rs. 1 crore. Joint investors can have a maximum of two participants. Joint investors can be:
In the case of a joint investor, each investor has to contribute to the AIF. An additional Rs. 1 crore shall apply for an additional investor.
Corpus means the amount committed to the fund by the investor by way of a written contract or any other document on a specified date. A minimum corpus of Rs. 20 crores is required as per the SEBI (AIF) Regulations. However, the minimum prescribed corpus for Angel Funds or Social Impact Funds is Rs. 5 crores. The minimum corpus set forth must be met at the time when the first close is declared.
The minimum investment amount prescribed under the SEBI (AIF) Regulations, 2012 is Rs. 1 crore. An exception to the minimum investment prescribed arises in the case of an employee or director of the AIF or the manager of an AIF where the minimum investment is Rs. 25 lakh. Further, in the case of Angel fund the minimum investment amount is Rs. 25 lakh and the maximum is Rs. 10 crores.
As per the SEBI (AIF) Regulations of 2012, the maximum number of investors for an AIF can be 1,000 except in the case of Angel Funds. However, if the AIF is set up under the IFSC (Fund Management) Regulations, 2022 the maximum number of investors are:
SEBI has inserted investment restrictions on Investable Funds. “Investable Funds” means a corpus of a scheme of the AIF after deducting or settling the estimated amount for administration and management of the fund during its tenure. There is a restriction on Category I and II AIF that they cannot invest more than 25%of the Investable Funds in a single investee company either directly or through the units of other AIF. Category III AIF is restricted to invest less than 10% of the investable funds in a single investee company either directly or through units of the other AIF investing in the equity of the listed investee company.
AIF does not invite subscriptions for its units from the public at large. They raise their funds only through private placements. In private placement, the sale of shares or bonds is done to pre-selected investors and institutions instead of an open market or public offering. To simplify the disclosure standards, SEBI has mandated a Private Placement Memorandum (PPM) Template. The PPM template gives prospective investors some amount of preliminary information in the format specified by SEBI. Part A of the PPM template requires minimal disclosures and Part B of the PPM template is the section where the investor can provide any other information as it deems necessary. SEBI has also mandated the inclusion of the Investor Charter component under PPM. Investor Charter is a document that provides information regarding the services offered, grievance procedure, duties of the investor, etc. Investor charter mandate informs the investors about the various AIFrelated actions to increase transparency regarding the process of resolving investor complaints.
Taxation rules for AIF differ under each category of AIF. Category I and II AIF enjoy the tax pass-through status where any income or loss other than business income, is taxed in the hands of the investor and the hands of the fund. So AIF investments in these two categories of AIF have to pay capital gain tax on profit or loss made from the fund within a given duration. The duration is vital since in Long-term capital gain, the tax rate is 20% along with indexation benefit and for short-term capital gain, the tax rate applicable is 15%. Over and above the tax rates, surcharge and cess charges are applicable. In addition to this, any income other than business income is liable to Dividend Distribution Tax and the investment fund has to deduct 10% TDS from it.
On the other hand, category III AIF is taxable at the fund level and does not enjoy the pass-through status. Tax is paid on the following types of income by Category III AIF:
The rapid growth of AIF in India is due to the reason that AIF reduces the instability pertaining to traditional investments. The performance of AIF does not depend upon the ups and downs of the stock market. It contributes to diversifying the market strategies and investment styles and therefore has huge potential in improving performance. AIF is excepted to grow further into establishing itself as a popular choice for investment subject to necessary action being taken by the government to remove the few prevailing hurdles.
Read our Article: Winding up and Liquidation of AIF
Ankita is an Advocate and has joined Enterslice as a Legal Researcher. Her work focuses on General Civil and Commercial laws, Corporate Taxation Laws, Labour and Employment Laws and Dispute Resolution. She is a law graduate from School of Law, University of Petroleum and Energy Studies. Prior to joining Enterslice, Ankita has the experience of practicing law in Delhi and Odisha.
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