AIF Taxation Update
13 January 2017
The Central Board of Direct Taxes (‘CBDT’) in its internal order dated January 24, 20171 (‘the Order’) clarified on characterisation of gains on sale of unlisted shares by SEBI Registered Category I and II Alternate Investment Funds (‘AIFs’).
The CBDT had earlier clarified the position regarding tax treatment of income arising from transfer of unlisted shares through order dated May 05, 20162 . This order stated that any transfer of unlisted shares is to be regarded as ‘Capital Gain’ irrespective of period of holding and subject to certain exceptions. One of the exceptions provided that the said clarification may not necessarily apply in case of transfer of unlisted shares made along with the ‘control and management of underlying business’.
Representations were made to the CBDT that to safeguard the interest of the investor, ‘control and management of the underlying business’ may be required to be exercised by AIFs investing in unlisted shares of ventures, new set ups or start ups. Consequently, the exception of transfer of unlisted shares made along with the ‘control and management of underlying business’ should not be applicable to Category I and II AIFs.
The order now clarifies that the exception in relation to transfer of unlisted shares along with ‘control and management of the underlying business’ shall not apply to AIFs. Thereby, any transfer of unlisted shares by AIFs shall be characterised as capital gains. The first two exceptions of the earlier clarification, mainly to address tax evasion, shall continue to apply.
Currently, in case where the income in the hands of the AIF is business income, such income is taxable at the maximum marginal rate, much higher than the applicable rate for capital gains. This clarification shall, therefore, provide a much awaited relief to the AIFs and its investors. Further, the clarification shall provide for much required impetus to start-ups and new ventures, attracting investments from AIFs.