Brief Primer on AIFs and How They Differ from PMS

Introduction:

The need for AIFs in India was boosted with the surge in venture capital investments. The government had been focusing on Venture Capital Funds (VCF) to promote growth of select sectors and early-stage companies. Due to the lack of clarity on the regulatory front, many real estate funds and private equity funds started registering themselves as VCF.

SEBI introduced SEBI AIF regulations in 2012 with an objective to identify distinct investments/asset classes such as Private Equity (PE), Venture Capital (VC), Real Estate (RE), etc.

What is an Alternate Investment Fund?

AIF is an investment avenue to pool in private monies for investing. As per SEBI 2012 regulations, AIFs in India can be incorporated in the form of a trust, company, body corporate, or an LLP.

AIFs can pool monies only on a private placement basis and not from the general public. The monies pooled will be invested according to the defined investment policy stated in the Private Placement Memorandum (PPM).

Just like Mutual Funds, Alternate Investments Funds follow unit accounting, and the underlying securities are held by the AIF and not in the investor’s demat.

Different Categories of AIFs:

Category I

• These AIFs invest in start-ups or early-stage ventures, social ventures, SMEs, infrastructure, or any other sector which the government or regulator considers to be socially and economically important. This category also includes Angel funds.
• Examples: SIDBI Social Ventures Fund, Exfinity Technology Fund, Akur Capital Fund, Unitus Seed Fund India, etc.

Category II

• AIFs which cannot be categorized in Category I or Category III fall under this category. Category II AIFs do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the regulations.
• Private equity funds and debt funds for which no specific incentives or concessions are given by the government or regulator fall under this category.
• Examples: True North PE Fund, Motilal Oswal PE Fund, Kae Capital, India Quotient, HDFC AMC Select AIF FOF, etc.

Category III

• These AIFs employ diverse or complex trading strategies and may employ leverage, including through investment in listed and unlisted derivatives.
• Hedge funds, PIPE funds, and long-only listed equity funds are categorized as Category III AIFs.
• Examples: Avendus Absolute Returns Fund, Abakkus Emerging Opportunities Fund, ASK Golden Decade Fund, ICICI Pru Long Short Fund, etc.

Eligibility Criteria/Conditions:

Minimum Investment for Investor:

• Rs 1 crore.
• Rs 25 lacs in case of employees/directors/fund managers of the AIF or Angel fund investors.

Maximum Number of Investors in an AIF:

• 1,000 investors.
• 200 investors in case of Angel funds.

Sponsor Contribution:

• 2.5% of the corpus or Rs 5 crore, whichever is less for Cat I & Cat II AIFs.
• 5% of the corpus or Rs 10 crore, whichever is less for Cat III AIFs.
• 2.5% of the corpus or Rs 50 lacs, whichever is less for angel funds.

Minimum Corpus:

• Rs 20 crore for all AIFs.
• Rs 10 crore in case of angel funds.

Nature:

• Cat I and Cat II AIFs need to be close-ended only and must have a minimum tenure of 3 years.
• Cat III AIFs can be open-ended or close-ended.

Leverage:

• Cat III funds can have a maximum of 200% leverage.
• No leverage is allowed in Cat I and Cat II AIFs.

Taxation:

• Cat I and Cat II AIFs have pass-through taxation. It implies that income/gains generated by these AIFs are not taxed at the fund level, and such income/gains are charged to income tax in the hands of the unit holder in the same manner as if the investments made by the AIFs have been directly made by the unit holder.
• For Cat III AIFs, income/gains generated by the AIFs are taxed at the fund level, and net of tax proceeds are passed on to the unit holder/investor.
• Taxation on investments in AIFs depends on:
  • underlying asset class i.e. private equity, listed equity, debt, structured debt, etc.
  • nature of income i.e. capital gains, accruals, business income, etc.
• Example:
  • Investments in equity-oriented PE and VC funds are taxed as per unlisted equities taxation, and the tax is paid by investors (Cat II AIF).
  • Income generated by hedge funds is treated as business income, which is taxed at the marginal rate and is paid by the fund (Cat III AIF).
  • Long-only listed equity funds have listed equity taxation, and the tax proceeds are paid by the fund (Cat III AIF).