Fund Formation Attracting Global Investors

MUMBAI S I L I CO N VA L L E Y B A N G A LO R E SINGAPORE M U M B A I B KC NEW DELHI MUNICH N E W YO R K GIFT CIT Y
Research
Fund Formation:
Attracting Global
Investors
Global, Regulatory and Tax
Environment impacting India
focused funds
May 2022
© Nishith Desai Associates 2022 www.nishithdesai.com

Research
Fund Formation:
Attracting Global
Investors
Global, Regulatory and Tax
Environment impacting India
focused funds
May 2022
WORKSITE!1107442.1
© Nishith Desai Associates 2022 [email protected]

Fund Formation: Attracting Global Investors. Global, Regulatory and Tax Environment impacting India focused funds
About NDA
We are an India Centric Global law firm (www.nishithdesai.com) with four offices in India and the only law firm
with license to practice Indian law from our Munich, Singapore, Palo Alto and New York offices. We are a firm of
specialists and the go-to firm for companies that want to conduct business in India, navigate its complex business
regulations and grow. Over 70% of our clients are foreign multinationals and over 84.5% are repeat clients. Our
reputation is well regarded for handling complex high value transactions and cross border litigation; that prestige
extends to engaging and mentoring the start-up community that we passionately support and encourage. We
also enjoy global recognition for our research with an ability to anticipate and address challenges from a strategic,
legal and tax perspective in an integrated way. In fact, the framework and standards for the Asset Management
industry within India was pioneered by us in the early 1990s, and we continue remain respected industry experts.
We are a research based law firm and have just set up a first-of-its kind IOT-driven Blue Sky Thinking & Research
Campus named Imaginarium AliGunjan (near Mumbai, India), dedicated to exploring the future of law & society.
We are consistently ranked at the top as Asia’s most innovative law practice by Financial Times. NDA is renowned
for its advanced predictive legal practice and constantly conducts original research into emerging areas of the law
such as Blockchain, Artificial Intelligence, Designer Babies, Flying Cars, Autonomous vehicles, IOT, AI & Robotics,
Medical Devices, Genetic Engineering amongst others and enjoy high credibility in respect of our independent
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pro-bono and public policy work. We have significant diversity with female employees in the range of about 49%
and many in leadership positions.
© Nishith Desai Associates 2022 Provided upon request only

Asia-Pacific:
Most Innovative Law Firm, 2016
Second Most Innovative Firm, 2019
Most Innovative Indian Law Firm, 2019, 2017, 2016, 2015, 2014
Asia Pacific:
Band 1 for Employment, Lifesciences, Tax, TMT,
2021, 2020, 2019, 2018, 2017, 2016, 2015
Tier 1 for Private Equity, Project Development: Telecommunications Networks,

2020, 2019, 2018, 2017, 2014
Deal of the Year: Private Equity, 2020
Asia-Pacific:
Tier 1 for Dispute, Tax, Investment Funds, Labour & Employment, TMT, Corporate
M&A, 2021, 2020, 2019, 2018, 2017, 2016, 2015, 2014, 2013, 2012
Asia-Pacific:
Tier 1 for Government & Regulatory, Tax, 2020, 2019, 2018.
Ranked
‘Outstanding’ for Technology, Labour & Employment, Private Equity, Regulatory, Tax,
2021, 2020, 2019.
Global Though Leader — Vikram Shroff

Thought Leaders-India — Nishith Desai, Vaibhav Parikh, Dr. Milind Antani
Arbitration Guide, 2021 — Vyapak Desai, Sahil Kanuga
Fastest growing M&A Law Firm, 2018
Asia Mena Counsel: In-House Community Firms Survey:

Only Indian Firm for Life Science Practice Sector, 2018

Please see the last page of this paper for the most recent research papers by our experts.
Disclaimer
This report is a copy right of Nishith Desai Associates. No reader should act on the basis of any statement
contained herein without seeking professional advice. The authors and the firm expressly disclaim all and any
liability to any person who has read this report, or otherwise, in respect of anything, and of consequences of
anything done, or omitted to be done by any such person in reliance upon the contents of this report.
Contact
For any help or assistance please email us on [email protected]
or visit us at www.nishithdesai.com
Acknowledgements
Parul Jain
[email protected]
Dhruv Sanghavi
[email protected]
Nandini Pathak
[email protected]
Prakhar Dua
[email protected]
Ipsita Agarwalla
[email protected]
Dibya Behera
[email protected]
Srishti Chhabra
[email protected]
* With special thanks to Ritul Sarraf and Athul Roshal Kumar for their assistance.

Dear Friend,
As the world came together digitally to combat the ongoing COVID-19 pandemic (the “Pandemic”), venture
capital (“VC”), private equity (“PE”) and other fund managers continued their raising and investment efforts. In
the early months of the Pandemic, GPs were focusing on their existing portfolio versus being aggressive on new
investments (or raising new capital).
With an attempt by the Indian economy to achieve steady adjustments, GPs started seeking opportunities in the
face of this crisis – focusing on distressed assets, credit opportunities, infrastructure, healthcare, telecommunication
to name a few. As the Pandemic situation was over, their time and attention was shifted back to execution of deals,
leading to a strong rebound. It has been observed that the industry has seen steady and tremendous growth and
the investments in alternative investment funds (“AIFs”) are on rise. The Pandemic also shifted more focus on
sustainable investments considering environmental, social and governance (“ESG”) as drivers for value creation.
Accounting for 42% of the investments by value in total, technology and e-commerce sectors witnesses record
investments of USD 16.3 billion and USD 15.9 billion respectively. The financial services sector, which had been a
leader in the previous decade fell to the third place, despite receiving its highest ever investments of USD 11.7 billion.
According to global LP surveys conducted in mid-2021, India was projected to be the most attractive emerging
market second to China, for allocating fresh commitments. Reportedly, investments into India have grown 48%
annually over the past five years (Bain 2022).
The investor appetite for India risk has been robust and that led to healthy fund raising for several tier 1 GPs with
track records. Indian Startups received investments up to USD 17 billion in 2021.
India was among the top 10 recipients of the FDI in 2020, which also saw a 27% increase from the previous year,
driving the FDI growth in South Asia.1 The year 2021, however, saw a 15% decrease in the FDI inflow, with FDI
inflow of USD 74.01 billion against USD 87.55 billion in calendar year 2020 .2 Similarly, owing to market sentiments
and massive sell-off by foreign investors, investments from Foreign Portfolio Investors (“FPIs”) in India significantly
decreased by about 50%, from USD 13.3 billion dollars in 2020 to USD 6.46 billion dollars in 2021.
With the establishment of the International Financial Services Centres Authority (“IFSCA”) under the
International Financial Services Centres Authority Act, 2019, considerable improvements / relaxations have been
made to provide a comprehensive framework for the asset management industry in the Gujarat International
Finance Tec-City (“GIFT City”), India’s first IFSC. Recently, the IFSCA released the International Financial
Services Centres Authority (Fund Management) Regulations, 2022 (“FME Regulations”) which will come into
force from May 19, 2022. The FME Regulations marks a paradigm shift from the existing regulatory regime for
AIFs in India and is consistent with global best practices for regulation of fund management.
In 2019, SEBI introduced the SEBI (Foreign Portfolio Investors) Regulations, 2019 (“FPI Regulations 2019”),
repealing the erstwhile SEBI (Foreign Portfolio Investors) Regulations, 2014 (“FPI Regulations 2014”). The FPI
Regulations 2019 are supplemented by the Operational Guidelines for FPIs, DDPs and Eligible Foreign Investors
released by SEBI in 2019 (“Operational Guidelines”) with an objective to facilitate implementation of the FPI
Regulations. The FPI Regulations 2019 divide the FPIs into 2 (two) categories and places increased reliance on
whether the FPI applicant and/or its investment manager is / are from a Financial Action Task Force (“FATF”)
member country jurisdiction/s. Further, the FPI Regulations 2019 has clarified that resident Indians, non-resident
Indians and overseas citizens of India can be constituents of an FPI, subject to fulfilment of certain conditions.
1. https://unctad.org/news/investment-flows-developing-asia-defy-covid-19-grow-4
2. https://pib.gov.in/PressReleasePage.aspx?PRID=1808793#:~:text=As%20per%20Reserve%20Bank%20of,billion%20in%20calendar%20year%20
2020.

The FPI Regulations 2019 permit issuance of offshore derivative instruments (“ODIs”) or participatory notes (“P-notes”),
such as Total Return Swaps. by Category I FPIs and can be subscribed only by persons eligible for Category I FPI
registration. This in effect means that an unregulated entity which is eligible, as per the parameters prescribed under the
FPI Regulations 2019, to seek registration as a Category I FPI is permitted to hold an ODI, subject to satisfaction of relevant
conditions and complying with the KYC norms.
Certain amendments were also introduced in the FDI regime in the form of the Foreign Exchange Management (Non-
Debt Instruments) Rules, 2019 (“NDI Rules”) superseding the erstwhile Foreign Exchange Management (Transfer or
Issue of Security by a Person Resident outside India) Regulations, 2017 (“TISPRO Regulations”) and Foreign Exchange
Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018.
Further, the Reserve Bank of India (“RBI”) also notified the Foreign Exchange Management (Debt Instrument) Regulations,
2019 (“DI Regulations”) superseding TISPRO and Foreign Exchange Management (Mode of Payment and Reporting of
Non-Debt Instruments) Regulations, 2019 providing for reporting requirements in relation to any investment under NDI
Rules. While the law around foreign investment has not been substantially modified by way of these amendments, there
have been a few changes in nomenclature of instruments, power of the RBI and some seemingly unintended changes due
to omission of certain provisions from the TISPRO. The NDI Rules also clearly demarcate between ‘debt instruments’ and
‘non-debt instruments’, which includes ‘capital instruments’ under the TISPRO and also certain other kinds of instruments
in AIFs, Real Estate Investment Trust (“REITs”), Infrastructure Investment Trust (“InvITs”), etc.
Further, certain sectoral caps and related changes were brought in through FDI Policy 2020, released in October 2020
in supersession of all the press releases/ circulars etc. released by the Department for Promotion of Industry and
Internal Trade (“DPIIT”). Pertinently, (a) 100% FDI under the automatic route was permitted for marketplace model
of e-commerce; (b) FDI upto 74% was allowed under automatic route for companies seeking new industrial license; (c)
100% FDI has been permitted in investment in companies registered as an NBFC with RBI; (d) FDI in Defence Sector under
the automatic permitted to be upto 74% from the prevailing limit of 49% and (e) FDI in insurance companies under the
automatic permitted to be upto 74% from the prevailing limit of 49%.
The taxation regime has largely remained unchanged, the Union Budget for financial year (“FY”) 2022-23 (“Union
Budget”) has introduced a regime for taxing virtual digital assets, provisions for to streamline process for tax litigation,
certain measures have been introduced to avoid repetitive appeals by the department in the higher courts. In order to put
an end to validity of assessments / re-assessments in case of business reorganizations, the Union Budget also amended
section 170 of the Income-tax Act, 1961 (“ITA”) to provide that where assessment / re-assessment proceedings are
initiated on predecessor entity during the pendency of reorganization proceedings, such proceedings shall be deemed
to have been made on the successor entity. A slew of other changes have also been made to the provisions of the ITA in
relation to search and seizure, faceless assessment, allowability of expenditure for the purposes of business or profession
and penal consequences.
Additionally, the introduction of the General Anti-Avoidance Rules (“GAAR”) in Indian domestic law has brought in a
shift toward a ‘substance over form’ approach in India, an approach that is also reflected in other actions of the Indian
government – in actively participating in the Organization for Economic Co-operation and Development’s (“OECD”)
Base Erosion and Profit Shifting (“BEPS”) project, recent policy changes, etc. Further, as a result of Action Plan 15 of the
BEPS project, the Multilateral Instrument (“MLI”) was brought into force on July 1, 2018 and it entered into force for India
on October 1, 2019. The MLI seeks to introduce a limitation of benefit (“LoB”) rule (detailed or simplified) or the principal
purpose test (“PPT”) to covered tax agreements (“CTAs”). Since few countries have chosen the LoB rule, it is anticipated
that several Indian tax treaties will be modified by the PPT. Having said this, it will be important to examine the interplay
of the provisions of GAAR and the PPT rule under the tax treaties and determine its impact on fund structuring.
In early 2021, the fund industry was also jolted by an adverse ruling by the Bangalore bench of the Custom, Excise
and Service Tax Appellate Tribunal (“CESTAT”) upholding levy of service tax on carried interest. Acknowledging the

extent of PE and VC investments in the Indian start-up eco-system, the Union Budget announced that an expert
committee would be set up to holistically examine the regulatory hurdles and other frictions that prevent further
scaling up of such investments. It is expected that the expert committee shall provide clarity on applicability of
goods and service tax (“GST”) and income tax on carried interest.
With the tax treaties with Mauritius and Singapore being amended, GPs and investors are considering other factors
like infrastructure for fund set up, timeline for grant of registration, manner of KYC processes etc. while deciding
the jurisdiction to set up the fund. In so far as grandfathered investments are concerned, tax authorities continue
to question the benefits under the India-Mauritius Double Taxation Avoidance Agreement (“India-Mauritius
DTAA”) on account of lack of commercial substance or alleging the Mauritian entity to be a conduit etc.
The government has been proactive in trying to establish a regulatory and tax climate that is conducive for raising
investment from foreign investors. In 2016, the government also made efforts to encourage domestic financial
institutions (“Domestic FIs”) such as pension funds and insurance firms to allocate investments towards
alternative asset classes such as Indian AIFs. The regulatory regime continues to be streamlined with relaxation of
pricing norms for foreign direct investments, clarity in relation to put / call options, rationalization of the foreign
portfolio investment regime and proposals for further liberalization of investment caps In March 2021, The
National Bank for Financing Infrastructure and Development Bill, 2021 (“NBFID Bill”) was passed by both the
houses of the parliament. The NBFID Bill seeks to establish the National Bank for Financing Infrastructure and
Development (NBFID) as the principal Domestic FIs for infrastructure financing and allows other Domestic FIs to
register by applying to RBI. Yet another major development is the proposed launch of a specialized AIF for export-
oriented small and mid-sized companies named - ‘Ubharte Sitaare’. The overall fund size is INR 250 crore with a
green shoe option of INR 250 crore.
Designing a fund is not just an exercise in structuring. It’s like being an architect is different from being a
structural engineer. For India-focused funds, not only knowledge of Indian regulatory and tax framework is
required but a deep insight into cross border legal and tax regimes is necessary, even when you are not raising
funds from overseas.
The investment fund industry clearly seems to be in a very different market today. In mid-2016, Indian funds
started seeing greater participation from domestic LPs (as compared to so far being primarily led by overseas
investors). Innovative structures varied from the traditional ‘blind-pool model’ are increasingly being seen. GPs
are increasingly evaluating different structures to contain any possible tax liability and minimize onerous
regulatory compliances. There is also an increasing shift from the traditional unified structures to co-invest
structures. India, as an investment destination, has been dominating the hedge funds market as well. Innovative
structures such as hedge funds with PE side pockets are also being adopted.
Other innovative structures are also coming up, with variations in the traditional unified structure, including a
combination of a unified and a co-investment structure to cater to commercial expectations while complying
with legal, regulatory and tax requirements. Changes in legal regimes are also altering sectoral focus – for example,
the implementation of a newly introduced statute on insolvency and bankruptcy has led to substantial interest in
creating investment platforms for accessing stressed assets. Following closely on the footsteps of the observations
by U.S. Securities and Exchange Commission (“SEC”) that there are several disconnects between “what [general
partners] think their [limited partners] know and what LPs actually know”, SEBI mandates certain disclosure and
reporting norms that AIFs have to observe.
However, from a regulatory viewpoint, the glare from the regulator to the alternative investments space has
been at its peak. A manager to an AIF must now contend with greater supervision and accountability to both
the regulator and the investors. While bespoke terms are designed to maintain investor friendliness, given the

recent observations by regulators in sophisticated jurisdictions, sight must not be lost on the disclosure norms
and fiduciary driven rules that are now statutorily mandated. There is increasing guidance from SEBI, including
on aspects such matters relating to treasury functions (permitted temporary investments) and investment
restrictions under the regulations.
In the United States, the primary laws regulating investment funds are the Securities Act of 1933, the Securities
Exchange Act of 1934, the Investment Company Act of 1940 and the Investment Advisers Act of 1940. Following
the financial crisis of 2008, a number of legislations have been introduced. These include the Dodd- Frank Act,
the Foreign Account Tax Compliance Act (“FATCA”) and the Jumpstart Our Business Startups Act (“JOBS Act”).
These legislations were enacted with the twin purpose of preventing future financial crisis on one hand and
facilitating the process of economic recovery on the other. From an investment fund perspective, these statutes
assume importance in the context of investor limitations and disclosure requirements that they usher into
the regulatory regime. Further, the US Internal Revenue Service has recently released proposed regulations on
taxation of carried interest under the Internal Revenue Code of 1986.
The European Commission introduced the Alternative Investment Fund Managers Directive (“AIFMD”) with
a view to provide a harmonized and stringent regulatory and supervisory framework for the activities of fund
managers within the European Union. The AIFMD seeks to regulate non-EU fund managers who seek to market a
fund, set up outside the EU to investors in the EU.
Back home, considering the recommendations from the Alternative Investment Policy Advisory Committee
(“AIPAC”) constituted by SEBI under the chairmanship of Mr. Narayana Murthy, several changes (like allowance
of pass through for net losses incurred by AIFs, introduction of framework for accredited investors etc.) have been
made under the SEBI (Alternate Investment Fund) Regulations, 2012 (“AIF Regulations”) and ITA.
SEBI has also introduced an online system for filings related to AIF. This online system can be used for application
for registration, reporting and filing in terms of the provisions of AIF Regulations and circulars issued thereunder.
Although there were certain teething issues faced in the transition to the online system, it is encouraging that
SEBI, in line with the government’s initiative to promote the alternative investment asset industry in India, is
consistently making efforts towards ease of regulatory formalities to operate in the industry.
Separately, there is also emerging jurisprudence which suggests that the threshold of fiduciary duties to be met
with by fund managers is shifting from “exercising supervision” to “making reasonable and proportionate efforts
commensurate with the situations”. A failure to perform such supervisory role could raise severe issues on fund
managers’ liabilities for business losses as would be seen in the case of fund directors in Weavering Macro Fixed
Income Fund, which continues to hold the most value in terms of precedence in fund governance jurisprudence.
To add to this, there has been a very active enforcement of anticorruption laws under the Foreign Corrupt
Practices Act (“FCPA”) against directors and executives.
Accordingly, apart from the expectation to set up investor-friendly structures, the shift in legal paradigm in which
an investment fund operates, requires that attention be given to articulating disclosures in fund documents
(including recording the economic substance and justifications in the fund’s board minutes) and intelligently
planning investment asset-holdings.
Globally, funds have been accorded pass through status to ensure fiscal neutrality and investors are taxed based
on their status. This is especially relevant when certain streams of income may be tax free at investor level due
to the status of the investor, but taxable at fund level. India has also accorded a pass-through status to Category
I and Category II AIFs registered with SEBI with a requirement to subject any income credited or paid by the
AIFs to a withholding tax of 10% for resident investors and as per the “rates in force” for non-resident investors.
Pass through status has still not been accorded to Category III AIFs. The tax uncertainty places certain types of

Category III AIFs at a significant disadvantage against off-shore funds with similar strategies. Further, from a
regulatory perspective, SEBI (from June, 2017) has permitted participation of Category III AIFs in the commodity
derivatives market with certain conditions.
While bespoke managed accounts are being created and structures that meet LPs’ demand to be more ‘closely
aligned to the portfolio selection process’ are being set up, it is imperative to design funds which address the issues
created by the continuously changing Indian and international regulatory and tax environment.
The shift in legal paradigm in which an investment fund operates requires that attention be given to articulating
disclosures in fund documents (including recording the economic substance) and intelligently planning
investment asset-holdings. In our experience, fund documentation is critical in ensuring protection for fund
managers (GPs) from exposure to legal, tax and regulatory risks. Fund counsels are now required to devise
innovative structures and advise investors on terms for meeting investor’s (LP) expectations on commercials,
governance and maintaining GP discipline on the articulated investment strategy of the fund. All these are to be
done in conformity with the changing legal framework.
The objective of this compilation is to bring to focus, aspects that need to be considered while setting up India-
focused funds and some of the recent developments that impact the fund management industry.
Regards,
Nishith Desai

NDA Fund Formation Practice

Our Approach
At Nishith Desai Associates, we are particularly known and engaged by multinational companies and funds as
strategic counsels. As engineers of some of the earliest innovative instruments being used by investment funds
(both PE and VC) in India we proactively spend time in developing an advanced understanding of the industry as
well as the current legal, regulatory and tax regime.
We provide end-to-end assistance to clients in formulating the fund structure, documentation, liaising with
regulatory authorities and merchant banker for obtaining license and responding to their queries. We have
developed expertise in assisting the client with LP negotiations considering industry best practices.
Diagnostics and Structuring

Structure follows strategy, and not vice versa. Developing an appropriate strategy is crucial in determining
not just the structure, but also the architecture of the fund platform. Adopting strategies for tapping different
categories of global investors, including institutional investors and non-institutional investors (such as family
offices and ultra-high net worth individuals) and on conformity with global benchmarks, such as the Institutional
Limited Partners’ Association (ILPA) Principles 3.0, the European Union’s AIFMD that have been gaining
prominence in the recent times. Strategic framework also needs to be developed for incorporation of best practices
on rights and liabilities of different counterparties, LP negotiations and drafting of various fund terms including
key person provisions, currency exchange related issues and removal provisions.
Selection of the fund vehicle requires careful planning and is driven by a variety of considerations as the same
would have an impact on the investors in the fund; particularly in their home jurisdictions. While deciding on the
optimum structure for a fund, varied objectives such as limited liability for investors, commercial convenience
and tax efficiency for investors and managers need to be considered. To meet these objectives, varied entities such
as pass-through trusts, limited liability partnerships, limited partnerships, limited liability companies, protected
cell companies etc. can be considered. Offshore funds investing in India may require the presence of investment
advisors in India to provide them with deal recommendations etc. This gives rise to tricky issues relating to
the taxation of such offshore funds in India that would depend on whether the Indian advisor is regarded as a
‘permanent establishment’ of the offshore fund in India or may lead to a risk of ‘place of effective management’
(“POEM”) of the offshore fund held to be in India. In this regard, we have successfully represented several funds
before the Indian Authority for Advance Rulings and have obtained landmark rulings for them.
After the OECD issued its report on Action Plan on BEPS, there has been an increased pressure to ensure
observance of key tax principles like demonstrating substance, establishing tax resident status and transfer
pricing principles. Tax authorities in several mature financial centers are adopting substance over form approach.
The implementation of the GAAR allows Indian tax authorities to re-characterize transactions on grounds of lack
of commercial substance among other things. This has prompted a shift while structuring funds to concentrate
several aspects constituting ‘commercial substance’ in the same entity. So, unless specific investors require ‘feeder’
vehicles for tax or regulatory reasons, an attempt is

being made to pool LPs in the same vehicle that invests in the foreign portfolio. Mauritius, Netherlands,
Singapore, Luxembourg, and the GIFT City in IFSC are being favorably considered while structuring India funds
or funds with India allocation.
To accommodate both domestic investor base and offshore investor base, unified structures have emerged as a
preferred choice for structuring India focused funds. There is also an increased participation from DFIs in India
focused funds, including unified structures. Accordingly, some global benchmarks need to be followed when
designing the structure and calibrating the fund documents including the governance, fiduciary aspects and
adherence to Environment and Social (“ESG”) policies. However, recently, we have also seen GPs and investors
oscillate towards co-invest structures.
Documentation
Once a decision has been taken on the optimum structure for the fund, the same has to be carefully incorporated in
the fund documents including the charter documents for the fund entity, the private placement memorandum, the
shareholders’ agreement, the share subscription or contribution agreement, the investment management agreement,
the investment advisory agreement, etc. SEBI has issued a circular mandating AIFs to adhere to a template PPM
ensuring that a minimum standard of disclosure is made available in the PPM. While SEBI has provided guidance
on certain key terms in the template PPM, in particular, one would need to keep in mind the potential “permanent
establishment” and association of persons (AoP) risk while drafting the fund documents. We also provide strategic
inputs on various fund terms including key person provisions, currency exchange related issues and removal
provisions. We also assist the client in developing structures for warehousing and co-investment.
The PPM should also achieve a balance between the risk disclosure requirements and the marketing strategy. We
also co-ordinate with overseas counsel to obtain requisite legends to keep the fundraising exercise compliant with
the laws of each jurisdiction in which the interests of the fund are being marketed.
Additionally, we also interact with other intermediaries involved with respect to an AIF such as the Trustees and
the Merchant Bankers to file the PPM to SEBI as per the recent SEBI (AIF) (Fourth Amendment) Regulations, 2021
dated August 13, 2021 and modalities issued subsequently.
Advisory
In addition to preparing the necessary fund documents, we also advise the fund on the local registration
requirements. Domestic funds may register themselves with SEBI pursuant to which they are required to comply
with certain investment restrictions and other prescribed conditions. Domestic funds are also accorded pass-
through status for Indian tax purposes upon the fulfilment of certain conditions. It is not mandatory for offshore
funds to register with SEBI. However, there are certain benefits available to offshore funds that register with SEBI as
‘foreign venture capital investors’ (“FVCI”) such as flexibility in entry and exit pricing, exemption from the lock-in
period required when the portfolio company becomes public effectively allowing the FVCI to exit the investment
immediately after the portfolio company is listed, exemption from take-over code in respect of the shares,
“Qualified Institutional Buyer” status, etc. Further, with respect to funds seeking to participate in the secondary
markets, apart from drafting of the information memorandum which is circulated to the investors of such a fund,
we have also advised and assisted them in obtaining registration as FPIs. We also advise funds on a day to day basis
from an Indian tax and regulatory perspective in relation to the execution of ODIs including P-notes.

LP Negotiations
LPs (particularly the first close LPs and institutional investors) to India focused funds have increasingly started
negotiating fund terms with the GPs with rigorous review of the fund documentation. Further, there is often a
need to harmonize the fund documents to cater to the requirements and internal policies of foreign institutional
investors / DFIs, which may vary or differ from those of Indian financial institutions.
Funds with a mixed pool of investors (domestic and foreign, institutional and retail) often face various issues
on fund terms including with respect to allocation of placement agent expenses, set-up costs for a feeder vehicle
to cater to foreign investors, exposure of the corpus of the fund to exchange rate fluctuations. Therefore, it
not only becomes critical for GPs to ensure that they are able to accommodate the LP asks within the realms
of the structure in the most efficient manner but also for the legal advisors to ensure that they are adequately
incorporated in the fund documentation.
Tax expertise: Sponsor and Carry Structuring

Being the pioneers of funds industry in India, we were also the early identifiers of tax issues with respect to the
funds industry. We have represented and argued in several landmark cases before Authority for Advance Rulings
(“AAR”), different High Courts and also the Supreme Court of India contributing to the development of tax
jurisprudence in fund management industry – illustratively, Aberdeen Institutional Commingled Funds, LLC,
Nicholas Applegate, Azadi Bachao Andolan, General Pension Electric Trust etc.
We have developed technical expertise in formulating tax efficient structures both for offshore and domestic
funds in light of the recent shift of focus from form to substance under the ITA. In view of the recent changes
in the tax treaties and the introduction of the GAAR and POEM provisions in the ITA, the architecture of a fund
becomes more critical than the structure. Our understanding of tax treaties also enables us to advise clients on
selection of appropriate jurisdictions for setting up feeder vehicles. With the development of GIFT City, our efforts
are constantly dedicated to develop the most efficient and futuristic fund structure for our clients.
With an increasing industry demand for a skin-in-the-game, GPs of India focused funds have also begun exploring
different innovative structures for employee GP commitment and carry structuring. We have also developed
significant expertise in carry structuring not only for domestic funds but also for offshore funds comprising of India
GPs and employees. Carry structuring involves a careful analysis of both regulatory and tax laws applicability on
certain aspects, while looking at the jurisdiction of residence and taxation of the ultimate carry recipients and also
the proportionality of investment in the fund vehicle by such recipients as employee GP commitment.
Global Project Management

We are the go-to firm for foreign investors investing in India and Indian investors looking to expand abroad.
Several Indian investment managers who are looking at raising funds with international investors need to
offer tax efficient and regulatory compliant structures to the foreign investors that generally seek safety and
repatriation of their original investments along with a tax-efficient way of receiving the gains earned. Thus, our
focus on international tax and our in-depth understanding of the legal, regulatory and tax regimes for funds in
different jurisdictions has enabled us to be at the cutting edge of structuring offshore and domestic funds.

Primary Contacts
Nishith Desai
[email protected]
Nishith Desai is the founder of the research-based strategy driven international law firm, Nishith Desai Associates
(www.nishithdesai.com) with offices in Mumbai, Silicon Valley, Bangalore, Singapore, Mumbai – BKC, New
Delhi, Munich and New York.
Nishith himself is a renowned international tax, corporate, IP lawyer researcher, published author and lecturer
in leading academic institutions around the world. He specializes in Financial Services sector and assisted
Government of Mauritius and Government of India in establishment of their offshore financial centers.
Soon after India opened up its economy to the outside world in 1991, he established the first five India Focused
funds and pioneered the roots of asset management industry and the firm has now worked for over 900 funds
across all classes of asset. As a pioneer in the Indian investment funds industry, Nishith is known for developing
new models in fund formation such as the first India focused index fund, first PE fund, first VC fund and real estate
fund and was also a member of SEBI’s committee which developed original regulations for FVCI and Venture
Capital Funds regime. More recently, he has been involved with the formation and subsequent amendments to
the AIF Regulations.

Parul Jain
[email protected]
Parul is Co-head, International tax and Fund Formation Practices at Nishith Desai Associates with over 20
years of experience. She is a Chartered Accountant, a Certified Public Accountant and an advocate. She focuses
primarily on international taxation and Fund Formation practice areas including cross border investments and
VC / PE funding structures. She has advised various PE clients with respect to their portfolio business operations
restructuring, including advice on M&A transactions, spin offs and group reorganisation strategies. She was
previously a partner in the Financial Services and M&A Tax Practices at a Big Four accounting firm.
Parul has been recognised by International Tax Review World Tax 2013 guide. She has also been listed in The
Legal500 Directory and has been recognized as one of the Leading Women Leaders in Tax 2016 and in 2017 by
International Tax Review. She was also part of a special Committee set up by Securities and Exchange Board of
India to evaluate the changes to the AIF Regulations related to Angel Funds.

Nishchal Joshipura
[email protected]
Nishchal Joshipura is a Partner and co-heads the Fund Formation practice at Nishith Desai
Associates. He is a Chartered Accountant, an MBA and a Lawyer. He is also a Partner in the Mergers & Acquisition
and PE practice. Nishchal specializes in legal and tax structuring of cross-border transactions and assists clients
on documentation and negotiation of mergers and acquisition (M&A) deals. His other practice areas include
Corporate & Securities laws, Transfer Pricing, International Taxation, Globalization, Structuring of Inbound /
Outbound Investments, PE Investments, Structuring of Offshore Funds, Taxation of E-Commerce and Exchange
Controls. He has contributed several articles in leading publications like Asialaw and has been a speaker at many
domestic and international conferences.
He has been highly “Highly Recommended” by various legal directories for legal and tax advice on M&A, PE and
Investment Funds. He has been nominated as a “Young Achiever” at the Legal Era Awards 2015 based on industry
research, reviews, rating and surveys conducted by Legal Era.

Kishore Joshi
[email protected]
Kishore Joshi heads the Regulatory Practice at Nishith Desai Associates. He has over two decades of experience in
advising clients on securities and exchange control laws. He handles matters on various aspects related to foreign
portfolio investors including the broad-based criteria, eligibility to trade P-Notes and the participation of various
investor categories under the FPI route.
Kishore has interacted extensively with the securities and exchange control regulator and has made numerous
representations seeking reform in the law. In addition, he regularly advises clients on fund investments,
issues related to corporate and regulatory laws. He has made several presentations on inbound and outbound
investments. Kishore holds a Bachelor’s degree in law from Mumbai University and is a member of the Bar
Council of Maharashtra & Goa.

Nandini Pathak
[email protected]
Nandini Pathak is a Leader in the Investment Funds practice at Nishith Desai Associates and is actively involved
in the firm’s thought leadership on the VC and PE side. With a strong focus on VC / PE funds, she has advised
several international and domestic clients on legal, regulatory and tax issues, fund governance and fund
economics best practices and negotiations with various participants at the fund formation stage. She frequently
interacts with the securities regulator and custodians. Her expertise includes tax efficient structuring for India
focused funds as well as investor negotiations.
With her practice base on the fund formation side, she also regularly advises clients on the regulatory front
including securities laws and exchange control laws. She believes in thought leadership through knowledge
sharing, and frequently authors publicly available analysis on relevant topics in the investment funds industry.
Nandini holds a B.A.,LL.B. (hons). degree from Jindal Global Law School, and has recently (in 2019) been
recognized as a ‘Distinguished Alumni Award for Exemplary Accomplishments in Professional Service / Work’
by her alma mater. She has recently completed her LL.M. (Corporate and Finance Law) from Jindal Global Law
School, her alma mater.

Contents
1. GLOSSARY OF TERMS 01
2. CHOICE OF JURISDICTION FOR SETTING UP AN INDIA-FOCUSED FUND 04
I. Why Offshore Investors are Pooled Outside India 04

II. Why Onshore Investors are Pooled in India 05
III. Which Jurisdictions are Typically Considered for Setting up India Focused Funds
Pooling Offshore Investors 05
3. STRUCTURAL ALTERNATIVES FOR INDIA-FOCUSED FUNDS 11
I. Structuring India focused Offshore Funds 11

II. Foreign Investment Regimes 11
4. ALTERNATIVE INVESTMENT FUNDS IN INDIA 18
I. Introduction 18
II. Alternative Investment Funds 18
III. Choice of Pooling Vehicle 19
IV. Classification of AIFs 21
V. Investment Conditions and Restrictions under the AIF Regulations 22
VI. Investment Restrictions and Conditions for AIFs 22
VII. Key Themes under the AIF Regulations 24
VIII. Taxation of Alternative Investment Funds 31
5. TRENDS IN PRIVATE EQUITY 39
I. Trending fund terms 39
6. FUND DOCUMENTATION 44
I. At the Offshore Fund Level 44

II. At the Onshore Fund Level 45
III. Investor Side Letters 46
IV. Agreements with Service Providers 47
V. Applicability of Stamp Duty 47
7. Hedge Funds 48
I. FPI Regulations 48
II. Onshore Hedge Funds 55
8. FUND GOVERNANCE 57
I. Investment Manager 57
II. Investment Committee 57
III. Advisory Board 57
IV. Aspects and Fiduciaries to be considered by Fund Directors 57
9. INTERNATIONAL TAX CONSIDERATIONS 61
I. Association of Persons (AOP) Risk 61

II. Taxation of Indirect Transfers 61
III. General Anti-Avoidance Rule (GAAR) 64
IV. Business Connection / Permanent Establishment Exposure 66

Contents
ANNEXURE I 69
Sector Focused Funds 69
ANNEXURE II 75
Summary of Tax Treatment for Mauritius, Singapore and Netherlands Based Entities
Participating in Indian Opportunities 75

1. Glossary of Terms
Term Explanation
AAR Authority for Advance Ruling, Ministry of Finance, Government of India
AC Authorised Company
ADIA Abu Dhabi Investment Authority
AIF Alternative Investment Fund as defined under the SEBI (Alternative Investment Funds) Regulations, 2012
AIFMD Alternative Investment Fund Managers Directive
AIF Regulations SEBI (Alternative Investment Funds) Regulations, 2012
AIPAC Alternative Investment Policy Advisory Committee
AML Anti-Money Laundering
AUM Assets under management
AOP Association of Persons
BACO Best Alternative Charitable Option
BEPS Base Erosion and Profit Shifting
BIPA Bilateral Investment Promotion and Protection Agreements
BIS Bank for International Settlements
CBDT Central Bureau of Direct Taxes, Department of Revenue, Ministry of Finance, Government of India
CBLO Collateralized Borrowing and Lending Obligations
CCD Compulsorily Convertible Debentures
CCPS Compulsorily Convertible Preference Share
Companies Act The Companies Act, 1956 and/or the Companies Act, 2013 (to the extent as may be applicable)
COR Certificate of Registration
CSR Corporate Social Responsibility
CTA Covered Tax Agreements
DDP Designated Depository Participant
DDT Dividend Distribution Tax
DFIs Development Financial Institutions
DI Regulations Foreign Exchange Management (Debt Instruments) Regulations, 2019
DTAA Double Taxation Avoidance Agreement
ECB External Commercial Borrowing
EEIG European economic interest groupings
ESG Environment, Social and Governance policies
FATCA Foreign Account Tax Compliance Act
FATF Financial Action Task Force
FATF Release Jurisdictions under Increased Monitoring
FCCB Foreign Currency Convertible Bond
FCPA Foreign Corrupt Practices Act
FDI/ FDI Policy Foreign Direct Investment / Consolidated Foreign Direct Investment Circular of 2017
FEMA Foreign Exchange Management Act, 1999
FII Foreign Institutional Investor
FII Regulations SEBI (Foreign Institutional Investors) Regulations, 1995
FIPB Foreign Investment Promotion Board, Department of Economic Affairs, Ministry of Finance, Government of
India
FMV Fair Market Value
FPI Foreign Portfolio Investor
FPI Regulations 2019 SEBI (Foreign Portfolio Investors) Regulations, 2019
FSC Financial Services Commission, Mauritius
FVCI Foreign Venture Capital Investor
FVCI Regulations SEBI (Foreign Venture Capital Investors) Regulations, 2000
FTS Fees for Technical Services
© Nishith Desai Associates 2022 Provided upon request only 1

GAAR General Anti-Avoidance Rules

GBC-1 Category 1 Global Business (GBC–1) License
GIFT City Gujarat International Finance Tech-City
GIIN Global Impact Investing Network
GIIRs Global Impact Investing Rating System
GPs General Partners (Fund Managers)
GST Goods & Services Tax
GoI Government of India
JOBS Act Jumpstart Our Business Startups Act
IC Investment Committee
ICDR Regulations SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009
IFSC International Financial Services Centers
IFSCA International Financial Services Centres Authority
IFSCA Act International Financial Services Centres Authority Act, 2019
Indian Rupee or “INR” The currency of Republic of India
or “Rs.”
InvIT Infrastructure Investment Trust registered with SEBI under the SEBI (Infrastructure Investment Trusts)
Regulations, 2014
IOSCO International Organization of Securities Commissions
IP Intellectual Property
IPO Initial Public Offer
IRIS Impact Reporting & Investment Standards
ITA Income-tax Act, 1961
ITA Rules Income Tax Rules, 1962
KYC Know Your Customer
LoB Limitations on Benefits
LLP Limited Liability Partnership
LLP Act Limited Liability Partnership Act, 2008
LPAC Limited Partners’ Advisory Committee
LPs Limited Partners (Fund Investors)
LRS Liberalised Remittance Scheme
MAT Minimum Alternate Tax
MIM Multiple Investment Management
Minimum Investment INR 10 million
Amount
MLI Multilateral Instrument
NAV Net Asset Value
NCD Non-convertible Debentures
NDI Rules Foreign Exchange Management (Non-debt Instruments) Rules, 2019
NRI Non-Resident Indian
OCB Overseas Corporate Body
ODI Offshore Derivative Instrument
ODI Regulations Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004
OECD Organisation for Economic Co-operation and Development
Onshore Fund Domestic Pooling Vehicle
Operational Operational Guidelines for FPIs, DDPs and EFIs
Guidelines
OEIC Open-ended Investment Company
ODI Offshore Derivative Instrument
Offshore Fund Means a pooling vehicle established outside India
OTT Over-The-Top
P-notes Participatory notes

PAN Permanent Account Number

PCC Protected Cell Companies
PE Private Equity
PPM Private Placement Memorandum
P-Notes Participatory Notes
POEM Place of Effective Management
PPT Principal Purpose Test
Protocol Protocol signed between India and Mauritius to amend the Mauritius India Double Taxation Avoidance
Agreement
QFI Qualified Foreign Investor
RBI Reserve Bank of India
REITs Real Estate Investment Trusts
RE Funds Real Estate Funds
RoC Registrar of Companies
RTA Registrar to an issue / share transfer agent
SCRA Securities Contracts (Regulation) Act, 1956
SEBI Securities and Exchange Board of India
SEBI Act Securities and Exchange Board of India Act, 1992
SEC U.S. Securities and Exchange Commission
SGD Singapore Dollars
SITA Singapore Income Tax Act
SMEs Small and Medium-sized Enterprises
SPCs Segregated Portfolio Companies
SPV Special Purpose Vehicle
TDS Tax Deducted at Source
TRC Tax Residency Certificate
TISPRO Regulations Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India)
Regulations, 2017
UN United Nations
USD US Dollars
VC Venture Capital
VCC Variable Capital Companies
VCF Venture Capital Fund
VCF Regulations SEBI (Venture Capital Funds) Regulations, 1996
VCPE Venture Capital and Private Equity
VCU Venture Capital Undertaking
2015 Circular Circular no. 4 of 2015

2. Choice of Jurisdiction for Setting up an

India-Focused Fund
There are several factors that inform the choice of jurisdiction for setting up a pooled investment vehicle.
A suitable jurisdiction for setting up a fund should primarily allow tax neutrality to the investors. ‘Neutrality’
ensures investors are not subject to any higher taxes than if they were to invest directly. From a regulatory
viewpoint, the jurisdiction should allow flexibility in raising commitments from resident as well as non- resident
investors, making investments and distribution of profits.
The government is working towards easing the norms for effective mobilization of the domestic pool of investors
in India (consisting of institutional investors like banks, insurance companies, mutual funds and high net worth
individuals). The AIPAC reports 1 have also recommended unlocking domestic capital pools for providing fund
managers an access to domestic pools as this investor class currently constitutes approximately 10% of the total
VCPE invested in India annually. In fact, the fourth AIPAC Report has also listed ‘expanding the existing domestic
capital pools’ as one of three imperative pillars for scaling up the industry to its next phase of growth. 2
The Finance Act, 2021, has introduced a regime to provide tax neutrality in case of relocation of foreign funds to
IFSC. Such amendment has made relocation from another country to IFSC tax neutral i.e. the transfer of capital
asset by an ‘original fund’ (from a tax treaty jurisdiction) to a ‘resultant fund’ in IFSC. The ‘relocation’ is exempt
from tax, subject to certain conditions. The details of this regime have been covered below.
I. Why Offshore Investors are Pooled Outside India

India follows source-based taxation on capital gains and taxes thereon may not be creditable in the home
jurisdiction of the offshore investors. Accordingly, offshore structures are used for offshore investors to invest into
India to avoid double taxation on the same income stream. Further, if the offshore investors are pooled outside
India, the requirement to obtain a Permanent Account Number (“PAN”) card and filing of tax returns will only be
on the Offshore Fund, as opposed to each of the offshore investors (in case of direct participation of such investors
in an onshore pooling vehicle). Further, India does not have Bilateral Investment Promotion and Protection
Agreements (“BIPA”) with all countries.
Offshore investors are preferably pooled in jurisdictions which have a BIPA with India, which may provide
investors an access to several reliefs, including fair and equitable treatment, protection against expropriation,
reparability of capital, an efficient dispute resolution framework and other rights and reliefs. Further, India based
structures with foreign participation which are not Indian managed and sponsored may require regulatory
approvals, compliance with pricing norms and may be subject to performance conditions in certain sectors.3
1. The report was issued on December 01, 2016 and can be accessed at http://www.sebi.gov.in/cms/sebi_data/ attachdocs/1480591844782.pdf. Our
memo on AIPAC I (dated January 20, 2016) can also be accessed at http://www.nishithdesai. com/ information/research-and-articles/nda-ho-
tline/nda-hotlinesingle-view/newsid/3304/html/1. html?no_cache=1).
2. https://ivca.in/wp-content/uploads/2018/08/AIPAC-4.pdf.
3. Any downstream investment by an AIF (which receives foreign contributions) will be regarded as foreign investment if the Sponsor and the In-
vestment Manager of the AIF are not owned and controlled by resident Indian ‘citizens. The ownership and control is determined in accordance
with the NDI Rules.

2. Choice of Jurisdiction for Setting up an India-Focused Fund
II. Why Onshore Investors are Pooled in India

Resident investors prefer onshore structures for the following reasons:
a. The Liberalised Remittance Scheme (“LRS”) issued by RBI allows Indian resident individuals to remit abroad
up to USD 250,000 per person per financial year for any permissible current or capital account transaction
or a combination of both, subject to the restrictions and conditions laid down in the Foreign Exchange
Management Act, 1999 (“FEMA”) and related rules and regulations.
b. Regulation 7 of the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations,
2004 (“ODI Regulations”) stipulates certain conditions to be met by Indian corporations when making
investments in an entity outside India engaged in financial services activities (including fund or fund
management vehicles). The conditions include, inter-alia, (i)_ that the Indian entity should have earned net
profits during the preceding three financial years from the financial services activities; (ii) that it is registered
with the regulatory authority in India for conducting the financial services activities; (iii) that it has obtained
approval from the concerned regulatory authorities, both in India and abroad, for venturing into such
financial sector activity; and (iv) has fulfilled the prudential norms relating to capital adequacy as prescribed
by the concerned regulatory authority in India. In addition to the aforementioned conditions, in case where
individual residents and Indian corporates invest abroad into a fund which further invests into India, it could
raise round tripping concerns.
c. Under a domestic fund structure, in most cases (especially for Category I or II AIFs), the fund vehicle (typically
a trust entity registered with SEBI as an AIF) is not to be taxed on any income that is earned from the
investments. The income earned is taxable in the hands of the investors when the venture capital fund / AIF
distributes the same to the investors. Further, the characterization of income in their hands is the same as that
realized / distributed by the investee company to the fund.
By contrast, if distributions were to be received in the form of dividend or interest from an Offshore Fund
structure, the Indian resident investors would typically have to recognize the distribution as ‘income’ and as a
result, could be taxed in India (at the time of receipt).
III. Which Jurisdictions are Typically Considered for

Setting up India Focused Funds Pooling Offshore
Investors
A. Mauritius
India has received FDI amounting to USD 154 billion (approximately) from Mauritius between April, 2000 –
December, 2021.4 Between April, 2000 and December, 2021, FDI from Mauritius accounted for 27% of the total FDI
received by India.5 During the FY 2020-21, India attracted USD 5.64 billion in FDI from Mauritius.6 The bilateral
trade between the countries dipped to USD 690 million in FY 2019-20 from USD 1.2 billion in FY 2018-19.7
4. https://dpiit.gov.in/sites/default/files/FDI%20Factsheet%20December%2C%202021.pdf
6. https://dpiit.gov.in/sites/default/files/FDI%20Factsheet%20December%2C%202021.pdf.
7. https://economictimes.indiatimes.com/news/economy/foreign-trade/india-inks-fta-with-mauritius-the-1st-with-an-africannation/article-
show/81165898.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Accordingly, in order to strengthen and enhance the trade and economic cooperation, Mauritius and India have
signed Comprehensive Economic Cooperation and Partnership Agreement (CECPA), a kind of free trade pact. 8
The Mauritian Financial Services Commission (“FSC”) issued its first ‘Anti-Money Laundering and Countering
the Financing of Terrorism Handbook’, designed to assist licensed financial institutions to adopt a ‘more effective,
risk-based and outcome-focused approach’ in January, 2020. The Handbook offers financial institutions guidance
on applying national measures to combat, inter-alia, money laundering and terrorist financing. On February 21,
2020, the FATF has issued a list of ‘Jurisdictions under Increased Monitoring’ commonly known as ‘the grey list’
which included Mauritius alongside 17 other jurisdictions.9 Consequently, it was also included (along with 11
other countries) on the European Union’s revised list of high-risk countries that have ‘strategic deficiencies in
their AML- CFT framework’. The EU ‘blacklisting’ applied as of 1 October 2020. After inclusion in the list, FDI
inflow from Mauritius fell from USD 8.24 billion in 2019-20 to USD 5.64 billion in 2020-21. 10
Following its listing, Mauritius made a high-level political commitment to the FATF to address the strategic
deficiencies identified. A committee headed by the Mauritius Prime Minister was assembled to accelerate
implementation of its action plan 11 and secure removal from the FATF list by September 2021. Building on the
regulatory and policy announcements, and following the work undertaken by the competent authorities in
Mauritius, the FATF, at its June 2021 Plenary Session, endorsed the substantial and expeditious progress made by
Mauritius to consolidate the jurisdiction’s AML/CFT regime. Due to this, on October 23, 2021 by an official order,
FATF announced the removal of Mauritius from the “FATF” grey list. 12
India and Mauritius have shared close economic, political and cultural ties for more than a century. There has
been close cooperation between the two countries on various issues including trade, investment, education,
security and defense.
The India-Mauritius DTAA underwent a change through the protocol signed between India and Mauritius on
May 10, 2016 (“Protocol”). Prior to the Protocol, the India-Mauritius DTAA included a provision that exempted
a resident of Mauritius from Indian tax on gains derived from the sale of shares of an Indian company. The
Protocol however, gave India a source based right to tax capital gains which arise from alienation of shares of an
Indian resident company acquired by a Mauritian tax resident (as opposed to the previous residence based tax
regime under the India-Mauritius DTAA). However, the Protocol had provided for grandfathering of investments
and the revised position became applicable to investments made on or after April 01, 2017. In other words, all
existing investments up to March 31, 2017 had been grandfathered and exits / shares transfers in respect of
such investments beyond this date would not be subject to capital gains tax in India. Additionally, the Protocol
introduced a LoB provision which shall be a pre-requisite for a reduced rate of tax 13 (50% of domestic tax rate) on
capital gains arising during a two-year transition period from April 01, 2017 to March 31, 2019.
The modification on capital gains taxation is limited to gains arising on sale of shares. This ensures continuity of
benefit to other instruments and also provides much needed certainty in respect of the position of the India-
8. https://economictimes.indiatimes.com/news/economy/foreign-trade/india-inks-fta-with-mauritius-the-1st-with-an-africannation/article-
show/81165898.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
9. https://www.fatf-gafi.org/publications/high-risk-and-other-monitored-jurisdictions/documents/increased-monitoring-february-2020.html.
10. https://dpiit.gov.in/sites/default/files/FDI%20Factsheet%20December%2C%202021.pdf.
11. With a view to enhancing the effectiveness of the AML/CFT measures and pursuant to Mauritius’ action plan, several working groups were
constituted at a national level to tackle the deficiencies identified in the jurisdiction’s AML/CFT regime.
12. Jurisdictions under Increased Monitoring - October 2021, FATF available at https://www.fatf-gafi.org/publications/high-risk-and-other-moni-
tored-jurisdictions/documents/increased-monitoring-october-2021.html.
13. This benefit shall only be available to such Mauritius resident who is (a) not a shell/conduit company and (b) satisfies the main purpose and
bonafide business test.

Mauritius DTAA. However, despite this, transactions related to the India-Mauritius DTAA continue to be closely
scrutinised by tax authorities in India.14
The sale of debentures continues to enjoy tax benefits under the India-Mauritius DTAA. That, coupled with the
lower withholding tax rate of 7.5% for interest income earned by Mauritius investors from India, comes as big
boost to debt investments from Mauritius. Prior to the Protocol, interest income arising to Mauritius investors
from Indian securities / loans were taxable as per Indian domestic law. The rates of interest could go as high as 40%
for rupee denominated loans to non-FPIs. The Protocol amended the DTAA to provide for a uniform rate of 7.5%
on all interest income earned by a Mauritian resident from an Indian company. The withholding tax rate offered
under the India-Mauritius DTAA is significantly lower than those under India’s treaties with Singapore (15%) and
Netherlands (10%). This should make Mauritius a preferred choice for debt investments into India, going forward.
Further, the Protocol introduced Article 26A to the India-Mauritius DTAA. It provided that India and Mauritius
shall lend assistance to each other in the collection of revenue claims. It allowed for Mauritius authorities to
enforce and collect taxes of Indian revenue claims, as if such claims were its own, upon a request from Indian
revenue authorities. Currently, in relation to MLI, Mauritius has not included India in its definitive notification,
accordingly, India-Mauritius DTAA is not considered a CTA. In case Mauritius notifies India-Mauritius DTAA as
CTA, there could be a significant change in tax positions from investments made through the Mauritius route and
its impact on fund structuring would have to be determined accordingly.
On a separate note, the FSC had introduced domestic substance rules to be satisfied by Mauritius based GBC-1
entities incorporated after January 01, 2015.The substance rules were amended vide circulars issued by the FSC
on October 12 and 15, 2018 to be effective from January 01, 2019. 15 Further, as part of the amendments brought
by the Finance Act, 2018, Category 1 and Category 2 Global Business licenses will no longer be issued by FSC
from January 01, 2019. Instead, new licenses namely the Global Business Corporation (“GBC”) and Authorised
Company (“AC”), were introduced by the FSC. The license requirements stipulate core income generating
activities to be carried out by the GBC namely: (i) employing, either directly or indirectly, a reasonable number of
suitably qualified persons to carry out the core activities; and (ii) having a minimum level of expenditure, which
is proportionate to its level of activities. While determining the same, the FSC will take into consideration the
nature and level of core income generating activities conducted (including the use of technology) by the GBC.
The FSC also provided indicative guidelines for determining what would constitute as “a reasonable number of
suitably qualified persons” and “a minimum expenditure which is proportionate to its level of activities”. Further,
in order to qualify for tax holidays under the Mauritius Income Tax Act, the FSC also stipulated that the licensees
would require to possess a physical office and also specified the minimum number of employees which should
be resident in Mauritius and also minimum amount of annual operating expenditure that should be incurred in
Mauritius or assets to be under their management depending on the type of office.
The FSC on October 12, 2021, published a draft Variable Capital Companies (“VCC”) Bill (“VCC Bill”). The VCC
Bill aims to provide a legal framework for the incorporation, conversion, structure, operation and termination of
VCCs in Mauritius. The proposed introduction of VCCs was first announced as part of the National Budget Speech
2020–2021 in June and is intended to further enhance the competitiveness of the financial services sector and
diversify the product base of the Mauritius International Financial Centre (IFC). This new corporate structure will
increase the competitiveness of Mauritius for alternative and flexible fund structures and propel the country to be
an equivalent jurisdiction for incorporating funds.16
14. Several MNCs under IT scanner for deals done via Mauritius Cos https://economictimes.indiatimes.com/news/economy/policy/several-mncs-
under-it-scanner-for-deals-done-via-mauritius-cos/articleshow/88419639.cms?utm_source=contentofinterest&utm_medium=text&utm_cam-
paign=cppst
15. https://f.datasrvr.com/fr1/118/86693/GBC_Circular_Substance.pdf.
16. https://www.fscmauritius.org/media/112460/communiqu%C3%A9-vcc-bill.pdf.

B. Singapore
Singapore is one of the more advanced holding company jurisdictions in the Asia-Pacific region. Singapore
possesses an established capital markets regime that is beneficial from the perspective of listing a fund on the
Singapore stock exchange. Further, the availability of talent pool of investment professionals makes it easier to
employ / relocate productive personnel in Singapore.
During April – December, 2021, India received the highest FDI from Singapore of approximately USD 11 billion.
17 India and Singapore are poised to see enhanced economic cooperation as well as an increase in trade and
investment flows. This is well reflected from the fact Singapore was one of the top source of FDI into India for
the third consecutive financial year, accounting for about 22 % of FDI inflows in 2020-21. 18 Singapore has also
launched the Variable Capital Companies (“VCC”) framework on January 14, 2020, to allow set up of investment
funds across traditional and alternative strategies marking a significant chapter in propelling Singapore as an
international fund management and domiciliation hub, VCCs provide fund managers with greater flexibility
on the domiciliation of extensive range of investment funds. The provision of operational flexibility and cost
savings has become an enticing factor for the Indian fund managers to set up offshore fund in the VCC form,
giving Singapore a distinct advantage which in turn will lead to the development of the overall fund management
industry in Singapore.
The India-Singapore DTAA, was co-terminus with the India-Mauritius DTAA, hence exemptions under the India-
Singapore DTAA would continue to be applicable till such benefits were available under the India-Mauritius
DTAA. Subsequent to the India-Mauritius DTAA being amended, India and Singapore also signed a protocol on
December 30, 2016 to amend the India-Singapore DTAA. The amendments introduced were largely along the
lines of those introduced under the India- Mauritius DTAA, wherein the fundamental change was to provide for
source base taxation of capital gains arising out of sale of Indian shares held by Singapore residents as opposed to
residence based taxation for the same.
Singapore does not impose tax on capital gains. Gains from the disposal of investments may, however, be construed
to be of an income nature and subject to Singapore income tax. Generally, gains on disposal of investments
are considered income in nature and sourced in Singapore if they arise from or are otherwise connected with
the activities of a trade or business carried on in Singapore. As the investment and divestment of assets by the
Singapore based entity are managed by a manager, the entity may be construed to be carrying on a trade or business
in Singapore. Accordingly, the income derived by the Singapore based entity may be considered income accruing in
or derived from Singapore and subject to Singapore income tax, unless the Singapore based fund is approved under
Section 13O and Section 13Urespectively of the Singapore Income Tax Act (Chapter 134) (“SITA”) and the Income
Tax (Exemption of Income of Approved Companies Arising from Funds Managed by Fund Manager in Singapore)
Regulations, 2010. Under these Tax Exemption Schemes, “specified income” derived by an “approved company”
from “designated investments” managed in Singapore by a fund manager are exempt from Singapore income tax.
For fund managers considering Singapore resident structures, a combination of Singapore resident investment
funds and Special Purpose Vehicles (“SPV”) can be considered, given the tax exemption schemes and the tax
proposals for the companies under the domestic law.
The protocol to the India-Singapore DTAA inserted Article 28A to the DTAA which reads:
“This Agreement shall not prevent a Contracting State from applying its domestic law and measures
concerning the prevention of tax avoidance or tax evasion.”
18. https://www.ibef.org/news/singapore-top-source-of-fdi-in-fy20-with-investments-worth-us-1467-billion.

The language of the newly inserted Article 28A made it clear that the Government of India (“GoI”) sees the GAAR
as being applicable even to situations where a specific anti-avoidance provision (such as an LoB clause) may already
exist in a DTAA. Interestingly, similar language was not introduced by the Protocol to the India-Mauritius DTAA.
Making the GAAR applicable to companies that meet the requirements of a LoB clause is likely to adversely
impact investor sentiment. Further, India-Singapore DTAA has been notified as a CTA and accordingly, the LoB
clause contained in Article 24A of the India-Singapore DTAA would be superseded by the PPT. Demonstration of
commercial substance would be imperative to claim benefits under the India-Singapore DTAA.
C. Ireland
Ireland is a tax-efficient jurisdiction when investment into the Indian company is in the form of debt or
convertible debt instrument. Interest, royalties and fees for technical services (“FTS”) arising in India and paid
to an Irish resident may be subject to a lower withholding tax of 10% under the India-Ireland DTAA. This is a
significant relief from the withholding under Indian domestic law which can be as high as 42% for interest.
Ireland can, therefore, be explored for debt funds or real estate funds that provide structured debt and also film
funds that provide production financing for motion pictures where cash flows received from distributors could be
in the nature of royalties. However, the characterization of income would need to be assessed on a case-by-case basis.
However, the changes introduced by the protocols to the India-Mauritius and India-Singapore DTAA on taxation
of interest income (as summarized above) make Mauritius and Singapore favorable choice of jurisdictions even
for debt funds. The costs of setting-up in Mauritius or Singapore are likely to be less expensive than Ireland.
D. Netherlands
With its robust network of income tax treaties, Netherlands is an established international fund domicile.
In the context of inbound investments to India, Netherlands emerges as an efficient jurisdiction for making
portfolio investments. post-Brexit, investors Britain is no longer part of the common market, and distributions
are likely to suffer double taxation, which was relieved through the various EU freedoms and the Parent-
Subsidiary Directive. Most Dutch people speak English fluently allowing for ease of communication. The Central
European Timezone and ease of mobility it provides between continents, the Netherlands provides an efficient
communications and physical bridge between India and the US. Its absence from any black or grey lists, and given
its stable legal and political regimes, enables the Netherlands to emerge as a front runner for fund formation.
From a tax perspective, the India-Netherlands tax treaty provides relief from economic double taxation by
ensuring that capital gains are exempt from tax in India in certain scenarios, arising both from direct as well as
indirect transfers. Gains arising to a Dutch resident arising from the sale of shares of an Indian company to non-
resident buyer would not be taxable in India. However, such gains would be taxable if the Dutch resident holds
more than 10% of the shares of the Indian company in case of sale to Indian residents. Even though the eligible
holding is capped, the same structure works well for FPIs, who are restricted to participate (whether directly or
indirectly or synthetically through ODIs) to less than 10% of the paid-up capital of an Indian company. In some
cases the capital gains may also qualify for the participation exemption in the Netherlands.
For a Dutch entity to be entitled to relief under the India-Netherlands DTAA, it has to be liable to pay tax in the
Netherlands. This should not be an issue for entities such as Dutch limited liability companies (BVs), public
companies (NVs) or Cooperatives investing or doing business in India.

In the case of KSPG Netherlands, 19 it was held that sale of shares of an Indian company by a Dutch holding
company to a non-resident would not be taxable in India under the India-Netherlands DTAA. It was further held
that the Dutch entity was a resident of the Netherlands and could not be treated as a conduit that lacked beneficial
ownership over the Indian investments. The mere fact that the Dutch holding company was set up by its German
parent company did not imply that it was not eligible to benefits under the India- Netherlands DTAA.
It may be noted that difficulties with respect to treaty relief may be faced in certain situations, especially in the
case of general partnerships and hybrid entities such as closed limited partnerships, European economic interest
groupings (“EEIG”) and other fiscally transparent entities.
19. [2010] 322 ITR 696 (AAR).

3. Structural Alternatives for India-Focused

Funds
I. Structuring India focused Offshore Funds

PE and VC funds typically adopt one of the following modes when investing into India: (1) direct investment
in the Indian portfolio company; (2) direct or indirect investment in an Indian investment fund vehicle;, or (3)
co-investment along-side the domestic fund vehicle directly in the Indian portfolio company: and (4) investment
through an AIF set-up in IFSC. We explore all models in the brief below.
II. Foreign Investment Regimes

India’s exchange control regime is set out within FEMA and the rules and regulations thereunder. FEMA regulates
all inbound and outbound foreign exchange related transactions, in effect regulating (or managing) the capital
flows coming into and moving out of the country. Subject to certain conditions, such as pricing restrictions, in
most industry sectors, if the percentage of equity holding by non- residents does not exceed certain industry-
specific thresholds (sectoral caps) then FDI does not require prior GoI approval. However, FDI requires prior
GoI approval by the concerned ministry/ department if it is in excess of sectoral caps, is in breach of specified
conditions or is made in a sector which specifically requires the approval.
The RBI is given primary authority to regulate capital flows through the FEMA. With the promulgation of
Finance Act 2015, the power to classify and regulate permissible capital account transactions involving non-debt
instruments was transferred to the Central Government whereas debt instruments remained with the RBI. This
re-allocation of powers was implemented when on October 17, 2019, the Central Government notified the NDI
Rules repealing TISPRO Regulations.
The primary routes for foreign investment into India are the (a) FDI 20 route, (b) FVCI 21 route and (c) FPI 22 route.
A. Pure Offshore Structure

A pure offshore structure is typically used for investing primarily into India where there is no intent to pool
capital at the domestic (i.e. India) level and the entire portion of the GP economics is intended to be extracted
overseas, without any Indian beneficiaries. The Offshore Fund manager, to the extent that it intends to make
investments into India, may engage an India based advisory team to provide non-binding investment advice
pertaining to suitable India opportunities.
20. This refers to investment through capital instruments by a person resident outside India in an unlisted Indian company; or in 10 percent or more
of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company. While the RBI allows capital account transactions,
these are subject to the NDI Rules. Thus, ‘direct’ investments by the offshore fund vehicles / SPVs (SPV would need to comply with the provi-
sions and restrictions stipulated under the NDI Rules.
21. Given that the FVCI regime has been developed to attract venture capitalists, there are certain incentives attached to being recognised as one.
This accordingly requires registration and approval from the regulators (SEBI and RBI). While granting approval to an FVCI, certain restric-
tions and conditions may be imposed including a restriction on the scope of investments that can be made by the FVCI. The RBI has recently
been prescribing in its approval letter to FVCI applicants that the investments by FVCI entities are restricted to select identified sectors (which
include, inter alia, infrastructure, biotechnology and IT related to hardware and software development). However, RBI has relaxed such sectoral
restrictions for investing FVCIs into “startups’ (as defined in the relevant amendment to NDI Rules). It is also important to note that SEBI-regis-
tered FVCIs are specifically exempted from the RBI pricing guidelines.
22. The FPI Regulations, 2014 classified FPIs into three categories based on their perceived risk profile. The FPI route as such is the preferred route
for foreign investors who want to make portfolio investments and trade in Indian listed stocks on the floor of the stock exchange.

3. Structural Alternatives for India-Focused Funds
Under this structure, a pooling vehicle (Offshore Fund) is set up in an offshore jurisdiction. Offshore investors
commit capital to the Offshore Fund which in turn makes investments into Indian portfolio companies (under
one or more of the inbound investment regimes mentioned above) as and when investment opportunities arise.
A pure offshore structure may also be used for strategies with a diversified geographical coverage, where India
may be one of the pockets. In such structures, depending on certain variables, Indian resident individuals may
also allocate commitments into the Offshore Fund.
The following diagram depicts a pure offshore structure:
Overseas
Various Jurisdictions
Investors
Management
Agreement / Fees Offshore
Offshore Fund Investment Manager
India Advisory
Services / Fees
Investment / Contribution
Distributions
Investment
Portfolio Advisor
Companies
B. Unified Investment Structure

Under this structure, an AIF as a trust or limited liability partnership (“LLP”) or company (i.e., the (“Onshore
Fund”) is formed in India. The domestic investors directly contribute to the Onshore Fund whereas overseas
investors pool their monies in an offshore feeder vehicle (“Feeder”) which, in turn, invests primarily in the
Onshore Fund. The Onshore Fund is registered with SEBI under the AIF Regulations.
A unified structure is generally used where commitments from both domestic and offshore investors are pooled
into a domestic pooling vehicle (Onshore Fund) and the team is split between India and overseas. Alternatively,
the unified structure can also be adopted by an India based management team that seeks to extract management
fee and carry allocations for the entire structure at the Onshore Fund level.

The following diagram depicts a typical unified investment structure:
Various Jurisdictions Foreign

Investors
Portfolio
Companies
Feeder
Fund
India
Management
agreement / fee
Investment
Manager Onshore Domestic
Fund Investors
Trustee
Distributions
Portfolio
Companies
Favorable reasons for a unified structure
a. Non- applicability of foreign investment restrictions: Under the unified structure, investments made by the
Onshore Fund into Indian opportunities with the capital contributions received from the Feeder or any other
foreign investors is not subject to any FDI related restrictions, if the manager and sponsor of the Onshore Fund
are owned and controlled by resident Indian citizens.. Therefore, the restrictions placed on foreign investments
such as FDI Policy related restrictions including (a) sector specific caps (b) choice in instruments being
limited to equity shares, fully, compulsorily convertible debentures and fully, compulsorily and mandatorily
convertible preference (c) optionality clauses being subject to conditions (d) pricing guidelines, etc. shall not be
applicable to the investments made in India through the unified platform (which would have been otherwise
applicable in respect of investments directly made by the Feeder in Indian opportunities).
b. Consolidation of corpus: A unified structure allows aggregation of assets-under-management across both

the Feeder and Onshore Fund level. A larger corpus at the Onshore Fund level will help tap more capital
from those LPs whose commitments are linked to the corpus of the Onshore Fund and allow the manager to
evaluate larger deals as the portfolio concentration requirements can be met using the larger aggregate pool at
the Onshore Fund level. In this regard, it is important to understand the differences between pooling offshore
investors directly into the Onshore Fund versus a unified structure. There is a consolidation of corpus in both
the cases, however, there are other reasons for pooling offshore investors in an offshore vehicle (i.e. unified
structure) which are summarized below: (i) In case of investment by offshore investors in the Onshore Fund,
each offshore investor may be required to obtain a PAN from Indian income tax authorities and file income tax
returns in India; (ii) while making distributions to offshore investors under the direct structure, the Onshore
Fund has to consider withholding tax rates in force between India and the concerned country of each of the
relevant offshore investor. In case of the Feeder set up, the tax status of the Feeder is to be considered.

c. Tax pass-through and DTAA eligibility: Category I and Category II AIFs have been accorded tax pass
through status under the ITA, i.e. the income received by a unit-holder through the Onshore Fund will be
chargeable to income-tax in the same manner as if it were the income arising to such unit-holder directly
from the Indian investments by the unit-holder.23 Accordingly, the tax liabilities of the Feeder should
remain the same (as would be for direct investments) under the unified structure. The protocols to the
India-Mauritius DTAA and India-Singapore DTAA give India the right to tax capital gains arising from
the transfer of equity shares. Despite the changes introduced by the protocols, Mauritius and Singapore
continue to be favorable jurisdictions from a tax perspective with respect to non-equity investments as
Mauritius and Singapore would continue to have the right to tax capital gains arising from the transfer of
such investments. Further, the lower withholding tax rate of 7.5 % introduced by the Protocol on interest
income earned by Mauritius resident from Indian companies provides Mauritius a competitive advantage
for debt investments in India as compared to other jurisdictions.
d. Favorable regime: The GoI wants to promote onshore fund management activities.
With amendments brought about by the Finance Act, 2015 (the “2015 Act”) in relation to the criteria for
determining the tax residence of companies incorporated outside India, a foreign company should not
be a tax resident of India in a particular financial year if the company’s POEM in that financial year is
not located in India. POEM has been defined to mean “a place where key management and commercial
decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made”.
The provisions in relation to POEM are applicable from the financial year 2016-17.
e. Decision-making: Under the unified structure, the Feeder will make a principal investment-related
decision i.e. whether or not to invest in the Onshore Fund. The Feeder may need to make additional
decisions if certain offshore / Indian investments are required to be made directly by the Feeder. Since most
of the decisions in respect of the Onshore Fund are to be taken by the India based investment manager,
risks such as that of the Feeder having a permanent establishment or its POEM in India, are reduced.
C. Co-investment / Parallel Investment Structure

A co-investment structure is adopted where the commercial expectation is to raise separate pools of capital for
domestic investors and for offshore investors as well as to extract carry outside India. Accordingly, separate
pooling vehicles will need to be set up in India (i.e. Onshore Fund) and in an offshore jurisdiction (Offshore Fund).
The Offshore Fund and the Onshore Fund typically have separate management structures. The Onshore Fund
is managed by an India-based investment manager which entity may provide recommendations on investment
opportunities to the management of the Offshore Fund on a non-binding basis.
Typically, the co-investment ratio between the Offshore Fund and the Onshore Fund is the ratio of their undrawn
capital commitments.
The co-investment structure allows independent investments by the Offshore Fund and the Onshore Fund on the
basis of their undrawn commitments in case the other runs out of dry powder. Further, it also provides greater
flexibility to Onshore Fund allowing it to make investments irrespective of the Offshore Fund’s ability to do so.
23. S. 115UB read with s. 10(23FBA), s. 10(23FBB) and s. 194LBB of the ITA.

Certain tax risks exist in such structures as there is a possibility of the Onshore Fund and the Offshore Fund being
taxed together in India as an ‘association of persons’ (“AOP”) and thus, suffer disproportionately higher tax rates.
However, the Indian tax authorities have so far not challenged any co-investment structures on such grounds.
Further, due to the CESTAT ruling upholding levy of service tax on carried interest, there is an increased interest
in exploring co-investment structures as significant amount of carried interest can be extracted outside India
depending upon commercial considerations.
The following diagram depicts a typical co- investment structure:
Overseas
Investors
Various Jurisdictions
Management
Agreement / Fees Offshore
Offshore
Fund Investment Manager
India
Management
Onshore Agreement
Investment / Contribution Domestic
Fund
Distributions Trustee Investment Manager
Management
fees + carry
Portfolio
Companies
D. AIF established in IFSC

The GoI is encouraging investments through IFSC with the objective of inter-alia onshoring the fund
management industry to India. Prior to the establishment of IFSCA in 2020, SEBI had introduced operating
guidelines for setting up AIFs in IFSC in 2015 and 2018, which were amended up to August 2020. While section
18 of the Special Economic Zone, Act, 2005 originally allowed SEBI to prescribe guidelines for units in IFSCs, the
IFSCA Act, 2019 (through section 13 read with section 33) amends the SEBI Act, 1992 and the Securities Contract
(Regulation) Act, 1956 (“SCRA”) to take away the power of SEBI under section 18 of the SEZ Act, 2005. Section(s)
13 and 33 of IFSCA Act, 2019 came into force on October 01, 2020.
Accordingly, the AIF Regulations except all amendments made by SEBI to the AIF Regulations after October 01,
2020 were applicable to AIFs in IFSC. The FME Regulations render the AIF Regulations inapplicable in IFSC from
the effective date (i.e. May 19, 2022) of the FME Regulations.

The recently introduced FME Regulations streamline the regulatory framework around registration of pooling
vehicles (as financial products) such as venture capital schemes and other alternative investment funds in IFSC
such that the manager operating such products is required to obtain registration with IFSCA rather than registering
the products each time with IFSCA. Once an AIF manager is registered with IFSCA, it is permitted to launch a fund
within 21 days of filing the private placement memorandum (“PPM”) of the fund with IFSCA (and incorporating all
observations of IFSCA received pursuant to such filing), or even through a green channel without having to wait
for IFSCA’s comments in case it is a fund with only accredited investors or a venture capital scheme.
Several benefits have also been provided to AIFs in IFSC. These benefits inter-alia include exemption from GST on
management fees, permission to borrow funds or engage in leveraging activities subject to fulfillment of certain
conditions and co-invest in a portfolio company through a segregated portfolio. It is also possible to argue that
non-resident investors investing in AIFs in IFSC may not be required to obtain PAN and file income-tax returns in
India, subject to fulfilment of certain conditions.
Further, certain amendments have also been made to regulatory and taxation framework to facilitate relocation
of offshore funds to GIFT City. For instance, the requirement of continuing interest by the manager or sponsor
has been made voluntary in case of relocation of offshore funds to IFSC, tax neutrality has been provided to such
relocation etc.
Having said this, considering that under the FME Regulations, the FME (not the AIF) will be registered, definition
of investment fund may be required to be amended for such funds / schemes to continue to benefit from a tax
pass-through under the ITA. This change will be crucial to ensure clarity and certainty on taxation of funds set up
in IFSC. As a stop gap solution, the IFSCA may issue a certificate of registration to each scheme to ensure that tax
pass through is available to funds based in IFSC as well however it may defeat the purpose of shifting registration
burden on the FME. Similarly, other provisions of ITA like section 56(2)(viib) providing exemption to AIFs from
angel tax, section 10(4D), section 47 of ITA providing tax regime for Category III AIFs in IFSC will also be required
to be amended to apply to funds managed by FMEs registered with IFSCA.
It is to be noted that several nuances are involved in structuring of investment through AIFs in IFSC as they are
considered as persons resident outside India from foreign exchange perspective, while being considered to be
resident of India for tax purposes.
One of the vexing issues which Indian managers while exploring set-up of funds in IFSC have been facing is
the requirement to obtain an approval from the RBI for investment in the manager entity in IFSC. While the
RBI issued a circular24 permitting investment of sponsor contribution from a sponsor Indian Party directly to
an overseas fund including a fund set up in IFSC, the circular did not resolve the issue on capitalisation of the
manager entity. This has been one of the key impediments for establishment of AIFs in IFSC by Onshore Fund
managers.
24. RBI/2021-22/38; A.P.(DIR Series) Circular No. 04 dated May 12, 2021.

The following diagram represents a typical structure of an AIF in IFSC (unified structure):
GIFT City Foreign

Portfolio
Investors
Companies
Management
agreement / fee
FME
AIF in
IFSC
India
Management
agreement / fee
Domestic
Investment Manager Onshore Domestic
Fund Investors
Trustee
Distributions
Portfolio
Companies

4. Alternative Investment Funds in India
I. Introduction
Before the emergence of the Venture Capital Private Equity (“VCPE”) industry in India, entrepreneurs primarily
depended on private placements, public offerings and lending by financial institutions for raising capital.
However, given the considerations involved, these were not always the optimal means of raising funds.
Following the introduction of the Securities and Exchange Board of India (Venture Capital Funds) Regulations
(“VCF Regulations”) in 1996, the VCPE industry successfully filled the gap between capital requirements of fast-
growing companies and funding available from traditional sources such as banks, IPOs, etc. The VCPE industry
has also had a positive impact on various stakeholders – providing much needed risk capital and mentoring to
entrepreneurs, improving the stability, depth and quality of companies in the capital markets, and offering risk-
adjusted returns to investors.
The growth in Venture Capital (“VC”) funding in India can be attributed to various factors. Once the GoI started
becoming more and more aware of the benefits of the VC investments and the criticality for the growth of the
different sectors such as software technology and internet, favorable regulations were passed regarding the ability
of various financial institutions to invest in a venture capital fund (“VCF”). Further, tax treatments for VCFs were
liberalized and procedures were simplified.
Subsequently, in 2012, SEBI took steps to completely overhaul the regulatory framework for domestic funds in
India and introduced the AIF Regulations. Among the main reasons cited by SEBI to highlight its rationale behind
introducing the AIF Regulations was to recognize AIFs as a distinct asset class; promote start-ups and early stage
companies; to permit investment strategies in the secondary markets; and to tie concessions and incentives to
investment restrictions.
Here it is relevant to note that SEBI has adopted a practical grandfathering approach which provides that funds
that are already registered under the VCF Regulations would continue to be governed by those regulations
including for the purpose of raising commitments up to their targeted corpus. However, existing venture capital
funds are not permitted to increase their targeted corpus. Further, new funds and existing funds that are not
registered under any regime would need to be registered under the AIF Regulations.
II. Alternative Investment Funds

Subject to certain exceptions, the ambit of the AIF Regulations is to regulate all forms of vehicles set up in India
for pooling of funds on a private placement basis. To that extent, the AIF Regulations provide the bulwark within
which the Indian fund industry is to operate.
An AIF means any fund established or incorporated in India in the form of a trust or a company or an LLP or a
body corporate which:
a. is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for
investing it in accordance with a defined investment policy for the benefit of its investors; and

b. is not covered under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996,
Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999 or any other
regulations of the Board to regulate fund management activities. 25
III. Choice of Pooling Vehicle

The AIF Regulations contemplate the establishment of funds in the form of a trust, a company, an LLP or a body
corporate. The following table provides a comparison of these entities from an investment fund perspective:
Issue Trust Limited Liability Partnership Company

General The person who reposes or The concept of LLP was recently A Company can be incorporated
declares the confidence is called introduced in India under the LLP under the Companies Act, 2013.
the “author of the trust” 26; Act. An LLP is a hybrid form of a The control of the company is with
the person who accepts the corporate entity, which combines board of directors who are elected by
confidence is called the “trustee”; features of an existing partnership the shareholders.
the person for whose benefit the firm and a limited liability company Separate classes of securities could
confidence is accepted is called (i.e. the benefits of limited liability be issued to different shareholders
the “beneficiary”; the subject for partners with flexibility to that shall determine their rights and
matter of the trust is called “trust organize internal management obligations
property”; the “beneficial interest” based on mutual agreement (as distinct from other classes) from
or “interest” of the beneficiary is amongst the partners). The both, the ‘voting’ perspective as well
the right against the trustee as functioning of an LLP is governed as from a ‘distribution’ perspective.
owner of the trust property; and by the LLP agreement. The class structure, however, would
the instrument, if any, by which need to be in compliance with
the trust is declared is called the Companies Act, 2013, as and when
“instrument of trust”/ “indenture all relevant sections thereof are
of trust” brought into effect.
Entities Involved The Settlor: The Settlor settles Partner: A ‘partner’ represents an Shareholders: Shareholders hold
a trust with an initial settlement. investor in the fund. To that extent, the shares of the company and are
Terms of the indenture of trust a partner has an obligation to fund granted special privileges depending
(“Indenture”) shall administer the its ‘commitment’ to the fund and on the class of shares they own
functioning of the trust (“Trust”). is entitled to distributions based
on fund documents (being the LLP Directors: Directors have a fiduciary
The Trustee: The Trustee Agreement in this case). duty towards the company with
is in charge of the overall respect to the powers conferred
administration of the Trust and Designated Partner: Though the on them by the Companies Act,
may be entitled to a trusteeship expression ‘designated partner’ 2013 and by the Memorandum
fee. The Trustee may also appoint is not explicitly defined, however, of Association and Articles of
an investment manager, who in on a plain reading of the LLP it is Association of the company. They
turn manages the assets of the under- stood that such ‘designated are trustees in respect of powers
Trust and the schemes / funds as partner shall be the person of the company that are conferred
may be launched under such Trust responsible and liable in respect upon them, for instance, powers
from time to time. of the compliances stipulated for of (a) issuing and allotting shares;
The Contributor: The contributor is the LLP. (b) approving transfers of shares;
the investor to the Trust (the Fund) (c) making calls on shares; and (d)
and makes a capital commitment forfeiting shares for non-payment of
under a contribution agreement. call etc. They must act bona fide and
exercise these powers solely for the
benefit of the company.
25. SEBI (AIF) Regulations, 2012, Section 2 (1)(b)

26. Commonly referred to as a ‘settlor’

Management The Trustee is responsible The LLP relies on the Designated The board of directors manages the
of entities for the overall management Partner in this respect. In company involved. In practice this
of the Trust. In practice this practice, this responsibility responsibility is outsourced to an
responsibility is outsourced to an may be outsourced to an investment manager pursuant to an
investment manager pursuant investment manager pursuant investment management agreement.
to an investment management to an investment management
agreement. agreement.
Market Practice Almost all funds formed in India Only a few funds are registered There are no clear precedents for
use this structure. under this structure. The Registrar raising funds in a ‘company’ format.
The regulatory framework of Companies (“RoC”) does
governing trust structures not favor providing approvals to
is stable and allows the investment LLPs. As per section
management to write its own 5 of the LLP Act, 2008, only an
standard of governance. individual or a body corporate is
eligible to be a partner in an LLP.
The following diagram depicts an AIF that is set up in the form of a trust:
Investors Sponsor
Management Investment
Fund Manager
Services
Eligible
Investments

IV. Classification of AIFs

Category I AIF Category II AIF Category III AIF
i. Category I AIFs are funds with strategies to i. Category II AIFs are funds which i. Category III AIFs are funds which employ
invest in start-up or early stage ventures or cannot be categorized as Category complex or diverse trading strategies and may
social ventures or SMEs or infrastructure I AIFs or Category III AIFs. These employ leverage including through investment
or other sectors or areas which the funds do not undertake leverage or in listed or unlisted derivatives and units of
government or regulators consider as borrowing other than to meet day- other AIFs.
socially or economically desirable. to-day operational requirements
and as permitted in the AIF ii. AIFs such as hedge funds or funds which
ii. Under the AIF Regulations, the following funds Regulations. trade with a view to make short-term returns
are designated as sub- categories of Category
I AIFs - venture capital funds, SME funds, ii. AIFs such as private equity funds or such other funds which are open ended and
social venture funds, infrastructure funds or debt funds for which no specific for which no specific incentives or concessions
and such other AIFs as may be specified. In incentives or concessions are given are given by the Government of India
September 2013, SEBI introduced ‘angel by the Government of India or any
investment funds’ as a sub-class of the other regulator are included in the or any other regulator are included in the
venture capital fund sub- category. Category II AIF classification. Category III AIF classification.
Recently, SEBI has added Special Situation

Funds (“SSFs”) as a new sub-category under
Category I AIFs.27 that invest in ‘special
situation assets’ 28, in accordance with its
investment objectives and such SSF may act
as a ‘resolution applicant’ under IBC.
AIFs which are generally perceived to have
positive spillover effects on the economy
and therefore, SEBI, the Government of
India or other regulators may consider
providing incentives
As mentioned previously in our introductory chapter, the AIF Regulations were introduced with the objective of
effectively channelizing incentives. For this purpose, the AIF Regulations define different categories of funds with
the intent to distinguish the investment criteria and relevant regulatory concessions that may be allowed to them.
A description of the various categories of AIFs along with the investment conditions and restriction relevant to
each category is summarized below:
1. AIFs may invest in securities of companies incorporated outside India subject to such conditions / guidelines
that may be stipulated by SEBI or the RBI;
Co-investment in an investee company by a Manager / Sponsor should not be on more favourable terms than
those offered to the AIF and the terms of exit from the Co-investment in an investee company including the
timing of exit shall be identical to the terms applicable to that of exit of the Alternative Investment Fund.29
Further, the AIF Regulations require that the any co-investment opportunity offered to the investors of the AIF
27. SEBI (Alternative Investment Funds) (Amendment) Regulations 2022 (“Amendment Regulations”), as further supplemented by a circular dated
January 27,2022
28. Special situation assets include (i)stressed loans available for acquisition in terms of Reserve Bank of India (Transfer of Loan Exposures)
Directions, 2021 (“Transfer Directions”) or as part of a resolution plan approved under IBC; (ii) Security receipts issued by ARCs; (iii) Securities of
investee companies (a.) whose stressed loans available for acquisition in terms of Reserve Bank of India (Transfer of Loan Exposures) Directions,
2021Transfer Directions or as part of a resolution plan approved under IBC; (b.) against whose borrowings, security receipts have been issued
by an ARC; (c) whose borrowings are subject to corporate insolvency resolution process under Chapter II of IBC; (d) who have disclosed all the
defaults relating to the payment of interest/ repayment of principal amount on loans from banks / financial institutions; and (iv)Any other asset/
security as may be prescribed by SEBI from time to time
29. The proviso is applicable for co-investment made from 08-12-2021.

shall be facilitated through a Co-investment Portfolio Manager as specified under the Securities and Exchange
Board of India (Portfolio Managers) Regulations, 2020 (“PMS Regulations”). In other words, the Manager will
be required to apply for registration with SEBI as a Co-investment Portfolio Manager.
2. Only a specific percentage of the investible funds (25% for Category I and II AIFs and 10% for Category
III AIFs) can be invested in a single investee company. For a Category I or Category II AIF, the sponsor or
the manager is required to have a continuing interest of 2.5% of the corpus of the fund or INR 50 million
whichever is lower and in the case of a Category III AIF, a continuing interest of 5% of the corpus or INR 100
million whichever is lower. The following is the list of general investment conditions applicable to all AIFs:
a. AIFs are not permitted to invest in associates or units of AIF managed or sponsored by its manager,
sponsor or associates of its manager of sponsor without the approval of 75% of investors by value of their
investments in the AIF 30; and
b. The un-invested portion of the investable funds and divestment proceeds of the AIF pending distribution
to unit holders may be invested in liquid mutual funds or bank deposits or other liquid assets of higher
quality such as Treasury bills, Triparty Repo Dealing and Settlement, Commercial Papers, Certificates of
Deposits, etc.
V. Investment Conditions and Restrictions under the

AIF Regulations
The AIF Regulations prescribe a general set of investment restrictions that are applicable to all AIFs and further
prescribe a specific set of investment restrictions that are applicable for each category of AIFs. SEBI is authorized
to specify additional criteria or provide relaxations.
In this regard, SEBI vide an amendment dated August 03, 2021 introduced large value funds for accredited
investors (“AI Funds”) which are offered relaxation from certain requirements of the AIF Regulations. Such AI
Funds are classified as funds in which each investor (other than the Manager, Sponsor, employees or directors of
the AIF or employees or directors of the Manager) is an accredited investor and invests not less than INR 70 crores.
An Accredited Investor is any person who is granted a certification of accreditation by an Accreditation Agency,
which for this purpose can be a subsidiary of a recognised stock exchange or a subsidiary of a depository, or any
other entity as may be specified by SEBI. Certain financial parameters are required to be satisfied to grant the
Accredited Investor status to such entity or individual.
VI. Investment Restrictions and Conditions for AIFs

The following table summarizes the investment restrictions that are applicable in respect of the various categories
of AIFs:
30. SEBI | Securities and Exchange Board of India (Alternative Investment Funds) (Second Amendment) Regulations, 2021

Category I AIFs i. Category I AIFs shall invest in investee companies or venture capital undertakings or in special purpose
vehicles or in limited liability partnerships or in units of other AIFs specified in the Regulations.
ii. A Category I AIF can simultaneously invest in investee companies as well as the units of other AIFs
provided the information about such combination of strategies is conspicuously disclosed in the PPM of
the investing AIF and the with the prior consent of at least two-third of the total unitholders of such AIF
by value.
iii. Category I AIFs shall not borrow funds directly or indirectly or engage in leverage except for meeting
temporary funding requirements for more than thirty days, on not more than four occasions in a year
and not more than 10% of its investible funds.
Category I AIFs shall invest not more than 25% percent of the investable funds in an investee company
directly or through investment in the units of other Alternative Investment Funds, provided that, AI Funds
of Category I and II, may invest up to 50% of its investable funds in an investee company. Further, SSFs
are permitted to invest 100% of its investable funds in a single special situation asset.
iv. Category I AIFs under the Venture Capital Fund (“VCF”) sub-category were mandatorily required to
invest at least two-thirds (66.67%) of the total investable funds in (i) unlisted equity shares or equity-
linked instruments of a VCU; or (ii) in companies listed or proposed to be listed on a Small and Medium
Enterprise exchange or Small and Medium Enterprise segment of an exchange. This requirement has
been changed to investing 75% of the total investible funds in the abovementioned avenues.31 In
addition to the above, other investment restrictions applicable on the residual portion of the investable
funds (i.e. one-third of the total investable funds) of the VCF have been done away with.
v. Category I AIFs under the sub-category SSFs, are required to invest in stressed assets such as (i)
stressed loans available for acquisition in terms of RBI (Transfer of Loan Exposures) Directions, 2021
or as part of a resolution plan approved under Insolvency and Bankruptcy Code, 2016; (ii) security
receipts issued by Asset Reconstruction Companies; (iii) securities of companies in distress; (iv) any
other asset/security as may be prescribed by SEBI from time to time. SSFs shall not accept investments
from any other AIF other than a SSF. Any investment by a SSF in the stressed loan acquired under
clause 58 of the Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions,
2021 as amended from time to time shall be subject to lock-in period as may be specified by SEBI.
In addition to these investment conditions, the AIF Regulations also prescribe a set of investment
conditions in respect of each sub-category of Category I AIFs.
Category II AIFs i. Category II AIFs shall invest primarily in unlisted investee companies or in units of other AIFs as may be
specified in the placement memorandum;
ii. Category II AIFs can simultaneously invest in investee companies as well as the units of other AIFs provided
the information about such combination of strategies is conspicuously disclosed in the PPM of the investing
AIF and the with the prior consent of at least two-third of the total unitholders of such AIF by value;
iii. Category II AIFs shall not borrow funds directly or indirectly or engage in leverage except for meeting
temporary funding requirements for more than thirty days, on not more than four occasions in a year
and not more than 10% of its investable funds;
iv. Category II AIFs shall invest not more than 25% of the investable funds in an investee company directly
or through investment in the units of other Alternative Investment Funds, provided that, AI Funds of
Category I and II, may invest up to 50% of its investable funds in an investee company
v. Category II AIFs may engage in hedging subject to such guidelines that may be prescribed by SEBI;
31. SEBI (AIF)(Fourth Amendment) Regulations, 2018

vi. Category II AIFs may enter into an agreement with a merchant banker to subscribe to the unsubscribed
portion of the issue or to receive or deliver securities in the process of market making under Chapter XB
of the ICDR Regulations; and
vii. Category II AIFs shall be exempt from Regulations 3(1) and 3(2) and 4 of the Insider Trading Regulations
in respect of investments in companies listed on SME exchange or SME segment of an exchange
pursuant to due diligence of such companies. This is subject to the further conditions that the AIF must
disclose any acquisition / dealing within 2 days to the stock exchanges where the investee company is
listed and such investment will be locked in for a period of 1 year from the date of investment.
Category III AIFs i. Category III AIFs may invest in securities of listed or unlisted investee companies or derivatives or
complex or structured products;
ii. Category III AIFs may deal in ‘goods’ received in delivery against physical settlement of commodity
derivatives whereby ‘goods’ refers to those notified by the Central Government under Section 2 (bc) of
the Securities Contracts (Regulation) Act, 1956 and forming the underlying of any commodity derivative;
iii. Funds of category III AIFs may invest in the units of Category I and Category II AIFs.
iv. Category III AIFs shall invest not more than 10% of the investable funds in one investee company
directly or through investment in the units of other Alternative Investment Funds, provided that AI Funds
of Category III may invest up to 20% of investable funds in an investee company.
v. In case of such investments made by a Category III AIF, the investment limit of ten per cent may be
calculated as either of the investable funds or the net asset value of the scheme and in case of such
investment made by AI Funds, investment limit of twenty per cent may be calculated as either of the
investable funds or the net asset value of the scheme, subject to the conditions specified by the SEBI
from time to time
vi. Category III AIFs engage in leverage or borrow subject to consent from investors in the fund and subject
to a maximum limit as may be specified by SEBI; and
Category III AIFs shall be regulated through issuance of directions by SEBI regarding areas such as
operational standards, conduct of business rules, prudential requirements, restrictions on redemption
and conflict of interest.
VII. Key Themes under the AIF Regulations

A. Continuing Interest
The AIF Regulations require the sponsor or the manager of an AIF to contribute a certain amount of capital to the
fund. The purpose of the clause is to have the sponsor or the investment manager to commit capital to the funds (i.e.to
have skin-in-the game). This portion is known as the continuing interest and will remain locked-in the fund until
distributions have been made to all the other investors in the fund. For a Category I or Category II AIF, the sponsor or
the manager is required to have a continuing interest of 2.5% of the corpus of the fund or INR 50 million whichever is
lower and in the case of a Category III AIF, a continuing interest of 5% of the corpus or INR 100 million whichever is
lower. For the angel investment funds, the AIF Regulations require the sponsor or the manager to have a continuing
interest of 2.5% of the corpus of the fund or INR 5 million whichever is lower. Further, the sponsor or the manager (as
the case may be) is required to disclose its investment in an AIF to the investors of the AIF.
It is interesting to note that, for an AIF set up in GIFT City, unlike the AIF Regulations, the ‘skin-in-the-game’ (or FME
contribution) requirement under the FME Regulations for venture capital schemes and restricted schemes (including
Special Situation Funds) depends on the target corpus (“TC”) of the scheme, and is capped as depicted below.

TC < USD 30 million TC >= USD 30 million

Close-ended 2.5% of TC up to 10% of TC USD 750,000 up to 10% of TC
Open-ended 5% of TC up to 10% of TC USD 1,500,000 up to 10% of TC
The TC of a scheme is estimated by the GP in its PPM and other offering documents. The exact raising of the entire
TC cannot be guaranteed due to both internal (first time GP, no track record) and external (macro- economic
issues, global pandemic, political upheaval) factors which may only be estimated. Accordingly, this provision
creates a large scope for confusion among industry participants.
B. Minimum Corpus
The AIF Regulations prescribe that the minimum corpus for any AIF shall be INR 200 million (“Minimum
Corpus”). Corpus is the total amount of funds committed by investors to the fund by way of written contract or
any such document as on a particular date. By its circular dated on June 19, 2014, (“June 2014 Circular”) SEBI
requires that where the corpus of an open-ended scheme falls below the Minimum Corpus (post redemption(s) by
investors or exits), the Fund Manager is given a period of 3 months to restore the Minimum Corpus, failing which,
all the interests of the investors will need to be mandatorily redeemed.
C. Minimum Investment
The AIF Regulations do not permit an AIF to accept an investment of less than INR 10 million (“Minimum
Investment Amount”) from any investor unless such investor is an employee or a director of the AIF or an
employee or director of the manager of the AIF in which case the AIF can accept investments of a minimum value
of INR 2.5 million. However, such requirement of Minimum Investment Amount is not applicable for Accredited
Investors investing in any AIFs. The June 2014 Circular has specifically clarified that in case of an open-ended
AIF, the first lump-sum investment received from an investor should not be less than the Minimum Investment
Amount.32 Further, in case of partial redemption of units by an investor in an open- ended AIF, the amount of
investment retained by the investor should not fall below the Minimum Investment Amount. 33
D. Qualified Investors
The AIF Regulations permit an AIF to raise funds from any investor whether Indian, foreign or non-resident
through the issue of units of the AIF. An AIF may accept the following as joint investors for the purpose of
investment of not less than one crore rupees: 34
i. an investor and his/her spouse
ii. an investor and his/her parent
iii. an investor and his/her daughter/son
With respect to the above investors, not more than 2 persons shall act as joint-investors in an AIF. In case of any
other investors acting as joint investors, for every investor, the minimum investment amount of one crore rupees
shall apply. Joint investors shall mean where each of the investor contributes towards the AIF.
32. CIR/IMD/DF/14/2014
33. Ibid.
34. Circular no. CIR/IMD/DF/14/2014 dated June 19, 2014

Further, SEBI has notified the SEBI (Alternative Investment Funds) (Third Amendment) Regulations, 2021
on August 03, 2021. The amendment introduced the criteria for certain investors in an AIF to be identified
as Accredited Investors. A deemed status of being an Accredited Investor is provided to (i) Central and State
Governments; (ii) any developmental agencies set up under the aegis of the Central and State Governments; (iii)
any funds set up by the Central Government or the State Governments; (iv) qualified institutional buyers4; (v)
Category I Foreign Portfolio Investors; (vi) sovereign wealth funds; and (vii) multilateral agencies and any other
entity as may be specified by SEBI. Since these entities are deemed to be Accredited Investors, it is not incumbent
on them to obtain any certification of accreditation from an Accreditation Agency.
E. Foreign investment in AIFs

The NDI Rules defines an ‘Investment Vehicle’ to, inter-alia, mean an AIFs governed by the AIF Regulations. The
NDI Rules permits a person resident outside India, other than a citizen of Bangladesh or Pakistan or an entity
incorporated in Bangladesh or Pakistan, to invest in units of an Investment Vehicle, in the manner and subject to
the terms and conditions specified in Schedule VIII of the NDI Rules.
The NDI Rules lay down certain terms and conditions governing investments in such Investment Vehicles in the
manner as follows:
§ A person resident outside India who has acquired or purchased units in accordance with Schedule VIII may sell
or transfer in any manner or redeem the units as per regulations framed by Securities and Exchange Board of
India or directions issued by the Reserve Bank.
§ An Investment Vehicle may issue its units to a person resident outside India against swap of capital
instruments of a SPV proposed to be acquired by such Investment Vehicle.
§ Investment made by an Investment Vehicle into an Indian entity shall be reckoned as indirect foreign investment
for the investee Indian entity if the sponsor or the manager or the investment manager (i) is not owned and not
controlled by resident Indian citizens; or (ii) is owned or controlled by persons resident outside India.
Provided that for sponsors or managers or investment managers organized in a form other than companies or
LLPs, Securities and Exchange Board of India shall determine whether the sponsor or manager or investment
manager is foreign owned and controlled.
‘Control’ of the AIF is expected to be in the hands of sponsors and managers, with the general exclusion to others.
In case the sponsors and managers of the AIF are individuals, for the treatment of downstream investment by
such AIF as domestic, sponsors and managers should be resident Indian citizens.
F. Maximum Number of Investors

The AIF Regulations caps the maximum number of investors for an AIF (other than angel funds) at 1,000. In case
of AIFs setup in IFSC, the FME Regulations provide for a maximum of (i) 50 investors for a venture capital scheme;
and (ii) 1000 investors for a restricted scheme.
G. Private Placement
The AIF Regulations prohibit solicitation or collection of funds except by way of private placement. While the
AIF Regulations do not prescribe any thresholds or rules for private placement, guidance is taken from the
Companies Act, 2013.

Further, the FME Regulations provide that advertisements shall be as per the advertisement code specified in the
FME Regulations. The FME Regulations define advertisement in an inclusive manner, thereby, increasing the
risk of inadvertent non-compliance. For example, during a roadshow, investors may seek information about past
performance of the manager. Such communications by the manager may come under the ambit of advertisement
as defined under the FME Regulations.
H. Tenure
While Category I and Category II AIFs can only be closed-end funds (which, according to SEBI, indicates that
their tenure needs to be ascertained upfront), Category III AIFs can be open-ended. The AIF Regulations prescribe
a minimum tenure of 3 years for Category I and Category II AIFs. SEBI vide its circular dated October 01, 2015,35
clarified that the tenure of any scheme of the AIF shall be calculated from the date of the final closing of the scheme.
Further, the tenure of any AIF can be extended only with the approval of 2/3rd of the unitholders by value of their
investment in the AIF. The SEBI (Alternative Investment Funds) (Third Amendment Regulations) (“SEBI AIF (Third
Amendment) Regulations, 2012”) allow AI Funds to extend the tenure beyond two years subject to the terms of the
contribution agreement, other fund documents and conditions specified by SEBI from time to time.
I. Overseas investments by AIFs

As per a circular dated October 1, 2015 issued by SEBI and, as amended recently by a circular dated May 21, 2021,
an AIF may invest in equity and equity-linked instruments of off-shore VCUs, subject to certain conditions
mentioned in the circular such as an overall aggregate limit of USD 1,500 million for all AIFs and VCFs registered
under the SEBI (Venture Capital Funds) Regulations, 1996 and the guidelines stipulated by the RBI in this respect.
Investments would be made only in those companies which have an Indian connection (i.e. company which has
a front office overseas, while back office operations are in India) and such investments would be up to 25% of the
investible funds of the AIF. The circular clarifies that an offshore VCU means a foreign company whose shares are
not listed on any of the recognized stock exchange in India or abroad. Such an investment by an AIF requires prior
approval from SEBI. The allocation of investment limits would be done on a ‘first come-first serve’ basis depending
on availability in the overall limit of USD 1,500 million, and in case an AIF fails to make the allocated investment
within a period of 6 months from date of approval, SEBI may allocate such unutilized limit to another applicant.
J. Reporting Obligations
Under the AIF Regulations, all AIFs are required to ensure transparency and disclosure of information to investors.
36 AIFs are required to provide at least on an annual basis, within 180 days from the year end, reports to investors
including the information as prescribed in the AIF Regulations.
Further, the Fund shall submit a quarterly report to SEBI in accordance with SEBI Circular dated July 29,
2013 (Circular CIR/IMD/DF/10/2013) on a quarterly (if leverage is not undertaken) and monthly (if leverage
undertaken) basis within 7 calendar days from the end of the quarter / month (as the case may be). SEBI has
revised the format in which such report must be submitted vide the Circular No. SEBI/HO/IMD/IMD-I/DOF6/
CIR/2021/549, dated April 7, 2021.
At the end of a financial year, the manager must prepare a compliance test report (“CTR”) on compliance with
AIF Regulations and circulars issued there under in the format as specified in the circular issued by SEBI on June
19, 2014 (CIR/IMD/DF/14/2014). The CTR has to be submitted to the Trustee and Sponsor within thirty (30) days
35. Circular No. (CIR/IMD/DF/7/2015)

36. Regulation 22 of the AIF Regulations

from the end of the financial year and the Trustee/Sponsor can intimate any observations/comments on the
CTR to the manager within thirty (30) days from the receipt of the CTR. Within fifteen (15) days of receipt of
such observations / comments, the manager will make necessary changes in the CTR and submit its reply to the
Trustee / Sponsor.
Further, with a view to providing relevant information to investors about the various activities pertaining to AIFs,
an Investor Charter as provided by SEBI in its circular dated December 10, 2021 (SEBI/HO/IMD/IMD-I/DOF9/P/
CIR/2021/682), (“December 2021 Circular”) which has to be disclosed in the PPM of each new scheme.
K. Change in Circumstances
The December 2021 Circular read with the June 2014 Circular provides that in case any ‘material change’ to the
fund structure, is said to have arisen in the event of (1) change in sponsor or manager of the AIF, (2) change in
control of the sponsor or manager of the AIF, (3) material Changes to the placement memorandum – (i) term of
the fund, (ii) investment strategy, (iii) increase in fees and charges, (4) winding up of the fund / scheme prior to
expiry of tenure, investor consent needs to be obtained.
There are increasing examples of acquisitions of fund management businesses by international and domestic
acquirers. The June 2014 Circular becomes especially relevant in navigating the regulatory landscape for
achieving such commercial transactions. Care must also be taken to ensure a proper diligence of the proposed
target, not just from a company perspective, but also from a legal, regulatory and tax perspective vis-à-vis the fund
manager by the target.
L. Key Considerations – FME Regulations

Recently, the IFSCA has notified the FME Regulations, which seeks to change the manner of fund formation in the
IFSC. The FME Regulations intend to regulate the Fund manager, instead of the fund, by providing a single unified
registration to the Fund Management Entities (“FME”), managing different schemes. The FME may seek registration
under any of the three categories, viz, authorised FME, registered FME (non-retail) and registered FME (retail).
The three categories have been proposed to follow risk based approach for supervision and to facilitate FMEs to
undertake activities dealing with sophisticated investors with ease. The FME Regulations allow an authorised FMEs
to manage venture capital schemes and family investment funds, whereas registered FME (Non-Retail) would be
allowed to manage restricted schemes, in addition to schemes managed by authorised FMEs. registered FMEs (Retail)
would be permitted to manage all schemes, retail as well as non-retail. In addition to the categories of FMEs, the FME
Regulations specify the types of schemes which the FME could launch and manage. These schemes are, inter alia,
venture capital schemes, restricted schemes (non-retail schemes), retail schemes and SSFs.
The FME Regulations have also provided for three key managerial personnel to be appointed by the FMEs. A
principal officer – to be appointed by all the three categories of FMEs, a compliance and risk manager – to be
appointed by Registered FME (Non-Retail) and Registered FME (Retail) and a fund manager – only to be appointed
by a Registered FME (Retail). The FME Regulations provide for the KMPs to be based out of the IFSC and those
initiating the proposal on the portfolio composition are also to be based in office of the FME in the IFSC. The
substance requirements also state that the key management and commercial decisions necessary for the
conduct of the FME’s business should in substance, be undertaken from the IFSC. Professional qualification and
experience requirements of the KMP have also been provided.

M.Standardized PPM
The SEBI vide its Circular No. SEBI/HO/IMD/DF6/CIR/P/2020/24, dated Feb 06, 2020 (“Feb 2020 Circular”)
introduced template(s) for PPM, subject to certain exemptions, and mandatory performance benchmarking for
AIFs with provisions for additional customized performance reporting. While the circular leaves ample scope for
the parties to give additional information, the mandatory template provides for two parts:
a. Part A – section for minimum disclosures, and
b. Part B – supplementary section to allow full flexibility to the Fund in order to provide any additional
information, which it deems fit.
The circular has specified two distinct templates, one for Category I and II AIFs and the other for Category III AIFs.
However, SEBI has exempted Angel Funds and AIFs/Schemes in which each investor commits to a minimum
capital contribution of INR 70 crores (USD 10 million or equivalent, in case of capital commitment in non-INR
currency) from the aforementioned compliances. This exemption is also extended to the AI Funds given that
investment by each Accredited Investor in an AI Funds is equal to or more than INR 70 crores.
N. Audit of PPM
In order to ensure compliance with the terms of PPM, the Feb 2020 Circular has also made it mandatory for AIFs
(other than angel funds, and / or those falling under exemptions explained below) to carry out an annual audit of
such compliance by an internal or external auditor/legal professional. The audit of sections of PPM relating to ‘Risk
Factors’, ‘Legal, Regulatory and Tax Considerations’ and ‘Track Record of First Time Managers’ shall be optional.
The findings of the audit, along with corrective steps, if any, shall be communicated to the Trustee or Board or
Designated Partners of the AIF, Board of the Manager and SEBI. Such audit of compliance shall be conducted at
the end of each Financial Year and the required parties have to be informed within six months from the end of the
Financial Year. 37
However, SEBI has exempted Angel Funds and AIFs/Schemes in which each investor commits to a minimum
capital contribution of INR 70 crores (USD 10 million or equivalent, in case of capital commitment in non-INR
currency) from the aforementioned compliances. This exemption is also extended to the AI Funds given that
investment by each Accredited Investor in an AI Funds is equal to or more than INR 70 crores. Furthermore, the
requirement of audit of compliance with terms of PPM shall not apply to AIFs which have not raised any funds
from their investors.
O. Performance Benchmarking
SEBI has also introduced mandatory benchmarking of the performance of the AIFs and the AIF industry and a
framework for facilitating the use of data collected by Benchmarking Agencies to provide customized reports. Any
association of AIFs (“Association”), which in terms of membership, represents at least 33% of the number of AIFs,
may notify one or more Benchmarking Agencies, with whom each AIF shall enter into an agreement for carrying
out the benchmarking process.
The agreement between the Benchmarking Agencies and AIFs shall cover the mode and manner of data reporting,
specific data that needs to be reported, terms including confidentiality in the manner in which the data received
37. Circular No.: SEBI/HO/IMD/DF6/CIR/P/2020/99, dated Jun12, 2020.

by the Benchmarking Agencies may be used, etc. AIFs, for all their schemes which have completed at least one
year from the date of ‘First Close’, shall report all the necessary information including scheme-wise valuation and
cash flow data to the Benchmarking Agencies in a timely manner.
The form and format of reporting shall be mutually decided by the Association and the Benchmarking Agencies.
If an applicant claims a track-record on the basis of India performance of funds incorporated overseas, it shall also
provide the data of the investments of the said funds in Indian companies to the Benchmarking Agencies, when
they seek registration as AIF.
In the PPM, as well as in any marketing or promotional or other material, where past performance of the AIF is
mentioned, the performance versus benchmark report provided by the benchmarking agencies for such AIF/
Scheme shall also be provided. In any reporting to the existing investors, if performance of the AIF/Scheme is
compared to any benchmark, a copy of the performance versus benchmark report provided by the Benchmarking
Agency shall also be provided for such AIF/scheme. SEBI has also issued the Operational Guidelines in this regard.38
P. Code of Conduct
SEBI by way of an amendment to the AIF Regulations dated May 5, 2021 has provided for AIFs, the key
management personnel, trustee, trustee company, directors, designated partners or directors of the AIFs, to abide
by the Code of Conduct inserted in the Fourth Schedule of the AIF Regulations. In addition to this, the manager
and the trustee or trustee company or board of directors or designated partners of the AIF are jointly required to
formulate detailed policies and procedures in order to ensure compliance of the various obligations of the fund.
Q. Grievance Redressal
In accordance with SEBI Circular No. CIR/OIAE/1/2014 dated December 18, 2014, the AIF, as a SEBI registered
intermediary, is required to register with the SEBI Complaints Redress System (SCORES) platform within one
month from the date of registration as an AIF. All disputes shall be resolved on the SCORES platform.
Further, as per the SEBI Circular no. SEBI/HO/IMD/IMD-I/DOF9/P/CIR/2021/682 dated December 10, 2021, details
of investor complaints received against AIF and its redressal status thereof must be disclosed in the PPM as a
separate section.
R. Co-Investments
SEBI has recently introduced amendments to the AIF Regulations, 2012 and PMS Regulations on November 9,
2021. As per the amendments, “Co-investment” means an investment made by a Manager or Sponsor or investor of
Category I and II AIFs in investee companies where such Category I or Category II AIF make investment, provided
that Co-investment by unit holders of the AIF shall be through a Co-investment Portfolio Manager as specified
under the PMS Regulations. The amendments also provide that the manager shall not provide advisory services to
any investor other than the clients of the Co-investment Portfolio Manager as specified in the PMS Regulations, for
investment in securities of investee companies where the AIF managed by it makes investment. Further, the terms
of Co-investment in an investee company by a Manager or Sponsor or co-investor, shall not be more favourable
than the terms of investment of the AIF. Further, the terms of exit by a Manager or Sponsor or co-investor from an
investee company including the timing of exit shall be identical to the terms applicable to that of the AIF.
38. https://www.sebi.gov.in/sebi_data/commondocs/feb-2020/ann_4_p.pdf

VIII. Taxation of Alternative Investment Funds

A. General
i. Scope of income chargeable to tax, residential status and rates of tax

Under the ITA, the scope of income chargeable to tax in India is determined on the basis of the residential status
of the person earning the income. The Indian tax year runs from April 01 until March 31. An Indian tax resident is
liable to tax in India on its worldwide income whereas non-residents are liable to tax only on India-source income
i.e. only and to the extent that such income accrues or arises or is deemed to accrue or arise in India or is received
or deemed to be received in India.
ii. Residential status and taxability in India

As per the provisions of the ITA, a company would be considered a resident of India if (a) it is an Indian company;
or (b) its POEM, in that year, is in India. Further, it is provided that for this purpose, the POEM would be the place
where the key management and commercial decisions that are necessary for the conduct of the business of the
entity as a whole are, in substance made.
iii. Benefits under the double taxation avoidance agreement (if any)
Under Section 90(2) of the ITA, if a non-resident is resident in a country with which India has a DTAA, they would
be taxable according to the provisions of the DTAA or the ITA, whichever is more beneficial to them.
Relief under a DTAA should normally be available as long as the non-resident is a resident and a separate legal
person under the laws of its country of residence and is liable to tax under its laws. Sections 90(4) and 90(5) require
a non-resident claiming treaty relief to:
i. Furnish a valid Tax Residency Certificate (“TRC”) issued by the government of its home country; and
ii. Provide certain additional information, as may be prescribed from time to time, in Form 10F.
At present, the following details are required to be provided by a non-resident claiming relief under a DTAA:
i. Status of the claimant i.e., individual, company, firm etc.;
ii. Nationality or country of incorporation;
iii. Claimant’s tax identification number in the country of residence and in case there is no such number, a
unique number on the basis of which the claimant is identified by the Government of the country of which
he claims to be a resident;
iv. Period for which the residential status, as mentioned in the TRC, is applicable; and
v. Claimant’s address outside India, during the period for which the TRC is applicable.
The taxability of such income of the non-resident investors, in the absence of benefits under the DTAA, would be
as per the provisions of the ITA. Also, the taxability of the income of the non-resident investors, from a country
with which India has no DTAA, would be as per the provisions of the ITA. Further, the taxability under the DTAA
depends of the provisions under the applicable treaty to the non-resident investor.

B. Taxation of funds registered as Category I or Category II AIFs
i. Tax pass-through status of the AIFs

The taxability of Category I and Category II AIFs (collectively, the “investment funds”) is governed by Section
10(23FBA), Section 10 (23FBB), Section 194LBB and Section 115UB (Chapter XII – FB - Special Provisions Relating
to Tax on Income of Investment Funds and Income Received from such Funds) of the ITA
Investment fund is defined under clause (a) of the Explanation 1 to Section 115UB of the ITA inter-alia as any fund
established or incorporated in India in the form of a trust or a company or a LLP or a body corporate which has been
granted a certificate of registration as a Category I or a Category II AIF and is regulated under the AIF Regulations.39
The ITA provides that any income accruing or arising to, or received by, a unit- holder of an investment fund out
of investments made in the investment fund shall be chargeable to income- tax in the same manner as if it were
the income accruing or arising to, or received by such person, had the investments made by the investment fund
been made directly by the unit- holder.40 In other words, the income of a unit-holder in an investment fund will
take the character of the income that accrues or arises to, or is received by the investment fund.
The ITA contemplates that income chargeable under the head ‘Profits and gains of business and profession’ will
be taxed at the investment fund level and the tax obligation will not pass through to the unitholders. In order to
achieve this, the Act has two provisions:
a. Section 10(23FBA) which exempts any income of an investment fund other than income chargeable under
the head ‘Profits and gains of business or profession’; and
b. Section 10(23FBB) which exempts the proportion of income accruing or arising to, or received by, a
unitholder of an investment fund which is of the same nature as income chargeable under the head ‘Profits
and gains of business or profession’.
ii. Taxation of unit holders of AIF

i. If the income from securities at the AIF level is not characterized as PGBP in the hands of the AIF, then such
income would be taxable in the hands of the unit holders of the AIF as under:
a. The income would be chargeable to tax in the hands of the unit holders in the same manner as if it were
the income accruing or arising to, or received by, such unit holder had the investments made by the AIF
been made directly by such unit holder. However, the Central Board of Direct Taxes (“CBDT”) vide its
Circular No. 14/2019 dated July 03, 2019 has clarified that the income in the hands of non-resident investor
from offshore investments routed through Category-I / Category-II AIFs shall not be liable to tax in India,
being a deemed direct investment made outside India by such non-resident investor;
b. The income paid or credited by the AIF would be deemed to be of the same nature and in the same
proportion in the hands of the unit holders as if it had been received by, or had accrued or arisen to, the AIF;
c. The income accruing or arising to, or received by, the AIF, during the financial year, if not paid or credited
to the unit holders would be deemed to have been credited to the account of the unit holders on the last
day of the financial year in the same proportion in which such unit holders would have been entitled to
receive the income had it been paid in that year;
39. Explanation 1 to Section 115UB of the ITA . 20.Explanation 1 to Section 115UB of the ITA.
40. Vide Notification No. 51 / 2015 dated June, 2015.

d. Once the income is included in the total income of the unit holders in a year, on account of having been
accrued or arisen in the said previous year, it would not be included in the total income of such person in
the year in which such sum is actually paid to the unit holders by the AIF;
e. Where the AIF incurs any losses (other than business losses), such losses will also be allocated to the unit
holders and will be available for set-off against other gains that they may have and will be allowed to be
carried forward by them, in case they do not have other taxable gains. However, such losses will not be
available for offset to unit holders if such loss has arisen in respect of a unit which has not been held by the
unit holders for a period of at least 12 (twelve) months;
f. Business losses incurred by the AIF will be retained at the level of the AIF and not be available for offset to
unit holders; instead, such losses must be offset by the AIF against subsequent business income, if any
ii. As stated above, in case the income of the AIF is characterized as PGBP, the same shall be taxable in the hands
of the AIF at the maximum marginal rate and such income would be exempt from tax in the hands of the unit
holders of the AIF
In case, the exemption under section 10(23FBA) is denied to the investment fund, then the income of the such
fund should be subject to tax as per the general principles of taxation of trusts under sections 161 to 164 of the ITA.
The taxation of gains realized on disposition of the securities of portfolio companies would depend on the
characterization of the AIFs activities. In principle, the AIF could either be regarded as being engaged in the
business of buying and selling securities or as an investor investing, rather than trading, in securities. The CBDT
has, vide circulars and notifications, laid down the following principles in respect of characterization of income
arising on sale of securities:
a. In respect of income arising from sale of listed shares and securities which are held for more than 12 (twelve)
months, the taxpayer has a one-time option to treat the income as either PGBP or capital gains and the option
once exercised, is irreversible.41
b. Gains arising from sale of unlisted shares are characterized as capital gains, irrespective of the period of
holding of such shares, except in cases where (i) the transaction is considered to be sham or not genuine, or
(ii) corporate veil is lifted or (iii) the transfer is made along with control and management of the underlying
business. In such cases, the CBDT has stated that the Indian tax authorities would take an appropriate view
based on the facts of the case. 42
c. The CBDT has clarified that the third exception i.e. where the transfer of unlisted shares is made along with
control and management of the underlying business, will not be applicable in case of transfer of unlisted shares by
Category-I and Category-II AIF registered with the SEBI. 43
iii. Withholding tax obligation of portfolio companies

In terms of Section 197A(1F) of the ITA and the notification issued by the CBDT, any income (other than income
under head PGBP) received by investment funds would be exempted from TDS by portfolio companies. This
should be helpful in case of interest / coupon payouts by portfolio companies to such funds. Previously, it was
administratively difficult for investors to take credit of the TDS withheld by portfolio companies.
41. Circular No. 6 of 2016 dated February 29, 2016

42. Order F.No.225/12/2016/ITA.II dated May 2, 2016
43. Order F.No.225/12/2016.II dated January 24, 2017

iv. Withholding tax obligation of AIFs

As per Section 194LBB of the ITA, in case of resident unit holders, the AIF would be required to deduct tax at the
rate of 10% on any income, which is eligible for tax pass-through, at the time of credit of such income to the
account of the unit holders or at the time of payment of such income to the unit holders, whichever is earlier.
Further, in case of non-resident unit holders, the AIF would be required to deduct tax at the rates in force i.e. the
rates specified in the Finance Act of the relevant year or rates specified in the applicable the DTAA entered into
between India and the country of residence of such non-resident; provided no taxes shall be withheld in case of
any income which is not chargeable to tax under the ITA.
C. Taxability of carried interest

Recently, a ruling by the Bangalore bench of the CESTAT has created significant uncertainty on the nature of
VCFs / AIFs set-up as trusts from a tax perspective. While the CESTAT decision pertains to the erstwhile service
tax regime, it is likely to have an impact under the GST and income-tax regime on all pooling vehicles in general.
The Bangalore CESTAT inter-alia held that a VCF set-up as a trust is a separate legal entity and upheld the levy of
service tax on carried interest distributed by the VCF, equating it to performance fee earned by the management
company (“Ruling”).44 The Ruling dealt with 31 appeals relating to ICICI Econet Internet and Technology Fund
and 10 other funds (“Appellants”) and regarding tax demands covering the period from 2005-2006 to 2011-2012.
The CESTAT held that the VCFs would be treated as juridical persons distinct from its beneficiaries for the
purpose of taxation. The CESTAT also held that the VCFs (set up as trusts) violated the principle of mutuality
by carrying out commercial activities and using discretionary powers to benefit a certain class of investors. The
CESTAT noted that the said trusts made provisions to act in a manner beyond the interest of the contributors,
such as the payment of huge amounts as performance fee and carried interest to the Investment Manager or
their nominees.
On whether service tax is leviable on carried interest, the CESTAT found that carried interest is neither interest
nor return or investment instead a portion of consideration for services rendered by the Appellants. The CESTAT
observed that the said trusts have been floated for drawing contributors and to facilitate them to earn profits. Any
amount retained by the said trusts out of the income that is otherwise distributable to the contributors would
constitute a fee for the services rendered. The CESTAT found that the fund structure enabled the investment
manager and their nominees to receive huge amounts as performance fee and in the guise of carried interest,
benefitting the recipients at the expense of the subscribers, and avoiding the taxes arising from such payment.
The Ruling has resurfaced the concerns regarding characterisation of carried interest as business income
(instead of capital gains). Internationally rules for taxation of carried interest are evolving, while no clarification
/ guidance has been released by the government in this aspect currently, it is imperative for India to adopt an
approach in line with global best practices. Having said this, it will also be essential for managers to revisit their
structures and documentation.
D. Taxability of sovereign wealth funds

With the intent to encourage long term stable capital participation from sovereign wealth funds (“SWFs”) and
to replace government spending in the creation of infrastructure assets, the Finance Act, 2020 inserted Section
10(23FE) to the ITA exempting any income of ‘specified persons’ in the nature of dividend, interest or long-term
44. Service Tax Appeal No 2900 of 2012 with others

capital gain arising from certain specified investments made on or after April 1, 2020 but on or before the March
31, 2024 and held for at least 3 years.
In this regard, ‘specified person’ (to whom exemption has been extended) includes the following:
a. wholly owned subsidiary of Abu Dhabi Investment Authority (“ADIA”) which:
• is a resident of the United Arab Emirates; and
• makes investment, directly or indirectly out of the fund owned by the Government of Abu Dhabi
b. a foreign SWF which satisfies the prescribed conditions;
c. a foreign pension fund which satisfies the prescribed conditions (including any pension fund specified by the
Central Government) .45
Section 10(23FE) provides that such investments shall be made in the form of debt or share capital or unit, in the
following:
a. a business trust (registered as InvIT or REIT); or
b. company or enterprise carrying on the business of developing, operating or maintaining any infrastructure
facility (as defined in explanation to Section 80-IA(4)(i)2 of the ITA) or as may be otherwise notified;
c. Category I or Category II of AIF (having not less than 50% investment in an InvIT or a company / entity
referred to in item (b) or (d) or (e) herein).
d. domestic company, set up and registered on or after the April 1, 2021, having at least 75% investments in one
or more of the companies entities referred to in item (b) above; or
e. a non-banking financial company registered as an Infrastructure Finance Company 46 or in an Infrastructure

Debt Fund, a non-banking finance company,47 , having minimum 90% lending to one or more of the
companies or enterprises or entities referred to in item (b) above.
The CBDT, vide a notification (44/2020/F. No. 370142/24/2020-TPL) dated 6th July, 2020, widened the scope
of ‘infrastructure’ for the purpose of claiming income tax exemption under Section 10 (23FE) of the ITA. The
Notification has extended the benefits of the exemption to the sovereign wealth funds and pension funds on their
investment in infrastructure sector.
The Finance Act, 2021, inter alia, inserted the seventh proviso to section 10(23FE) to provide that in case the SWF
or pension fund has loans or borrowings, directly or indirectly, for the purposes of making the investment in
India, such fund shall be deemed to be not eligible for exemption under section 10(23FE).
45. In exercise of the powers conferred under section 10(23FE) of the ITA, the Central Government has specified several pension funds (illustrative
list including MIC Redwood 1 RSC Limited, (Dubai), 2452991 Ontario Limited (Canada), OMERS Administration Corporation (Canada), BCI IRR
India Holdings Inc (Canada), Indo-Infra Inc. (Canada), Government Employees Superannuation Board (Australia), 2726247 Ontario Inc (Cana-
da)) as a ‘specified person’ for purposes of section 10(23FE) subject to the fulfillment of conditions specified in the respective notifications
46. As referred to in notification number RBI/2009-10/316 issued by the RBI
47. As referred to in the Infrastructure Debt Fund - Non-Banking Financial Companies (Reserve Bank) Directions, 2011

E. Taxation of Category III AIFs

As mentioned earlier, AIFs are usually set up as trusts and consequently they are subject to the tax framework
that is applicable to trusts in India. Under Indian tax law, a trust is not a separate taxable entity. Taxation of
trusts is laid out in sections 161 to 164 of the ITA. Where the trust is specific, i.e., the beneficiaries are identifiable
with their shares being determinate, the trustee is assessed as a representative assessee and tax is levied on and
recovered from them in a like manner and to the same extent as it would be leviable upon and recoverable from
the person represented by them.
In the case of AIG (In Re: Advance Ruling P. No. 10 of 1996), it was held that it is not required that the exact
share of the beneficiaries be specified for a trust to be considered a determinate trust, and that if there is a pre-
determined formula by which distributions are made the trust could still be considered a determinate trust. The
tax authorities can alternatively raise an assessment on the beneficiaries directly, but in no case can the tax be
collected twice over.
While the income tax officer is free to levy tax either on the beneficiary or on the trustee in their capacity as
representative assessee, as per section 161 of the ITA, it must be done in the same manner and to the same extent
that it would have been levied on the beneficiary. Thus, in a case where the trustee is assessed as a representative
assessee, they would generally be able to avail of all the benefits / deductions etc. available to the beneficiary, with
respect to that beneficiary’s share of income. There is no further tax on the distribution of income from a trust.
On July 28, 2014, CBDT issued a circular to provide ‘clarity’ on the taxation of AIFs that are registered under the
AIF Regulations.
The Circular states that if ‘the names of the investors’ or their ‘beneficial interests’ are not specified in the trust
deed on the ‘date of its creation’, the trust will be liable to be taxed at the ‘maximum marginal rate’.
The Bangalore Income Tax Appellate Tribunal in the case of DCIT v. India Advantage Fund – VII48 held that
income arising to a trust where the contributions made by the contributors are revocable in nature, shall be
taxable at the hands of the contributors. The ruling comes as a big positive for the Indian fund industry. The
ruling offers some degree of certainty on the rules for taxation of domestic funds that are set up in the format
of a trust by regarding such funds as fiscally neutral entities. Globally, funds have been accorded pass through
status to ensure fiscal neutrality and investors are taxed based on their status. This is especially relevant when
certain streams of income maybe tax free at investor level due to the status of the investor, but taxable at fund
level. Funds, including AIFs that are not entitled to pass through status from a tax perspective (such as Category
III AIFs) could seek to achieve a pass-through basis of tax by ensuring that the capital contributions made by the
contributors is on a revocable basis).
F. Taxation on relocation of an AIF to IFSC

SEBI has released a circular allowing one-time off-market transfer of securities by an FPI to the IFSC.49 This
2021 Circular will allow relocation of foreign funds (set-up as FPIs) to set up Category-III AIFs in IFSC. The
FME Regulations provide that the requirement of continuing interest by the FME shall be voluntary in case of
relocation of offshore funds to IFSC.
The Finance Act, 2021 amended several provisions of the ITA to facilitate the relocation of offshore funds to the
IFSC in a tax neutral manner both for the offshore fund as well as investors. Such provisions are applicable where
48. ITA No.178/Bang/2012

49. SEBI circular no. SEBI/HO/FPI&C/P/CIR/2021/0569 dated June 01, 2021

the assets of the ‘original fund’ are ‘relocated’ to a ‘resultant fund’ in GIFT City. For this purpose, the ITA defines
the term ‘original fund’, ‘relocation’ and ‘resultant fund’ as under:
Original fund: Original fund means a fund establish outside India which collects funds from its members for
investing such funds for their benefit and fulfills the following conditions:
a. the fund is not a person resident in India;
b. the fund is a resident of a country with which India has a tax treaty;
c. the fund and its activities are subject to applicable investor protection regulations in the country where it is
established or incorporated; and
d. fulfils such other conditions as may be prescribed
Resultant fund: Resultant fund means a fund established or incorporated in India in the form of a trust or a
company or a limited liability partnership, which:
a. has been granted certificate of registration as a Category I or Category II or Category III AIF and is regulated by
SEBI or IFSCA; and
b. is located in IFSC
Considering that under the FME Regulations, the FME (not the AIF) will be registered, above definition may have
to be amended to ensure that tax neutrality is available in case of relocation of funds to IFSC.
Relocation: Relocation means a transfer of assets of the original fund, or of its wholly owned special purpose
vehicle, to a resultant fund on or before March 31, 2023 where consideration for such transfer is discharged in the
form of share or unit or interest in the resulting fund to:
a. shareholder or unit holder or interest holder of the original fund in the same proportion in which the share or
unit or interest was held by such shareholder or unit holder or interest holder in such original fund, in lieu of
their shares or units or interests in original fund; or
b. The original fund, in the same proportion as referred in sub-clause (i), in respect of which share or unit or
interest is not issued by resultant fund to its shareholder or unit holder or interest holder.
Essentially, relocation will encompass transfer of assets of an offshore fund (say in Mauritius or Delaware)
to an AIF in IFSC the consideration of which would be discharged by way of a swap. The swap will include
proportionate issuance of units by the AIF in IFSC to either the unit holders of the offshore fund in lieu of units
held in the offshore fund or to the offshore fund (in case where share or unit or interest is not issued by AIF in
IFSC to shareholder or unit holder or interest holder of offshore fund).
G. Other benefits on relocation

Pursuant to the Finance Act, 2021, the ITA has also been amended to provide the following provisions for
ensuring tax neutrality of relocation:
a. Exemption from capital gains tax on capital gains arising from transfer of capital asset in a relocation by the
offshore fund to the AIF in IFSC.11 This provision essentially seeks to exempt capital gains tax arising on
transfer of shares of Indian companies and other Indian securities held by an offshore fund to an AIF in IFSC.
The ITA levies capital gains tax on gains arising on transfer of shares or securities of an Indian company. In

absence of this exemption transfer of shares or securities of an Indian company by an offshore fund to AIF in
IFSC pursuant to relocation would have been subject to tax in India;
b. Exemption from capital gains tax on capital gains arising from transfer by a shareholder / unit holder, in a
relocation, of capital asset being share / unit held by him in the offshore fund in consideration for share / unit
in the resultant fund. This provision seeks to exempt the transfer at the shareholder level from capital gains tax
on account of indirect transfer provisions;
c. Exemption from capital gains tax on capital gain income arising or received by a non-resident investor or a
specified fund, on account of transfer of shares of an Indian company by the AIF in IFSC or specified fund
which were acquired by the AIF in IFSC or specified fund pursuant to relocation and where the capital gains
on such shares were not been chargeable to tax had the relocation not taken place. This provision seeks protect
grandfathered investments of offshore fund. It ensures that the outcome for the non-resident investor remains
the same whether the exit from Indian company takes place by the offshore fund or the AIF in IFSC;
d. Cost of acquisition of shares of an Indian company acquired by the AIF in IFSC upon the relocation is deemed
to be the cost of the previous owner i.e. cost base of shares of Indian company in hands of offshore fund is
available to AIF in IFSC;
e. Cost of acquisition of units of the AIF in IFSC acquired by the unit holders on relocation of the offshore fund is
deemed to be the cost of the previous owner;
f. The period of holding of shares of an Indian company acquired by the AIF in IFSC upon the relocation is
deemed to be include the period for which the shares of the Indian company were held by the offshore fund;
g. The period of holding of units of AIF in IFSC acquired by the unit holders upon the relocation is deemed to be
include the period for which such unit holders held the units of the offshore fund;
h. Section 79 has also been amended to allow the Indian company the benefit of set off and carry forward of loss
to the extent the change in shareholding has taken place on account of relocation;
i. Lastly, corresponding changes have also been made to the provisions of Section 56(2)(x) to ensure that the AIF
in IFSC or the unit holders of the offshore fund are not subject to tax on account of the swap transaction.

5. Trends in Private Equity

The standard of what constitutes an ‘alignment of interests’ between fund investors (LPs) and fund managers
(GPs) of an India-focused fund or an India- based fund has undergone some degree of change over the years.
Typically, LP participation in a fund is marked by a more hands-on approach in discussing and negotiating fund
terms which by itself is influenced by a more comprehensive due diligence on the track record of the GP and the
investment management team.
As discussed briefly earlier, given the issues associated with the levy of service tax on extraction of carried interest
in India in unified structures and risk of being considered as AOP, co-investment structures have now emerged as
a preferred choice for structuring India focused funds. There is also an increased participation from DFIs in India
focused funds, including unified structures. Accordingly, some global benchmarks need to be followed when
designing the structure and calibrating the fund documents including the governance, fiduciary aspects and
adherence to ESG policies and AML policies. With one or more DFIs or sovereign investors in the mix, the fund
terms continue reflecting a more LP tilt in balance even for fund managers raising a series III or a series IV fund.
There can be variations of a unified structure depending on the investment strategy of the fund, allocation of
economics for the GP and certain legal and regulatory considerations involving the LPs. In addition to the above,
there can be other variations to the investment structure depending on the commercials involved.
The overseas fund could directly invest in India based opportunities or adopt a co-investment structure (i.e. the
offshore fund invests alongside the Indian fund in eligible investment opportunities).
The FDI Policy will however be applicable to investments made directly by an offshore fund in India.
An optimum structure should reconcile the investment strategy, team economics and LP preferences.
New investment funds with more focused strategies are seen coming up as India introduces favorable policy and
regulatory changes such as introduction of the Insolvency and Bankruptcy Code, passing of a single goods and
services tax (“GST”), tax initiatives for Small and Medium Enterprises, policy initiatives for the insurance sector
and increased focus on technology driven payment mechanisms.
This chapter provides a brief overview of certain fund terms that have been carefully negotiated between LPs and
GPs in the Indian funds context.
I. Trending fund terms

A. Investment Committee and Advisory Board
Sophisticated LPs insist on a robust decision- making process whereby an investment manager will refer
investment and / or divestment proposals along with any due diligence reports in respect of such proposals to
an investment committee comprising representatives of the GP. The investment committee has traditionally
been authorized to take a final decision in respect of the various proposals that are referred to it. The committee
is also empowered to monitor the performance of investments made by the fund a view to limiting the quantum
of expenses that are paid by the fund, LPs insist on putting a cap on expenses. The cap is generally expressed as a
percentage of the size of the fund or as a fixed number can become a debatable issue depending on the investment
strategy and objective of the fund. GPs often try to negotiate for annual caps for operating expenses, given the long
tenure of VC/PE funds and the difficulty in ascertaining the appropriate cap for the entire tenure upfront; whereas,

LPs prefer a cap for the entire tenure to be disclosed upfront in the fund documents. If an annual cap method is
chosen, LPs often seek the right to be consulted before setting the annual cap by GPs.
Separately, as a measure of aligning interests, LPs insist that allocations made from their capital contributions
towards the payment of expenses should be included while computing the hurdle return whereas the same
should not be included while determining management fee after the commitment period.
Additionally, certain LPs also insist that specific fund expenses associated with certain LPs must be allocated to
LPs only. For instance, if an investor enters the fund through a placement agent, the placement fees to be borne
by the fund shall be allocated from the capital contribution of the said investor. The ratio of distributions is
accordingly expected follow the ratio of each investor’s participation in the deals.
However, SEBI from time to time gives feedback on such provisions. For example, SEBI vide its notification
dated October 19, 2020 (“2020 Notification”) had statutorily provided for the constitution of an Investment
Committee (“ICOM”) by the IM. It also provided that the members of the ICOM would be severally and jointly
liable for the investment decisions and compliance of the AIF Regulations as well as the governing documents of
the AIF. As the notification tried to fasten responsibility for legal compliances on the ICOM which is primarily
responsible for the commercial decision of the AIF, the funds’ industry reacted negatively to the notification.
To address the concerns of the stakeholders, SEBI released another notification in January 2021 (“Amendment
Notification”). This Amendment Notification introduced a mechanism to obtain a waiver from the requirements
and responsibilities outlined in the 2020 Notification. The waiver mechanism allows the AIFs in which each
investor other than the AIF Manager, sponsor, employees, or directors of the AIF or employees or directors of the
AIF Manager, has committed to invest not less than INR 70 crore and has furnished a waiver to the AIF in respect
of compliance with the said clauses, in the manner as specified by SEBI. Currently, SEBI has stipulated that the
ICOM members shall ensure that their decisions are also in compliance with the policies and procedures of the
AIF. ICOM members may not be jointly liable with AIF managers due to the amendments; however, SEBI seems
to have retained regulatory authority over such members. The above changes reflected the market regulators’
continual approach to strike a balance between accountability of the AIF managers towards the investors and the
flexibility such managers would need to effectively run their operations. Moreover, these measures have resulted
in increased investor protection by ensuring transparency and accountability of the concerned personnel.
B. Waterfall
A typical distribution waterfall involves a return of capital contribution, a preferred return (or a hurdle return), a
GP catch-up and a splitting of the residual proceeds between the LPs and the GP. With an increasing number of GPs
having reconciled themselves to the shift from the 20% carried interest normal, a number of innovations to the
distribution mechanism have been evolved to improve fundraising opportunities by differentiating product offerings
from one another. Waterfalls have been structured to facilitate risk diversification by allowing LPs to commit capital
both on a deal-by- deal basis as well as on a blind pool basis. Further, distribution of carried interest has been structured
on a staggered basis such that the allocation of carry is proportionate to the returns achieved by the fund.
In a unified structure, the distribution waterfall at the Onshore Fund level may require that distributions to the
Feeder be grossed-up to the extent of the expenses incurred at the Feeder level. The distribution proceeds at the
Onshore Fund level could be allocated between the domestic investors and the Feeder providing them INR and
USD denominated preferred returns respectively.
While the taxation of carried interest remains unclear globally, several Indian GPs are considering allowing their
employees (who are entitled to carry) to track the carry directly from the fund, including through structures such
as employee welfare trusts.

C. Giveback
While there have been rare cases where some LPs have successfully negotiated against the inclusion of a giveback
provision, GPs in the Indian funds industry typically insist on an LP giveback clause to provide for the vast risk
of financial liability including tax liability. The LP giveback facility is a variant to creating reserves out of the
distributable proceeds of the fund in order to stop the clock / reduce the hurdle return obligation. With a view to
limiting the giveback obligation, LPs may ask for a termination of the giveback after the expiry of a certain time
period or a cap on the giveback amount. However, this may not be very successful in an Indian context given that
the tax authorities are given relatively long time-frames to proceed against taxpayers.
As bespoke terms continue to emerge in LP-GP negotiations, designing a fund may not remain just an exercise
in structuring. The combination of an environment less conducive for fund raising and changes in legal, tax and
regulatory environment along with continuously shifting commercial expectations requires that fund lawyers
provide creatively tailored structural alternatives.
There are certain India specific issues which may complicate LP giveback negotiations beyond global standards.
For example, a Category I or II AIF in India which is set up as a determinate trust could, separately and in addition
to the LP giveback clause, seek a tax indemnity from each of its investors for the AIF, its manager or its trustee
doing good any tax liability on behalf of any of such investors.
D. Voting rights
In a unified structure, the Onshore Fund will issue different classes of units / shares (as applicable) to the domestic LPs
and the Feeder respectively upon receiving their capital contributions. In respect of issues where a vote is required
to be cast by the Feeder in its capacity as an investor in the Onshore Fund, the board of the Feeder may seek the
recommendations of its shareholders (i.e. the offshore investors) on such matters and cast votes on the units / shares
(as applicable) of the Onshore Fund in a manner reflective of that and in keeping with their fiduciary obligations.
E. USD-INR hurdle rates

In a unified structure, the Onshore Fund may either offer an INR hurdle rate to all its investors, whether Indian or
foreign; or (ii) an INR hurdle rate to Indian investors and a USD hurdle rate to foreign investors.
Commitments by the Indian investors and the Feeder to the Onshore Fund will be denominated and drawn down
in Indian Rupees and commitments by the offshore investors to the offshore fund will be denominated and drawn
down in US Dollars. This exposes the corpus of the Indian fund to exchange rate fluctuations which impacts the
ratio of unfunded capital commitments among Indian investors and offshore investors.
There are a variety of options available to deal with the exchange rate fluctuations in a unified structure,
depending on the commercial expectations. The exchange rate ratio may either be fixed from the date of the first
closing itself, or may be closed at the time of final closing, as no further commitments will be expected after the
final closing into the Onshore Fund.
If there are certain unfunded commitments remaining at either the Feeder level or the Onshore Fund level due to
currency fluctuations while the other vehicle’s unfunded capital commitments have reduced to nil (in case the GP
is unable to align the ratio of drawdown between the two pools of investors with the exchange rate fluctuation),
then the commitment period of the relevant vehicle may be terminated at the discretion of the manager / advisor
(as applicable). Alternatively, with the approval of the requisite investors, such remaining capital commitments
may also be utilized.

F. Co-Investment Opportunities
In a unified structure, offering of co-investment rights to LPs of the offshore fund needs to be designed carefully to
allow efficient implementation. SEBI has recently introduced amendments to the AIF Regulations, 2012 and PMS
Regulations on November 9, 2021 providing for the framework of offering co-investment opportunities to the
investors of the AIF. For a detailed overview of the same, please refer to the paragraph titled “Co-investments” above.
G. Key person events

Existing India funds are seen grappling with key person clauses given the reshuffling of investment management
personnel (including spinoffs and formation of new ventures). Many large PE fund managers of India focused
funds have recently seen senior level officials quit to start their own ventures.
GPs are exploring ways of identification of key persons and related (proportionate) consequences, as LPs look to
be as inclusive as possible while determining time commitment of key persons. While the CXO level personnel
continue to be relevant, LPs also expect the GP team to take a haircut on its economics if it is unable to retain
talent at the investment management team level. Concepts of ‘super key person’ and ‘standard key person’ are
increasingly becoming common.
Consequences of key person events are not expected to be limited to suspension of investment period anymore,
but if uncured, may also trigger consequences that are at par with removal for cause events.
H. Side-letter items
Typically, investors may seek differential arrangements with respect to co-investment allocation, membership
to LPACs, excuse rights, specific reporting formats, prohibited investment sectors etc. An investor may also
insist on including a ‘most favored nation’ (or MFN) clause to prevent any other investor being placed in a better
position than itself.
It is relevant for all investors that the Onshore Fund is able to effect the terms entered into by investors whether
directly at the Onshore Fund level or the Feeder, including making available rights under MFN provisions.
In the template PPM provided under the February 2020 Circular, SEBI has prescribed that investors be informed of
any side letters that have been entered into by the Fund. It also prescribes that certain rights such as rights related
to preferential exit from AIF, contribution to indemnification, contributor giveback and drawdowns (except as
per the provision for ‘excuse and exclusion’) cannot be offered under the Side Letter to any investor.
I. Closing Adjustments
A common fund term in all PE funds is one related to closing adjustments to be made when a new investor is
admitted to the fund at any closing subsequent to the first closing.
In a unified structure, a new investor in the offshore fund would be required to compensate the existing investors
at the offshore fund level as well as the Onshore Fund level and vice-versa for a new investor participating
subsequent to the first closing in the Onshore Fund.

J. Excuse Rights
Domestic insurers continue to remain a significant source of asset allocation. Indian insurers regulated by the
Insurance Regulatory and Development Authority of India are required to ensure that their capital contributions
are not invested outside India. Likewise, other statutory / state-aided Indian institutional investors impose similar
conditions while making commitment to a fund. Investment programs for several DFIs too require that they be
excused from certain deals if the fund were to explore certain opportunities. However, the terms on which an
investor maybe excused shall be disclosed upfront in the relevant agreements.
K. Removal of GPs
‘For cause’ removal typically refers to the premature termination of the manager’s services to the fund by the LPs,
owing to events of default – mainly fraud, willful misconduct, and gross negligence.
The relevant question in the context of some of the recent funds has been on who determines whether a ‘Cause’
event has occurred. Global LPs are circumspect about the determination standard to be Indian courts, because of
the perception that dispute resolution by way of litigation in India may take unreasonably long to conclude.
Further, it is also being observed that many LPs require the Manager to take haircuts on carry even when the
Manager is removed for no cause.

6. Fund Documentation
Fund counsels are now required to devise innovative structures and advise investors on terms for meeting
investor’s (LP) expectations on commercials, governance and maintaining discipline on the articulated
investment strategy of the fund. All these are to be done in conformity with the changing legal framework.
To attract high quality LPs, it is essential that the fund documents (including the investor pitch and the private
placement memorandum) include an articulation on the fund’s governance standard. It is also essential that global
best practices are taken into account when preparing such fund documents including contribution agreements, LP
side letters and closing opinion, and to ensure that the same are not just confined to Indian regulatory and tax aspects.
Enforceability of provisions contained in the fund documents, and their inter-se applicability on investors and
fund parties is of utmost importance while designing fund documents. Investors expect their side letters to prevail
with respect to them over the other fund documents, whereas, for collective claims by all investors, the charter
documents should prevail.
Fund documents are an important aspect of the fundraising exercise. They are also critical to determine whether a
pooling vehicle is in compliance with the applicable law across various jurisdictions. For an India-focused fund or
a fund with India allocation which envisages LP participation both at the offshore level and at the Indian level, the
following documents are typically prepared:
I. At the Offshore Fund Level

A.Private Placement Memorandum / Wrapper
The private placement memorandum (“PPM”) is a document through which the interests of the fund are marketed
to potential investors. Accordingly, the PPM outlines the investment thesis of a fund, summarizes the key terms
on which investors could participate in the fund’s offering and also presents the potential risk factors and conflicts
of interest that could arise to an investor considering an investment in the fund. A wrapper is a short supplement
that is attached to the PPM of a domestic fund (in case of ‘unified structure’) to help achieve compliance with the
requirements for private placement of the securities / interests of an offshore fund to investors in jurisdictions
outside India. The use of a wrapper is common in the case of unified investment structures as the risks of the
onshore fund are inherent in the shares / LP interests issued to investors to the offshore fund.
B. Constitution
A constitution is the charter document of an offshore fund in certain jurisdictions. It is a binding contract between
the company (i.e. the Fund), the directors of the company and the shareholders (i.e. the investors) of the company.
C. Subscription Agreement
The subscription agreement is an agreement that records the terms on which an investor will subscribe to
the securities / interests issued by an offshore fund. The subscription agreement sets out the investor’s capital
commitment to the fund and also records the representations and warranties made by the investor to the fund.
This includes the representation that the investor is qualified under law to make the investment in the fund. 50
50. In case the fund is set up in the format of a limited partnership, this document would be in the format of a limited partnership agreement (with
the ‘general partner’ holding the management interests).

D. Advisory Agreement
The board of an Offshore Fund may delegate its investment management / advisory responsibilities to a separate
entity known as the Investment Advisor or the Investment Manager. The Investment Advisory Agreement
contains the general terms under which such investment advisor renders advise in respect of the transactions for
the Fund’s board.
Sometimes, the investment advisor / manager of an offshore fund enters into a ‘sub-advisory agreement’ with
an on-the-ground investment advisory entity (the sub-advisor). The sub- advisory agreement typically provides
that the sub-advisor will provide non-binding investment advice to the investment advisor of the offshore fund
for remuneration.
II. At the Onshore Fund Level

A. Private Placement Memorandum
AIF Regulations require that a concerned fund’s PPM should contain all material information about the AIF,
including details of the manager, the key investment team, targeted investors, fees and other expenses proposed
to be charged from the fund, tenure of the scheme, conditions or limits on redemption, investment strategy, risk
factors and risk management tools, conflicts of interest and procedures to identify and address them, disciplinary
history, terms and conditions on which the manager offers services, affiliations with other intermediaries, manner
of winding up the scheme or the AIF and such other information as may be necessary for an investor to make an
informed decision as to whether to invest in the scheme of an AIF. 51
SEBI has now directed fund managers to add by way of an annexure to the placement memorandum, a detailed
tabular example of how the fees and charges shall be applicable to the investor and the distribution waterfall for
AIFs.52 In addition, by a circular dated December 10, 2021, SEBI has mandated that (i) investor charter; and (ii)
data on investor complaints received against AIFs and each of their schemes and redressal status thereof shall be
disclosed by all AIFs in a format as prescribed by the said circular.
AIFs should also include disciplinary actions in its PPM. 53 It has been clarified by SEBI that AIFs should also
include a disciplinary history of the AIF, sponsor, manager and their directors, partners, promoters and associates
and a disciplinary history of the trustees or the trustee company and its directors if the applicant for AIF
registration is a trust. 54
Any changes made to the PPM submitted to SEBI at the time of the application for registration as an AIF must be
listed clearly in the covering letter submitted to SEBI and further to that, such changes must be highlighted in the
copy of the final PPM.55 In case the change to the PPM is a case of a ‘material change’ (factors that SEBI believes to be
a change significantly influencing the decision of the investor to continue to be invested in the AIF), said to arise in
the event of (1) change in sponsor / manager, (2) change in control of sponsor / manager, (3) change in fee structure or
hurdle rate which may result in higher fees being charged to the unit holders), existing unit holders who do not wish
to continue post the change shall be provided with an exit option.56 Further, such material changes to the PPM, shall
be intimated to investors and SEBI on a consolidated basis, within 1 month of the end of each financial year.
51. Regulation 11 of the AIF Regulations, 2012.

52. 4. Paragraph 2(a)(i)of the SEBI Circular CIR/IMD/DF/14/2014.
53. 5. Regulation 11(2) AIF Regulations.
54. Paragraph 2(a)(ii) of the SEBI Circular CIR/IMD/ DF/14/2014Regulation
55. 7. Paragraph 2(b)(i) of the SEBI Circular CIR/IMD/DF/14/2014.
56. 8. Paragraph 2(b)(iv)(a) of the SEBI Circular CIR/IMD/DF/14/2014.

This change is critical for fund managers to note. Such disclosure reduces the space for ‘views’ being taken by a
fund manager in a given liquidity event leading to distribution. This also requires that the fund manager engages
more closely with the fund counsel to articulate the waterfall in a manner that they can actually implement with
a degree of automation. Any deviance from the waterfall as illustrated in the fund documents could potentially be
taken up against the fund manager.
While global investors prefer excluding the PPM from being an ‘applicable fund document’ to investors, SEBI
expects the manager to ensure that each of the investors has read and agreed to the terms in the PPM. Also, as
explained above, SEBI primarily reviews the PPM to grant registration as an AIF to the applicants. This often
becomes a matter of concern during LP-GP negotiations. Unless a waiver has been taken, the AIF shall abide by the
template form of the PPMs as discussed in detail in the previous section.
B. Indenture of Trust
The Indenture of Trust is an instrument that is executed between a settlor and a trustee whereby the settlor conveys
an initial settlement to the trustee towards creating the assets of the fund. The Indenture of Trust also specifies the
various functions and responsibilities to be discharged by the appointed trustee. It is an important instrument from
an Indian income - tax perspective since the formula for computing beneficial interest is specified.
The formula for computing beneficial interest is required to establish the determinate nature of the trust and
consequently for the trust to be treated as a pass-through entity for tax purposes.
C. Investment Management Agreement

The Investment Management Agreement is to be entered into by and between the trustee and the investment
manager (as the same may be amended, modified, supplemented or restated from time to time). Under this
Agreement, the trustee appoints the investment manager and delegates all its management powers in respect of the
fund (except for certain retained powers that are identified in the Indenture of Trust) to the investment manager.
D. Contribution Agreement
The Contribution Agreement is to be entered into by and between each contributor (i.e. investor), the trustee and
the investment manager (as the same may be amended, modified, supplemented or restated from time to time)
and, as the context requires. The Contribution Agreement records the terms on which an investor participates in a
fund. This includes aspects relating to computation of beneficial interest, distribution mechanism, list of expenses
to be borne by the fund, powers of the investment committee, etc. A careful structuring of this document is
required so that the manager / trustee retain the power to make such amendments to the agreement as would not
amend the commercial understandings with the contributor.
SEBI also requires that the terms of the Contribution Agreement should be in alignment with the terms of the
PPM and should not go beyond the same.
III. Investor Side Letters

It is common for some investors to ask for specific arrangements with respect to their participation in the fund.
These arrangements are recorded in a separate document known as the side letter that is executed by a specific
investor, the fund and the investment manager. Typically, investors seek differential arrangements with respect
to management fee, distribution mechanics, participation in investment committees, investor giveback, etc. An

investor may also insist on including a ‘most favoured nation’ (“MFN”) clause to prevent any other investor being
placed in a better position than itself. An issue to be considered is the enforceability of such side letters unless it is
an amendment to the main contribution agreement itself.
SEBI has now, through its Circular on Disclosure Requirements, made it mandatory for the PPMs to provide for
various disclosures. Some of them include disclosure of whether any side letters shall be offered, the criteria for
offering differential rights (quantitative/qualitative/both), list of commercial / non-commercial terms on which
differential rights may be / may not be offered. SEBI also mandated for the PPM to include a declaration to the
effect that the terms of the side letters shall not alter the rights of other investors.
IV. Agreements with Service Providers

Sometimes, investment managers may enter into agreements with placement agents, distributors and other service
providers with a view to efficiently marketing the interests of the fund. These services are offered for a consideration
which may be linked to the commitments attributable to the efforts of the placement agent / distributor.
V. Applicability of Stamp Duty

The amendments to the Indian Stamp Act, 1899 (w.e.f. from July 01, 2020) have made provision for the payment
of stamp duty on issuance and transfer of securities (other than debentures). The definition of ‘securities’ to be
perused for this provision has to be borrowed from the Securities Contracts (Regulation) Act, 1956 (“SCRA”) and
will also include any other instrument as declared by the Central Government. While prior to the introduction
of this provision, the AIF units were not considered ‘securities’ as per the SCRA, the SEBI recently issued a
Circular 57 to this effect thus bringing the AIF units within the purview of the said amendment. Furthermore, the
Department of Economic Affairs also released a set of FAQs to clarify this aspect.
Hence, as per the amendment, issuance of AIF units will now attract a stamp duty of 0.005% of the value of units
excluding charges such as management fee, GST etc. Transfer of units on delivery basis will attract a stamp duty of
0.015% whereas transfer on a non-delivery basis will attract a stamp duty of 0.003% on the transfer consideration.
It is noteworthy that the redemption of units shall not require payment of stamp duty. The FAQs have clarified
that the stamp duty will be collected by Registrar to an issue/share transfer agent (“RTA”) and in demat form will
be collected by a depository in terms of Section 9A of the Stamp Act.
57. https://www.sebi.gov.in/legal/circulars/jun-2020/collection-of-stamp-duty-on-issue-transfer-and-sale-of-units-of-aifs_46983.html.

7. Hedge Funds
‘Hedge funds’ lack a precise definition. The term has been derived from the investment and risk management
strategies they tend to adopt.
The Indian regulators’ comfort in allowing access to global hedge funds is of recent origin. It was only gradually
that several investment opportunities were opened for investors participating under the FII Regulations that
allowed for a wider gamut of strategy implementation for a hedge fund.
The FPI Regulations 2014 were recently overhauled to render effect to the recommendations of the HR Khan
Committee. This section deals with eligible participants under the FPI Regulations, 2019 the range of investment
and hedge strategies that may be adopted and the scope of dealing with contract notes (swaps and offshore
derivative instruments, i.e. ODIs).
On the onshore side, SEBI allows hedge strategies as a possible investment strategy that a ‘Category III’ AIF could adopt.
This section also deals with the basic framework within which such onshore ‘hedge’ funds are allowed to operate.
I. FPI Regulations
SEBI notified the FPI Regulations 2014 on January 07, 2014. Subsequently, on the recommendations made by the
H R Khan Committee to simplify and rationalize the FPI Regime, SEBI notified the FPI Regulations 2019 along
with the Operational Guidelines to operationalize and facilitate implementation of the new regulations and
ensure efficient transition from the FPI Regulations 2014.
A. Meaning of FPI
The term ‘FPI’ has been defined to mean a person who has been registered under Chapter II of the FPI
Regulations 2019 and is deemed to be an intermediary in terms of provisions of the Securities and Exchange
Board of India Act, 1992 (“SEBI Act”). No person is permitted to transact in securities as an FPI unless it has
obtained a Certificate of Registration (“COR”) granted by the DDP on behalf of SEBI. An offshore fund floated by
an asset management company that has received no-objection certificate in accordance with the Mutual Fund
Regulations, shall be required to obtain registration as an FPI for investment in securities in India, till the expiry
of the block of three years.
The application for grant of registration is to be made to the DDP in a prescribed form along with the specified
fees. The eligibility criteria for an FPI, inter-alia, include:
i. The applicant is a person not resident in India; 58
ii. The applicant is not a non-resident Indian or an overseas citizen of India;
iii. non-resident Indians or overseas citizens of India or resident Indian individuals can be constituents of the
applicant provided they meet conditions specified by the Board from time to time;
iv. The applicant is a resident of a country whose securities market regulator is a signatory to the International
Organization of Securities Commission’s Multilateral Memorandum of Understanding or a signatory to a
bilateral Memorandum of Understanding with the SEBI; provided that an applicant being Government or
58. The term “persons”, “non-residents” and “resident” used herein have the same meaning as accorded to them under the ITA.

7. Hedge Funds
Government related investor shall be considered as eligible for registration, if such applicant is a resident in
the country as may be approved by the Government of India;
v. The applicant or its underlying investors contributing twenty-five percent or more in the corpus of the
applicant or identified on the basis of control, shall not be the person(s)mentioned in the Sanctions List
notified from time to time by the United Nations Security Council and is not a resident in the country
identified in the public statement of FATF as–
a. a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism

deficiencies to which counter measures apply; or
b. a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to
an action plan developed with the FATF to address the deficiencies;
vi. The applicant being a bank,59 is a resident of a country whose Central bank is a member of Bank for
International Settlements: Provided that a central bank applicant need not be a member of Bank for
International Settlements;
vii. the applicant is a fit and proper person based on the criteria specified in Schedule II of the Securities and
Exchange Board of India (Intermediaries) Regulations, 2008;
viii. any other criteria specified by the Board from time to time:
provided that, clause (i), (iv) and (vi) shall not apply to an applicant incorporate or established in an IFSC.
A certificate of registration granted by a DDP shall be permanent unless suspended or cancelled by SEBI or
surrendered by the FPI.
B. Categories of FPI
Following are the two categories of FPIs: :
Category I Category II
i. Government and Government related investors such as central banks, i. appropriately regulated funds not eligible as Category-I
sovereign wealth funds, international or multilateral organizations or foreign portfolio investor;
agencies including entities controlled or at least 75% directly or indirectly
owned by such Government and Government related investor(s); ii. endowments and foundations;
ii. Pension funds and university funds; iii. charitable organisations;
iii. Appropriately regulated entities such as insurance or reinsurance entities, iv. corporate bodies;
banks, asset management companies, investment managers, investment
advisors, portfolio managers, broker dealers and swap dealers; v. family offices;
iv. Entities from the FATF member countries, or from any country specified by vi. Individuals;
the Central Government by an order or by way of an agreement or treaty
with other sovereign Governments which are – vii. appropriately regulated entities investing on behalf of
their client, as per conditions specified by the SEBI
from time to time;
59. In case of an applicant being a bank or its subsidiary, the DDP is required to forward the details of the applicant to SEBI who would in turn
request the RBI to provide its comments. The comments of the RBI would be provided by the SEBI to the DDP

7. Hedge Funds
a. appropriately regulated funds; viii. Unregulated funds in the form of limited partnership
and trusts;
b. Unregulated funds whose investment manager is appropriately
regulated and registered as a Category I foreign portfolio investor,
provided that the investment manager undertakes the responsibility of
all the acts of commission or omission of such unregulated fund;
c. university related endowments of such universities that have been in
existence for more than five years;
v. An entity (A) whose IM is from the FATF country and such an IM is

registered as a Category I FPI; or (B) which is at least 75% owned, directly
or indirectly by another entity, eligible under sub-clause (ii), (iii) and (iv)
of clause (a) of this regulation and such an eligible entity is from a FATF
member country:
vi. Provided that such an IM or eligible entity undertakes the responsibility

of all the acts of commission or omission of the applicants seeking
registration under this sub-clause.
An applicant incorporated or established in an IFSC is deemed to be appropriately regulated. 60
An “appropriately regulated” entity means an entity which is regulated by the securities market regulator or
the banking regulator of home jurisdiction or otherwise, in the same capacity in which it proposes to make
investments in India;61 In order to find out whether an entity is regulated in the same capacity, the DDP has the
option of verifying if the FPI is allowed by its regulator to carry out such activity under its license / registration
granted by the regulator. 62
C. FATF Compliances
The FPI Regulations place an increased focus on classification of countries or jurisdictions by the FATF when
prescribing eligibility criteria for registration as an FPI both generally and specifically for eligibility as a Category I FPI.
SEBI introduced an amendment vide a notification dated April 7, 2020, in the FPI Regulations, pursuant to which
the Indian government may notify FPIs from countries that are not member countries of the FATF as eligible to
register as Category I FPIs. Soon thereafter, Ministry of Finance vide an order dated April 13, 2020, 63 specified
Mauritius as an eligible country, allowing Mauritius based FPIs to register under Category I. Similarly, the
Government on June 14, 2021, notified Cyprus of its status as an eligible country for the purpose of FPI Category I
license. Pursuant to an official order dated October 23, 2021 by, Mauritius was taken out of the FATF grey list.64
D. Investments under FPI Regulations

Under the FPI Regulations, FPIs are permitted to invest in the following:
a. shares, debentures and warrants issued by a body corporate; listed or to be listed on a recognized stock
exchange in India,
60. Explanation to Regulation 5.

61. Regulation 2 (1)(b) of the FPI Regulations.
62. Operational Guidelines for Foreign Portfolio Investors, Designated Depository Participants and Eligible Foreign Investors.
63. https://nsdl.co.in/downloadables/pdf/2020-0008-Policy-DDP-Ministry%20of%20Finance%20order%20dated%20April%2013,%202020.pdf.
64. Jurisdictions under Increased Monitoring - October 2021, FATF available at https://www.fatf-gafi.org/publications/high-risk-and-other-moni-
tored-jurisdictions/documents/increased-monitoring-october-2021.html

7. Hedge Funds
b. units of schemes floated by mutual funds under Chapter V, VI-A, and VI-B of the Mutual Fund Regulations,
1996;
c. units of scheme floated by a Collective Investment Scheme in accordance with CIS Regulations, 1999;
d. derivatives traded on a recognized stock exchange;
e. units of REITs, InvITs and units of Category III AIFs registered with the Board;
f. Indian depository receipts;
g. any debt securities or other instruments as permitted by the RBI for FPIs to invest in from time to time; and
h. Any such other instruments specified by SEBI from time to time.
In respect of investments in the secondary market, the following additional conditions shall apply:65
An FPI shall transact in the securities in India only on the basis of taking and giving delivery of securities
purchased or sold except in the following cases:
a. any transactions in derivatives on a recognized stock exchange;
b. short selling transactions in accordance with the framework specified by SEBI;
c. any transaction in securities pursuant to an agreement entered into with the merchant banker in the
process of market making
or subscribing to unsubscribed portion of the issue in accordance with Chapter IX of the Securities and
Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018;
d. any other transaction specified by SEBI.
Furthermore, with regards to secondary markets, transactions involving dealing in securities by an FPI shall only
be through stock brokers registered with the Board except in cases mentioned under Regulation 20 (4)(d).
NDI Rules provide for a larger array of investment instruments which are within the permissible limits of FPIs and
these include equity instruments, units of Category III AIFs, units of REITs and InvITs, derivatives traded on a RSE,
units of CIS amongst several others. No single FPI or investor group (any group of FPIs having common ownership
of at least 50% or common control) is permitted to hold 10% or more of equity instruments of a single company.
With effect from 1st April, 2020, the aggregate investment limit for the FPIs is the sectoral caps applicable to the
Indian company as laid out in Schedule I of the Foreign Exchange Management (Non-debt Instruments) Rules,
2019 with respect to its paid-up equity capital on a fully diluted basis.
In the event investment in a company by an FPI results in a breach of either the individual or aggregate limits,
such FPI would have a window period of five trading days from the day of settlement of trades causing the breach
to divest its holdings in such company to a level below the concerned limit; provided that in case the FPI fails to
divest the excess holding, the entire investment in the company by such FPI including its investor group shall be
considered as investment under the FDI, as per the procedure specified by SEBI and the FPI and its investor group
shall not make further portfolio investment in that company under the FPI Regulations
65. Regulation 20(4) of the FPI Regulations.

7. Hedge Funds
E. Beneficial Ownership Identification and Verification

The Operational Guidelines also provide guidance on the identification of BOs. In respect of FPIs (other than
Category I FPI registered under Regulation 5(a)(i)) coming from “high risk jurisdictions” as identified by
intermediary, the intermediaries may apply lower materiality threshold of 10% for identification of BO. For
Category I FPIs (other than registered under regulation 5(a)(i)) from high risk jurisdictions) KYC documentation
as applicable for category II FPIs need to be provided. The materiality threshold to identify the beneficial owner
should be first applied at the level of FPI and next look through basis shall be applied to identify the beneficial
owner of the intermediate shareholder/ owner entity.
BO and intermediate shareholder/ owner entity with holdings equal & above the materiality thresholds in the
FPI need to be identified on a look-through basis. For intermediate material shareholder/ owner entity/ies, name,
country and percentage holding shall also be disclosed as per Annexure E to the Operational Guidelines. In case
the intermediate shareholder/ owner entity is eligible for registration as Category I FPI under Regulation 5(a)(i),
there is no need for further identification and verification of beneficial owner of such intermediate shareholder/
owner entity.
In a key addition to the requirements under the previous regime as well as the look-through principle enshrined
under the PMLA Rules, the Guidelines mandate the disclosure of intermediate shareholders / owner entities
with holdings equal to and above the materiality thresholds in the FPI (25% for companies in non-high-risk
jurisdictions, 15% for partnerships and trusts in non-high risk jurisdictions and 10% for FPIs coming out of high
risk jurisdictions).
F. FPIs in International (IFSC) Financial Services Centre

SEBI registered FPIs, proposing to operate in IFSC, shall be permitted, without undergoing any additional
documentation and/or prior approval process. In case of participation of FPI in IFSC, due diligence carried out by
SEBI registered Intermediary during the time of account opening & registration shall be considered. FPIs, who
presently operate in Indian securities market and propose to operate in IFSC also, shall be required to ensure
clear segregation of funds and securities. Custodians shall, in turn, monitor compliance of this provision for
their respective FPI clients. Such FPIs shall keep their respective custodians informed about their participation
in IFSC.66 The FPI Regulations 2019 have extended certain leeway to entities established in IFSC, in terms of the
eligibility norms required to be fulfilled by FPIs for registration with SEBI.
- Exemption in eligibility criteria for FPIs in IFSC: Certain eligibility norms in relation to the registration of
an applicant with SEBI as an FPI, under Regulation 4 of the FPI Regulations 2019, i.e. the applicant should (a)
not be a resident Indian, (b) be a resident of the country whose securities market regulator is a signatory to
the International Organization of Securities Commission’s Multilateral Memorandum of Understanding or a
signatory to the bilateral Memorandum of Understanding with SEBI; and (c) in case the applicant is a bank, then it
should be a resident of a country whose central bank is a member of the Bank for International Settlements, have
been exempted for applicants incorporated or established in IFSC.
- As mentioned earlier, an applicant incorporated or established in IFSC shall be deemed to be appropriately

regulated, for the purposes of the SEBI (FPI) Regulations. 67 Therefore, an applicant incorporated or established in
IFSC can apply for registration as a Category I FPI.
66. Part E, Operational Guidelines for Foreign Portfolio Investors, Designated Depository Participants and Eligible Foreign Investors.
67. Explanation to Regulation 5 of the SEBI (FPI) Regulations 2019

7. Hedge Funds
G. Offshore Derivative Instruments

Under the FPI Regulations 2019, an ODI is defined to mean any instrument, by whatever name called, which is
issued overseas by an FPI against securities held by it in India, as its underlying. FPIs can issue, subscribe to or
otherwise deal in ODIs, directly or indirectly, provided the following conditions are satisfied:
§ Such ODIs are issued only by persons registered as Category I FPI;
§ Such ODIs are issued only to persons eligible for registration as Category I FPI;
§ Such issuance should be in compliance with the ‘know your client’ norms;
§ FPI has to ensure that any transfer of any ODIs issued by or on behalf of it is subject to the following conditions:
a. ODI are transferred to persons subject to the fulfilment of the conditions provided above in this section
“Offshore derivative instruments” i.e. it shall be transferred to persons who are eligible to be registered as a
Category I FPI and such transfer shall be in compliance with the ‘know your client’ norms;
b. Prior consent of the FPI is obtained for such transfer, except in cases, where the persons to whom the ODIs
are to be transferred, are pre-approved by the FPI
§ FPI fully discloses to SEBI any information concerning the terms of and parties to the ODIs issued at the back
of any Indian securities listed or proposed to be listed on a RSE in India, as and when such information is called
for by SEBI;
§ FPI collects the applicable regulatory fee, from every subscriber of the ODI issued by it and deposit the same
with SEBI
§ Such other conditions as may be specified by SEBI from time to time.
H. Ownership Restrictions
In addition to the various eligibility criteria laid down under the FPI Regulations, the Operational Guidelines
inter-alia state that:
a. NRI / OCI / RI Constituents: The Guidelines provide that participation by a single NRI / OCI / RI should be
restricted to 25% and in aggregate to below 50% of the total contribution in the corpus. SEBI has clarified that
the contribution of RIs is permitted if made through the LRS approved by the RBI in global funds that have an
India exposure of less than 50%.
NRI / OCI / RI management and control of FPIs: The Guidelines stipulate that NRI / OCI / RI should not be in
control of FPIs. This condition is not applicable for FPIs which are an ‘offshore fund’ for which no-objection
certificate has been provided by SEBI in terms of the Mutual Fund Regulations), or, is controlled by investment
manager (“IMs”) which is owned and controlled by NRIs / OCIs/ RIs if (i) the IM is appropriately regulated in
its home jurisdiction and registers itself with SEBI as a non-investing FPI; or (ii) the IM is incorporated or set
up in India and appropriately registered with SEBI. Further, SEBI has clarified that a non-investing FPI may be
owned and / or controlled by a NRI / OCI / RI.
b. The FPI Regulations provide that multiple entities registered as FPIs, and directly or indirectly, having common
ownership of more than 50% or common control shall be treated as part of the same investor group and
the investment limits of all such entities shall be clubbed at the investment limit as applicable to a single

7. Hedge Funds
FPI. Hence, entities which are not registered as FPIs will not form part of an investor group under the FPI
Regulations and correspondingly would not be subjected to investment limits prescribed for FPIs under the FPI
Regulations.
An investor group is constituted where multiple entities registered as FPIs and directly or indirectly, having
common ownership of more than 50% or common control.
I. Tax Treatment of FPI Investments

The tax treatment of FPIs registered under the FPI Regulations 2014/ 2019 would be similar to the treatment
accorded to FIIs. Accordingly, all such FPIs would be deemed to be Foreign Institutional Investors under
Explanation (a) to section 115AD and would be taxed similarly.
The characterization of income earned by FPIs has been a long standing point of contention under Indian tax law.
This is because, under Indian tax treaties, the business income of a non-resident is not taxable in India unless the
non-resident has a permanent establishment in India. However, this debate has been put to rest by virtue of an
amendment in the definition of capital asset under the ITA. Pursuant to the amendment, securities held by an FPI
will be considered “capital assets”, accordingly, gains derived from their transfer will be considered “capital gains”
The ITA contains various provisions which govern the taxation of FPIs specifically. Section 115AD of the ITA
provides a special regime of taxation for FPIs, which inter-alia provides the following rate of tax for income earned
by FPIs in India:
S No. Nature of income

Rate of tax 68
1. Interest income 20%
2. Long-term capital gains 10%
3. Short-term capital gains 30%
4. 20%
Dividend income 69
J. Issuance of Participatory Notes and Derivate Instruments

Part D of the Operational Guidelines consolidate the requirements prescribed by SEBI with regards to issuance of
ODIs by FPIs under FPI Regulations.
As per the latest guidelines, FPIs are not allowed to issue ODIs referencing derivatives and hedge their ODIs with
derivative positions on stock exchanges in India. An exception has been created for FPI through a separate FPI
registration of an ODI issuing FPI under Category I:
68. The amount of tax is increased by applicable surcharge and the aggregate amount of tax and surcharge is further increased by health and educa-
tion cess of 4%. Rates of surcharge for financial year 2020-21 are as under:
Taxable income FPIs
Up to INR 5 million (including capital gain and dividend income) Nil
Above INR 5 million up to INR 10 million (including capital gain and dividend income) 10%
Above INR 10 million up to INR 20 million (including capital gain and dividend income) 15%
Above INR 20 million to INR 50 million (excluding capital gain and dividend income) 25%
Above 50 million (excluding capital gain and dividend income) 37%
69. Pertinent to note that the Finance Act, 2020 abolished the dividend distribution tax (“DDT”) – a 15% additional income-tax payable by Indian
companies on amounts declared, distributed or paid by them as dividends and instead move to the classical system of taxing the shareholders on
the dividends received, at the applicable marginal tax rate. Prior to amendment by the Finance Act, 2020, Indian company distributing dividends
to FPIs was liable to deduct DDT and such dividend income was exempt in hands of FPIs

7. Hedge Funds
i. Derivative positions that are taken on stock exchanges by the FPI for ‘hedging of equity shares’ held by it in India,
on a one to one basis; and/or (The Guidelines define the term “hedging of equity shares” as taking a one-to-one
position in only those derivatives, which have the same underlying as the equity share held by the FPI in India.)
ii. An ODI issuing FPI may hedge the ODIs referencing equity shares with derivative positions in Indian stock
exchanges, subject to a position limit of 5% of market wide position limits for single stock derivatives. The
permissible position limit for stock index derivatives is higher of INR 100 crores or 5% open interest; and/or
iii. An ODI issuing FPI, which hedges its ODI only by investing in securities (other than derivatives) held by it in
India, cannot undertake proprietary derivative positions through the same FPI registration. Such FPI must
segregate its ODI and proprietary derivative investments through separate FPI registrations.
K. Position of Tax on P-Notes

Under sections 4 and 5 of the ITA, non- residents may be taxed only on income that accrues in India or which
arises from sources in India. The source rules for specific types of income are contained in section 9, which
specifies certain circumstances where such income is deemed to accrue or arise in India.
Capital gains from the transfer or sale of shares or other securities of an Indian company held as capital assets
would ordinarily be subject to tax in India (unless specifically exempted).
Under section 9(1)(i) of the ITA, income earned by a non-resident from the transfer of a capital asset situated in
India would be deemed to have been accrued in India (i.e. be sourced in India). Therefore, a non-resident may be
liable to tax in India if it earns income from the transfer of a capital asset situated in India.
In case of an ODI holder, while the value of the ODI can be linked to the value of an asset located in India
(equity, index or other forms of underlying securities from which the swap derives its value), it is a contractual
arrangement that does not typically obligate the ODI issuer to acquire or dispose the referenced security.
The Protocol amending the India-Mauritius DTAA may have an adverse effect on ODI issuers that are based
out of Mauritius. While most of the issuers have arrangements to pass off the tax cost to their subscribers, the
arrangement may have complications due to a timing mismatch as the issuer could be subject to tax on a first-in-
first out (“FIFO”) basis (as opposed to a one-to-one co-relation).
II. Onshore Hedge Funds

As has been previously discussed, SEBI introduced different categories of AIFs to cater to different investment
strategies. Category III AIFs is a fund which employs diverse or complex trading strategies and may involve
leverage including through investments in listed or unlisted derivatives.
While the general characteristics of Category III AIFs have been discussed previously, it is important to stress on
certain key aspects. The AIF Regulations provide that Category III AIFs may engage in leverage or borrow subject
to consent from the investors in the fund and subject to a maximum limit specified by SEBI. On July 29, 2013, SEBI
issued a circular which lays down certain important rules relating to redemption restrictions and leverage.
A. Suspension of Redemptions
A Category III AIF cannot suspend redemptions unless the possibility of suspension of redemptions has been
disclosed in the placement memorandum and such suspension can be justified as being under exceptional

7. Hedge Funds
circumstances and in the best interest of investors or is required under AIF Regulation or required by SEBI.
Further, in the event of a suspension of redemption, a fund manager cannot accept new subscriptions and will
have to meet the following additional obligations:
a. Document reasons for suspension of redemption and communicate the same to SEBI and to the investors;
b. Build operational capability to suspend redemptions in an orderly and efficient manner;
c. Keep investors informed about actions taken throughout the period of suspension;
d. Regularly review the suspension and take necessary steps to resume normal operations; and
e. Communicate the decision to resume normal operations to SEBI.
B. Leverage Guidelines
SEBI limits the leverage that can be employed by any scheme of a fund to two times (2x) the after deducting the
value of investments in units of the Investee AIFs from the net asset value (“NAV”) 70 of the of the total portfolio
investment held by such fund. The leverage of a given scheme is calculated as the ratio of total exposure of the
scheme to the prevailing NAV of the fund. While calculating leverage, the following points should be kept in mind:
a. Total exposure will be calculated as the sum of the market value of the long and short positions of all securities
/ contracts held by the fund;
b. Idle cash and cash equivalents are excluded while calculating total exposure;
c. Further, temporary borrowing arrangements which relate to and are fully covered by capital commitments
from investors are excluded from the calculation of leverage;
d. Offsetting of positions shall be allowed for calculation of leverage in accordance with the SEBI norms for
hedging and portfolio rebalancing; and
e. NAV shall be the sum of value of all securities adjusted for mark to market gains / losses including cash and
cash equivalents but excluding any borrowings made by the fund.
The AIF Regulations require all Category III AIFs to appoint a custodian. In the event of a breach of the leverage
limit at any time, fund managers will have to disclose such breach to the custodian who in turn is expected to
report the breach to SEBI before 10 AM, IST (India Standard Time) on the next working day. The fund manager
is also required to communicate the breach of the leverage limit to investors of the fund before 10 AM, IST on
the next working day and square off the excess exposure to rebalance leverage within the prescribed limit by the
end of the next working day. When exposure has been squared off and leverage has been brought back within
the prescribed limit, the fund manager must confirm the same to the investors whereas the custodian must
communicate a similar confirmation to SEBI.
70. SEBI circular no. SEBI/HO/IMD-I/DF6/P/CIR/2021/584 dated June 25, 2021

8. Fund Governance
A pooled investment vehicle typically seeks to adopt a robust governance structure. The genesis of this obligation
(other than as may be required under applicable laws) is in the generally accepted fiduciary responsibilities of
managers with respect to the investor’s money.
In a fund context, the decision-making framework typically follows the following structure –
I. Investment Manager
The investment manager is concerned with all activities of a fund including its investment and divestment related
decisions. These are typically subject to overall supervision of the board of directors of the fund (if set up in the
format of a ‘company’).
II. Investment Committee

The Investment Committee (“IC”) scrutinizes all potential transactions (acquisition as well as exit). The IC’s role
includes maintaining pricing discipline, ensuring that all transactions adhere to the fund’s strategy and assessing
the risk-return profile of the deals.
The functions of the IC typically include review of (1) transactions that are proposed by the investment manager,
(2) performance, risk profile and management of the investment portfolio and (3) to provide appropriate
recommendations to the investment manager (4) ensuring compliance with the Code of Conduct of the AIF as
prescribed in the PPM and other constitutive documents of the AIF.
III. Advisory Board

Typically, the Advisory Board’s role is to provide informed guidance to the investment manager / IC of the fund
based on the information / reports shared by the investment manager with the Advisory Board.
The Advisory Board typically provide recommendations to the investment manager / IC in relation to (1)
managing “conflicts of interest” situations; (2) approval of investments including co-investment opportunities
made beyond the threshold levels as may have been defined in the fund documents; (3) approval of reduction of
equalization premium amount; (4) investment manager’s overall approach to investment risk management and;
(5) corporate governance and compliance related aspects.
IV. Aspects and Fiduciaries to be considered by Fund

Directors
The emerging jurisprudence suggests that the threshold of fiduciaries that is required to be met by the directors
is shifting from “sustained or systematic failure to exercise oversight” to “making reasonable and proportionate
efforts commensurate with the situations”. A failure to perform their supervisory role could raise several issues
concerning liabilities of independent directors for resultant business losses as would be seen in the case of
Weavering Macro Fixed Income Fund (summarized below).

8. Fund Governance
As a matter of brief background, Weavering Macro Fixed Income Fund (“Fund”) was a Cayman Islands based
hedge fund. The Fund appointed an investment manager to ‘manage the affairs of the Fund subject to the overall
supervision of the Directors’. The Fund went into liquidation at which point in time, action for damages was
initiated by the official liquidators against the former “independent” directors.
The Grand Court of Cayman Islands found evidence that while board meetings were held in a timely manner, the
meetings largely recorded information that was also present in the communication to fund investors and that
the directors were performing ‘administrative functions’ in so far as they merely signed the documents that were
placed before them.
Based on such factual matrix, the Grand Court held against the directors for willful neglect in carrying out
their duties. It was also observed that based on their inactions, the defendant directors “did nothing and carried
on doing nothing”. The measure of loss was determined on the difference between the Fund’s actual financial
position with that of the hypothetical financial position had the relevant duties been performed by the directors.
The Grand Court ruled against each of the directors in the amount of $111 million. It was also observed, that the
comfort from indemnity clauses are for reasonably diligent independent directors to protect those who make an
attempt to perform their duties but fail, not those who made no serious attempt to perform their duties at all.
The Grand Court observed that the directors are bound by a number of common law and fiduciary duties
including those to (1) act in good faith in the best interests of the fund and (2) to exercise independent judgment,
reasonable care, skill and diligence when acting in the fund’s interests.
However, the Cayman Islands Court of Appeal (“CICA”) set-aside the order of Cayman Islands Grand Court in
the case of Weavering Macro Fixed Income Fund Limited (In Liquidation) vs. Stefan Peterson and Hans Ekstrom,
through its judgment dated February 12, 2015.
The CICA, while affirming the original findings of breach of duty by the directors held that there was no element
of ‘wilful’ negligence or default on their part; therefore, the indemnity provisions in the Fund documents relieved
the directors from liability arising out of breach of their duties.
The CICA held that the evidence available to the Grand Court was insufficient to support the finding that the
directors’ conduct amounted to “wilful neglect or default”. The CICA accordingly set aside the earlier judgments
against each of the directors for $111 million.
Further, in India, the recent case of RBI & Ors v. Jayantilal N. Mistry & Ors.71 the Supreme Court of India
considered the meaning of the term ‘fiduciary,’ and held that it referred to a person having a duty to act for the
benefit of another (a ‘duty of loyalty’), showing good faith and candour (‘duty of care’), where such other person
reposes trust and special confidence in the person owing or discharging the duty. The court took the view that the
term ‘fiduciary relationship’ is used to describe a situation or transaction wherein one-person (the beneficiary)
places complete confidence in another person (the fiduciary) in regard to his affairs, business or transaction(s).
The term also referred to a person who held a thing in trust for another (the beneficiary). The fiduciary is expected
to act in confidence and for the benefit and advantage of the beneficiary, and to employ good faith and fairness
in dealing with the beneficiary or with things belonging to the beneficiary. In the aforesaid case, the court held
that “…RBI has no legal duty to maximixe the benefit of any public sector bank, and thus there is no relationship of
‘trust’ between them.” 72
71. 1. AIR 2016 SC 1.

72. 2. Ibid

8. Fund Governance
In a relevant case, HMRC v Holland 73 it was observed that the fact that a person is consulted about directorial
decisions, or asked for approval, does not in general make him a director because he is not making the decision.
From a regulatory point of view, Regulation 21 of the AIF Regulations states that, in addition to the ‘trustee’ (the
discharge of whose trusteeship services constitutes a fiduciary relationship with the investors), it is the ‘sponsor’
and the ‘investment manager’ of the AIF that are to act in a fiduciary capacity toward the investors.
In light of the above, it becomes important to ensure that the Advisory Board of the Fund is not given any roles or
responsibilities with respect to the Fund which would subject the members to fiduciary duties.
We summarize below the duties of directors (of fund managers, in case the fund is not self- managed) based on the
above judgments that should guide a director during the following phases in the life of a fund:
A. At the Fund Formation Stage

Directors must satisfy themselves that the offering documents comply with applicable laws, that all conflict
of interest situations are addressed upfront, that the structure of the fund is not only legally compliant but also
ethically permissible, that the terms of the service providers’ contracts are reasonable and consistent with industry
standards, and that the overall structure of the fund will ensure a proper division of responsibility among service
providers. Directors must act in the best interests of the fund which, in this context, means its future investors.
In this respect, we believe ‘verification notes’ can be generated. The notes would record the steps which have been
taken to verify the facts, the statements of opinion and expectation, contained in the fund’s offering document(s).
The notes also serve the further purpose of protecting the directors who may incur civil and criminal liability for
any untrue and misleading statements therein or material or misleading omissions therefrom. Alternatively, a
‘closing opinion’ may also be relied upon.
B. During the Fund’s Tenure
i. Appointment of Service Providers

Directors should consider carefully which service providers are selected for appointment. They should
understand the nature of the services to be provided by the service providers to the fund.
ii. Agenda
The formalities of conducting proper board meetings should be observed. An agenda for such meetings should list
the matters up for discussion, materials to be inspected, and inputs from the manager, the service providers and
directors themselves. It should be circulated well in advance.
iii. Actions outside Board Meetings

The directors should review reports and information that they received from the administrator and auditors from
time to time to independently assess the functioning of the fund and whether it is in keeping with the fund’s
investment strategy and compliant with the applicable laws.
73. 3. [2010] 1 WLR 2793.

8. Fund Governance
iv. Decision Making Process

Directors should exhibit that there was an application of mind when considering different proposals before it. The
decision making process will also play a pivotal role in determining the substance of the fund from an Indian tax
perspective as India moves away from its principle of “form over substance” to “substance over form” post April
01, 2017. For example, in case of investor ‘side letters’ that may restrict the fund’s investments into a restricted
asset class, etc., could raise issues. While execution of such ‘side letters’ may not be harmful to the fund, but an
approval at ‘short notice’ may be taken up to reflect on the manner in which the directors perform their duties.
v. Minutes
Board meetings should be followed by accurately recorded minutes. They should be able to demonstrate how the
decision was arrived at and resolution thereon passed. The minutes should reflect that the directors were aware of
the issues that were being discussed. Clearly, a ‘boilerplate’ approach would not work.
vi. Remuneration
The remuneration for independent directors should be commensurate to the role and functions expected to be
discharged by them. While a more-than- adequate remuneration does not establish anything, an inadequate
recompense can be taken as a ground to question whether the concerned director intends to perform his / her
duties to the fund.
vii. Conflict of interest

If related party transactions or transactions that may raise conflict of interest cannot be avoided, a policy should
be outlined where events and mechanisms to identify and resolve events which could lead to potential conflicts,
should be recorded. Suitable measures that demonstrate governance and that the interest of the investors would
be unimpaired, should be adopted.
The rulings discussed confirm that a fund’s board has duties cast on it and the ‘business judgment rule’ may
ensure that liability is not shielded in all cases.
There are certain non-delegable functions for the directors to discharge on an on-going basis and none are more
paramount than reviewing of the fund’s performance, portfolio composition and ensuring that an effective
compliance program is in place. These functions require action ‘between’ board meetings and not only ‘during’
board meetings.
The Advisory Board of a fund plays an important role in resolving conflicts of interest. However, it is pertinent
to note that while the Advisory Board may take a decision with reference to policies as may be defined under the
fund documents, these decisions are not binding on the investment manager. While the Advisory Board may
put forward its viewpoints in terms of the decisions arrived at by it, the Investment Manager possesses the final
decision-making power.

9. International Tax Considerations
I. Association of Persons (AOP) Risk

An AOP is a ‘person’ recognized under Section 2(31) of the ITA and is, therefore, a separate taxable entity. The
Supreme Court of India has held that in order to constitute an AOP, persons must join in a common purpose or
common action and the object of the association must be to produce income - it is not enough for the persons
to receive income jointly. The Supreme Court has also held that the question whether there is an AOP must be
decided upon the facts and circumstances of each case. The Indian tax authorities may claim that the control and
management of an offshore Fund vests with the domestic investment manager and therefore, the offshore Fund
and the onshore fund together constitute an AOP. The consequence of constitution of an AOP would primarily be
that all assessments would be conducted at the AOP level rather than qua the beneficiaries of the onshore fund.
II. Taxation of Indirect Transfers

In India, residents are taxable on their worldwide income whereas non-residents are taxable on Indian source income
i.e. income that accrues or arises, or is deemed to accrue or arise, or is received or is deemed to be received in India.
As stated above, for a non-resident to be subject to tax in India, the ITA requires that the income should be received,
accrued, arise or deemed to be received, accrued or arisen to him in India. 74 In this regard, section 9(1)(i) of the ITA
provides the circumstances under which income of a non- resident may be deemed to accrue or arise in India.
The indirect transfer provisions were introduced in the ITA as a knee-jerk reaction to the Supreme Court’s
decision in the Vodafone International Holdings. 75 The retrospective amendments introduced by the Finance
Act, 2012 effectively negated the decision of the Supreme Court wherein the Court had held that offshore transfer
of shares was not liable to tax in India.
The Finance Act, 2012 retrospectively amended Section 9(1)(i) of ITA by adding Explanation 5 clarifying that an
offshore capital asset would be considered to have situs in India if it substantially derived its value (directly or
indirectly) from assets situated in India. However, the Finance Act, 2012 did not define the word ‘substantially’.
Subsequently, Finance Act, 2015 introduced Explanations 6 and 7 to Section 9(1)(i) to specify the situations to
which Explanation 5 would apply.
A. Threshold test on substantiality and valuation

The ITA, pursuant to amendment by the Finance Act, 2015, provides that the share or interest of a foreign company
or entity shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in
India, if on the specified date, the value of Indian assets (i) exceeds the amount of INR 100 million; and (ii) represents
at least 50% of the value of all the assets owned by the company or entity. The value of the assets shall be the Fair
Market Value (“FMV”) of such asset without reduction of liabilities, if any, in respect of the asset. 76
The CBDT notified rules prescribing the method of computation of FMV of assets (Rule 11UB), computation of
income attributable to such assets in India (Rule 11UC) and reporting requirements under the indirect transfer
74. Section 5(2) of the ITA.

75. Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613.
76. Explanation 6 to Section 9(1)(i) of the ITA.

provisions (Rule 114DB).77 Broadly, Rule 11UB in relation to computation of FMV of assets prescribes the adding
back of liabilities that were deducted while calculating the FMV through internationally accepted methods
of valuation. As stated above, the indirect transfer tax should apply if the total asset value of the Indian assets
is above the aforementioned thresholds without taking into account any deduction on the basis of existing
liabilities. Rule 11UB prescribes separate rules and methods with respect to each asset class such as listed shares,
unlisted shares, interests in a partnership and other capital assets in India and slightly different valuation rules for
similar assets held abroad.
The FMV of shares of unlisted Indian companies 78 will be as determined by a merchant banker or an accountant
in accordance with any internationally accepted valuation methodology for valuation of shares on an arm’s
length basis as increased by the liability, if any, considered in such determination. The methodologies for
computing the value of all the assets of a foreign entity are also prescribed in Rule 11UB.
i. Date for determining valuation

Typically, the end of the accounting period preceding the date of transfer shall be the specified date of valuation.
However, in a situation when the book value of the assets on the date of transfer exceeds by at least 15%, the book
value of the assets as on the last balance sheet date preceding the date of transfer, then the specified date shall be
the date of transfer. 79
ii. Apportionment of gains

The gains arising on transfer of a share or interest deriving, directly or indirectly, its value substantially from assets
located in India will be taxed on a proportional basis based on the assets located in India vis-à-vis global assets.
iii. Exemptions
The ITA, pursuant to amendment by the Finance Act, 2015, provides for situations where indirect transfer
provisions shall not be applicable.
a. Where the transferor of shares of or interest in a foreign entity, along with its related parties does not hold
at any time during the twelve months preceding the date pf transfer (i) the right of control or management
(directly or indirectly); and (ii) the voting power or share capital or interest exceeding 5% of the total voting
power or total share capital or total interest in the foreign company or entity directly holding the Indian assets
(Holding Co).
b. In case the transfer is of shares or interest in a foreign entity which does not hold the Indian assets directly,
then the exemption shall be available to the transferor if it along with related parties does not hold (i) the
right of management or control in relation to such company or entity; and (ii) any rights in such company
which would entitle it to either exercise control or management of the Holding Co or entitle it to voting power
exceeding 5% in the Holding Co, at any time during twelve months preceding the date of transfer:
c. In case of business reorganization in the form of demergers and amalgamation, exemptions have been
provided. The conditions for availing these exemptions are similar to the exemptions that are provided under
the ITA to transactions of a similar nature.
77. Notification No. 55 of 2016, dated June 28, 2016.

78. Rule 11UB(3) of the ITR.
79. Rule 11UB(6) of the ITR.

iv. Other clarifications on applicability of indirect transfer provisions
a. Distribution of dividends
The indirect transfer tax provisions raise critical concerns for an organization which seeks to take exposure to
an Indian entity through an intermediary holding vehicle. Not only at the time of exit, but there is also a risk of
taxation when cash is up-streamed by way of redemption of shares of the holding company that are held by the
parent company.
However, the CBDT through Circular No. 4 of 2015 had clarified that a distribution of dividends by an offshore
company with underlying assets deriving substantial value from India would not result in a tax liability under the
indirect transfer provisions since it does not have the effect of transfer of any underlying assets located in India.
b. Applicability on investments by FPIs/ AIFS
The Finance Act, 2017 brought changes to clarify that the indirect transfer tax provisions shall not be applicable
to an asset or capital asset that is held directly / indirectly by way of investment in a Category I or Category II
FPI 80 under the FPI Regulations 2014. Further, due to the recategorization of categories of FPIs under the FPI
Regulations 2019, the Finance Act, 2020 exempted the applicability of indirect transfer tax provisions to Category
I FPIs under the FPI Regulations 2019.
The clarifications were implemented retrospectively from FY starting April 1, 2012, and therefore would help
bring about certainty on past transactions that have been entered into by Category I and Category II FPI entities
(under FPI Regulations 2014)/ Category I FPIs (under FPI Regulations 2019).
In November 2017, the CBDT notified that the indirect transfer provisions shall not apply to income arising or
accruing on account of redemption or buyback of share held indirectly by a non-resident in the Category I and
Category II AIFs, venture capital company or a venture capital fund, if it is in consequence of transfer of share or
securities held in India by such funds and if such income is chargeable in India. Thus, adverse effect of indirect transfer
provisions has been minimized by not taxing a non-resident for its capital gain, in case it made through such funds.
v. Reporting Requirement
The ITA, pursuant to amendment by the Finance Act, 2015, provides for a reporting obligation on the Indian
entity through or in which the Indian assets are held by the foreign entity.
The Indian entity has been obligated to furnish information relating to the offshore transaction which will have
the effect of directly or indirectly modifying the ownership structure or control of the Indian entity. In case of any
failure on the part of Indian entity to furnish such information, a penalty ranging from INR 500,000 to 2% of the
value of the transaction can be levied.
In this context, it should be pointed out that it may be difficult for the Indian entity to furnish information in
case of an indirect change in ownership, especially in cases of listed companies. Further, there is no minimum
threshold beyond which the reporting requirement kicks in. This means that even in a case where one share is
transferred, the Indian entity will need to report such change.
80. Proviso to Explanation 5 to Section 9(1)(i).

vi. Removal of retroactive application of indirect transfer provisions

Recently, the Indirect Transfer provisions were amended by the Taxation Laws (Amendment) Act, 2021 (“2021
Act”) to remove the retrospective application of such Indirect Transfer provisions. The 2021 Act makes following
changes in the Indirect Transfer provisions:
§ An embargo on future tax demands: The 2021 Act provides that the indirect transfer provisions would not
apply to income accruing or arising as a result of an indirect transfer undertaken prior to May 28, 2012. The
2021 Act has added a proviso to Explanation 5 to section 9(1)(i) of the ITA for non-application of indirect
transfer provisions on (i) assessments or reassessments initiated under specified sections, (ii) orders passed
enhancing a tax assessment or reducing a refund and (iii) orders passed deeming a person to be an assessee-in-
default for not withholding taxes in respect of indirect transfers prior to May 28, 2012.
§ Nullification of tax demands raised: The 2021 Act also provides that demands raised for indirect transfers of
Indian assets made prior to May 28, 2012 shall be nullified, subject to fulfilment of the following conditions81
by the person in whose case such demand has been raised:
• withdrawal or an undertaking for withdrawal of appeal filed before an appellate forum or a writ petition
filed before a High Court or the Supreme Court of India;
• withdrawal or an undertaking for withdrawal of any proceedings for arbitration, conciliation or mediation
initiated by such person such as under a bilateral investment treaty; and
• furnishing of an undertaking waiving their rights to seek or pursue any remedy or any claim in relation to
such income whether in India or outside India.
§ Refund of amounts paid: The 2021 Act also provides that the Government shall refund the taxes paid in cases
where the application of indirect transfer provisions is being withdrawn due to fulfilment of the conditions
mentioned above. However, no interest, cost or damage shall be paid by the Government on such refund of taxes.
III. General Anti-Avoidance Rule (GAAR)

Chapter X-A of the ITA provides for GAAR, which has come into effect from April 1, 2017. GAAR confers broad
powers on the revenue authorities to deny tax benefits (including tax benefits applicable under the DTAA), if the
tax benefits arise from arrangements that are “impermissible avoidance arrangements”.
The introduction of GAAR in the ITA is effective from financial year 2017-18 and brings a shift towards a
substance based approach. GAAR targets arrangements whose main purpose is to obtain a tax benefit and
arrangements which are not at arm’s length, lack commercial substance, are abusive or are not bona fide. It
grants tax authorities powers to disregard any structure, reallocate / re-characterize income, deny DTAA relief
etc. Further, the ITA provides that GAAR is not applicable in respect of any income arising from transfer of
investments which are made before April 1, 2017.
Section 90(2A) of the ITA contains a specific DTAA override in respect of GAAR and states that the GAAR shall
apply to an assessee with respect to DTAAs, even if such provisions are not beneficial to the assessee.
The CBDT has issued clarifications on implementation of GAAR provisions in response to various queries
received from the stakeholders and industry associations. Some of the important clarifications issued are as under:
81. On August 28, 2021, the Government has notified the draft rules for public consultation to specify the conditions to be fulfilled and the process
to be followed to give effect to the amendment made by the 2021 Act

i. Where tax avoidance is sufficiently addressed by the LOB clause in a tax treaty, GAAR should not be invoked.
ii. GAAR should not be invoked merely on the ground that the entity is located in a tax efficient jurisdiction.
iii. GAAR is with respect to an arrangement or part of the arrangement and limit of INR 30 million cannot be
read in respect of a single taxpayer only.
The Supreme Court ruling in McDowell & Co. Ltd. CTO 82 stated that under the Indian tax laws, even while
predominantly respecting legal form, the substance of a transaction could not be ignored where it involved sham
or colorable devices to reduce an entity’s tax liabilities.
Therefore, as per judicial anti-avoidance principles, the Indian tax authorities have the ability to ignore the form
of the transaction only in very limited circumstances where it is a sham transaction or a colourable device.
The GAAR provisions extend the power of the Indian tax authorities to disregard transactions even when such
transactions / structures are not a “sham” in case where they amount to an “impermissible avoidance arrangement”.
An impermissible avoidance arrangement has been defined as an arrangement entered into with the main
purpose of obtaining a tax benefit. These provisions empower the tax authorities to declare any arrangement as an
“impermissible avoidance arrangement” if the arrangement has been entered into with the principal purpose of
obtaining a tax benefit and involves one of the following elements:
A. Non-arm’s Length Dealings

It refers to arrangements that create rights or obligations not normally created between independent parties
transacting on an arm’s length basis.
B. Misuse or Abuse of the Provisions of the Act

It results directly or indirectly, in the misuse or abuse of the ITA.
C. Lack of Commercial Substance

Arrangements that lack commercial substance or are deemed to lack commercial substance would include round
trip financing involving transfer of funds between parties without any substantial commercial purpose, self-
cancelling transactions, arrangements which conceal, and the use of an accommodating party, the only purpose
of which is to obtain a tax benefit. Arrangements are also deemed to lack commercial substance if the location of
assets, place of transaction or the residence of parties does not have any substantial commercial purpose.
D. Non-Bona Fide Purpose

Arrangements that are carried out by means or in a manner which is not ordinarily employed for a bona fide purpose.
In the event that a transaction / arrangement is determined as being an ‘impermissible avoidance arrangement’,
the Indian tax authorities would have the power to disregard entities in a structure, reallocate income and
expenditure between parties to the arrangement, alter the tax residence of such entities and the legal situs of
assets involved, treat debt as equity, vice versa, and the like. The tax authorities may deny tax benefits even if
conferred under a DTAA, in case of an impermissible avoidance arrangement.
82. McDowell & Co. Ltd. CTO 154 ITR 148.

Investors have been worried about the scope of the GAAR provisions and concerns have been raised on how they
would be implemented. A re-look at the scope of the provisions will definitely be welcomed by the investment
community and it is hoped that when revised provisions are introduced, they will be in line with global practices.
IV. Business Connection / Permanent Establishment

Exposure
Offshore Funds investing in India have a potential tax exposure on account of having constituted a permanent
establishment in India. In case of determination of a permanent establishment, the profits of a non-resident entity
are taxable in India only to the extent that the profits of such enterprise are attributable to the activities carried
out through its PE in India.
What constitutes permanent establishment?
Management teams for India focused Offshore Funds are typically based outside India as an onshore fund
manager enhances the risk of the fund being perceived as having a PE in India. Although DTAAs provide for the
concept of a permanent establishment in Article 5 (as derived from the OECD
and United Nations (“UN”) Model Convention), the expression has not been exhaustively defined anywhere. The
Andhra Pradesh High Court, in CIT v. Visakhapatnam Port Trust 83 , held that:
“The words “permanent establishment” postulate the existence of a substantial element of an enduring or permanent
nature of a foreign enterprise in another country which can be attributed to a fixed place of business in that country. It
should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country into the
soil of another country.”
The presence of the manager in India could be construed as a place of management of the Offshore Fund and thus
the manager could be held to constitute a permanent establishment. Consequently, the profits of the Offshore
Fund to the extent attributable to the permanent establishment, may be subject to additional tax in India.
What tantamounts to business connection in the context of an Offshore Fund?
‘Business connection’ is the Indian domestic tax law equivalent of the concept of PE under a DTAA scenario. The
term business connection, however, is much wider. The term has been provided as an inclusive definition per
Explanation 2 to Section 9(1)(i) of the ITA, whereby a ‘business connection’ shall be constituted if any business
activity is carried out through a person who (acting on behalf of the non-resident) has and habitually exercises in
India the authority to conclude contracts on behalf of the non-resident.
Thus, the legislative intent suggests that (in absence of a DTAA between India and the jurisdiction in which
the Offshore Fund has been set up) under the business connection rule, an India based fund manager may be
identified as a ‘business connection’ for the concerned Offshore Fund.
It is important to note that the phrase ‘business connection’ is incapable of exhaustive enumeration, given that
the ITA provides an explanatory meaning of the term which has been defined inclusively. A close financial
83. CIT v. Visakhapatnam Port Trust 144 ITR 146

association between a resident and a non-resident entity may result in a business connection for the latter in India.
The terms of mandate and the nature of activities of a fund manager are such that they can be construed as being
connected with the business activity of the Offshore Fund in India.
Accordingly, Offshore Funds did not typically retain fund managers based in India where a possibility existed that
the fund manager could be perceived as a PE or a business connection for the fund in India. Instead, many fund
managers that manage India focused Offshore Fund, tend to be based outside India and only have an advisory
relationship in India that provide recommendatory services.
However, the Finance Act, 2015 introduced amendments to encourage fund management activities in India – by
providing that having an eligible manager in India should not create a tax presence (business connection) for
the fund in India or result in the fund being considered a resident in India under the domestic POEM rule and
introducing section 9A to the ITA.
While Section 9A may be well intentioned, it employs a number of rigid criteria that would be impossible for PE
funds and difficult for FPIs to satisfy.
Under section 9A of the ITA, if the Fund is falling within the criteria given in Section 9A (3), then the said Fund
will not be taken as resident in India merely because the eligible fund manager, undertaking fund management
activities, is situated in India.
The conditions given under Section 9A are as follows: - (i) the fund must not be a person resident in India; (ii) the
fund must be a resident of a country with which India has entered into an agreement under Section 90(1) or 90A(1)
of the ITA or is established or incorporated or registered in a country or a specified territory notified by the GoI in
this behalf; (iii) investment in the fund by persons resident in India should not exceed 5% of the corpus of the fund;
provided that for the purposes of calculation of the said aggregate participation or investment in the fund, any
contribution made by the eligible fund manager during the first three years of operation of the fund, not exceeding
twenty-five crore rupees, shall not be taken into account (iv) the fund and its activities are subject to investor
protection regulations in the country in which it is incorporated or resident; (v) the fund must have minimum
twenty five members, who are not connected persons (vi) any member of the fund along with connected persons
should not have any participation interest in the fund exceeding 10 % (vii) the aggregate participation interest of
ten or less members along with their connected persons in the fund, should be less than 50% (viii) the fund should
not invest more than 20%. of its corpus in any single entity (ix) the fund should not make any investment in its
associate entity; (x) the monthly average of the corpus of the fund should not be less than INR 1 billion; provided that
if the fund has been established or incorporated in the previous year, the corpus of fund shall not be less than INR 1
billion at the end of a period of twelve months from the last day of the month of its establishment or incorporation.
Nevertheless, this provision shall not be applicable in case of the year in which the fund is wound up (xi) the fund
should not carry on or control and manage, directly or indirectly, any business in India (xii) the fund should not
engage in any activity which will constitute business connection in India; (xiii) the remuneration paid by the fund to
the fund manager should be not less than the arm’s length price. The conditions (i) to (xiii) may not be applicable to
eligible fund managers located in IFSC and have commenced its operations on or before 31st March of 2024.
Added to this are certain relaxations provided to the fund set up by the government or the Central Bank of a
foreign state or a sovereign fund, or any other fund as notified by the GoI These funds do not have to comply with
the conditions given in clauses (v), (vi) and (vii) of the above given conditions.
Section 9A also requires an ‘eligible fund manager’ in respect of an eligible investment fund to means any person
who is engaged in the activity of fund management and fulfils the following conditions, namely (a) the person is
not an employee of the eligible investment fund or a connected person of the fund; (b) the person is registered as
a fund manager or an investment advisor in accordance with the specified regulations; (c) the person is acting in

the ordinary course of his business as a fund manager; (d) the person along with his connected persons shall not
be entitled, directly or indirectly, to more than twenty per cent of the profits accruing or arising to the eligible
investment fund from the transactions carried out by the fund through the fund manager. The Finance Act, 2019
amended one of the conditions for availing safe harbour under section 9A by removing the requirement for the
eligible fund manager to receive an arm’s length remuneration for performing the fund management activity and
replacing it with a minimum fee to be prescribed by the CBDT. On December 5, 2019 CBDT had released draft
notification to amend Rule 10V of the IT Rules for public comments and inputs and the amendments have now
been notified through Income Tax (Amendment) Rules, 2020 (“Notification”). The Notification introduces new
rules on remuneration for fund managers to qualify for safe harbour under section 9A. 84
In case where the eligible investment fund is a registered Category I FPI which has obtained such registration due to its
status as an endowment fund, a sovereign wealth fund, a Government, a university, an appropriately regulated entity
(banks, insurers, managers, advisers etc.) under the relevant provisions as described in the Notification, the amount of
remuneration for the eligible fund manager shall be at least 0.10% of AUM. As per the recent amendment to the ITA, it
has been provided that the conditions mentioned above in (a) to (d) shall not be applicable on eligible fund managers
located in IFSC and have commenced its operations on or before the 31st day of March, 2024.
In other cases (i.e. other than for Category I FPIs of the kind explained above), the amount of remuneration for the
eligible fund manager is required to be at least:
i. 0.30% of AUM; or
ii. 10% of profits derived by the fund in excess of the specified hurdle rate, where the fund manager is entitled
only to remuneration linked to the income or profits derived by the fund; or
iii. 50% of management fee, where the fee is shared with another fund manager reduced by operational expenses.
The Notification also allows for the CBDT to approve a lower remuneration to be charged if the eligible
investment fund is able to satisfy CBDT.
Despite the efforts of the government, onerous conditions such as the requirement to have a minimum of twenty-
five investors and the requirement to charge fee that is not less than the arm’s length price continue to act as
roadblocks in the progress of the provision, as explained in detail below.
Furthermore, regard must also be had to the fact that Section 9A primarily caters to managers of open-ended
funds. PE and VC funds are unlikely to consider using the provision as the minimum investor requirement, the
requirement to not invest more than 20% of corpus in one entity and the restriction on “controlling” businesses
in India make it impractical for such funds to consider using the safe harbour. This is in fact, a mismatch for the
industry as India focused PE and VC funds have a greater need to have management personnel based out of India.
The proposed amendments do not leave funds worse off – however, they are unlikely to provide benefit to PE
/ VC funds or FPIs. Firstly, a fund manager exemption is more relevant in a PE / VC context, where on ground
management is more of a necessity.
For the reasons discussed above, PE / VC funds are unlikely to be able to take advantage of section 9A. If the intent
was to provide PE exclusion benefits to FPIs investing in listed securities, it would have been more appropriate
to clarify the risk on account of colocation servers in India on which automated trading platforms are installed.
Secondly, FPI income is characterized as capital gains, and hence, the permanent establishment exclusion may
only be relevant to a limited extent arrangement.
84. Notification No G.S.R. 315(E) dated May 27, 2020.

Annexure I
Sector Focused Funds
I. Social Venture Funds

A. Introduction
Even though social venture funds were existent in practice, it was only under the AIF Regulations that it were
formally recognized. Under the AIF Regulations, a social venture fund is defined as, “an alternative investment
fund which invests primarily in securities or units of social ventures (which also includes companies registered
under section 8 of the Companies Act, 2013) and which satisfies social performance norms laid down by the fund
and whose investors may agree to receive restricted or muted returns.”
Typically, social venture funds tend to be impact funds which predominantly invest in sustainable and innovative
business models. The investment manager of such fund is expected to recognise that there is a need to forecast
social value, track and evaluate performance over time and assess investments made by such funds.
B. Characteristics of Social Venture Funds

Social venture funds tend to be different from VC funds or PE funds not just in the investments that they make,
but also in the nature of commitments that they receive from their limited partners / investors. The following is a
list of some of the characteristics that a social venture fund may expect to have:
§ nvestors making grants (without expectation of returns) instead of investments;
§ Fund itself providing grants and capital support considering social impact of such participation as opposed to
returns on investment alone;
§ Fund targeting par returns or below par returns instead of a fixed double digit IRR;
§ Management team of the fund participating in mentoring, “incubating” and growing their portfolio companies,
resulting in limited token investments (similar to a seed funding amount), with additional capital infused as
and when the portfolio grows;
§ Moderate to long term fund lives in order to adequately support portfolio companies.
Social venture funds also tend to be aligned towards environmental, infrastructure and socially relevant sectors
which would have an immediate impact in the geographies where the portfolio companies operate.
C. Tools to Measure Social Impact

Managers of social impact funds rely on specific systems to quantify the social value of investments. Some of
these include:
§ Best Alternative Charitable Option (“BACO”), developed by the Acumen Fund.
§ Impact Reporting & Investment Standards (“IRIS”), developed by Global Impact Investing Network (“GIIN”).

Annexure I
§ Global Impact Investing Rating System (“GIIRS”).
D.Laws Relating to Social Venture Funds Investing into India

Offshore social venture funds tend to pool capital (and grants) outside India and make investments
in India like a typical venture capital fund. Such Offshore Fund may not directly make grants to otherwise eligible
Indian opportunities, since that may require regulatory approval.
Onshore social venture funds may be registered as a Category I AIF under the specific sub- category of social
venture funds. In addition to the requirement to fulfill the conditions set out in the definition (set out above),
social venture funds under the AIF Regulations are subject to the following specific restrictions and conditions:
§ Requirement to have at least 75% of their investable funds 85 invested in unlisted securities or partnership
interest of ‘social ventures’86 ;
the amount of grant that may be accepted by the fund from any person shall not be less than twenty-five lakh
rupees. 87 Accredited Investors are permitted to contribute an amount lower than the prescribed minimum
amount as a grant to such social venture funds.88
§ Allowed to receive grants (in so far as they conform to the above investment restriction) and provide grants.
Relevant disclosure in the placement memorandum of the fund will have to be provided if the social venture
fund is considering providing grants as well; and it is also allowed to receive muted returns.
II. Media & Entertainment Funds

A. Media Funds – An Introduction
A media fund seeks to provide select sophisticated investors with an opportunity to participate in the financing of
a portfolio of content, e.g., motion pictures and televisions serials.
In current times, when demand for high quality films and media products has increased, such pooling platforms
play the role of providing organized financing to various independent projects or work alongside studios and
production houses. A unique feature is the multiple roles and level of involvement that the fund manager can
undertake for the fund and its various projects. Further, with the rise in the amounts invested in OTT platforms,
which are subscription based there has been increased interests of the VC Firms in investing in such OTT Platforms.
B. Media Funding Models

Most film funds take a ‘slate financing’ approach wherein the investment is made in a portfolio of films / media
projects, as opposed to a specific project. However, as a variation, investors can even be introduced at the project
specific level i.e. for a single production only.
In terms of risk mitigation, the slate financing model works better than a specific project model owing to risk-
diversification achieved for the investor.
85. As defined under section 2(u) of the AIF Regulations, 2012

86. Regulation 16(4) of the AIF Regulations 2012
87. Ibid.
88. SEBI (Alternative Investment Fund) (Fourth Amendment) Regulations, 2018

Annexure I
Apart from typical equity investments, film funds may additionally seek debt financing pursuant to credit facilities
subject to compliance with local laws e.g., in the Indian context, debt financing by Offshore Fund may not work.
C. Risks and Mitigating Factors

Film fund investors should take note of media industry specific risks such as - risk of abandonment of the project
(execution risks), failure to obtain distributors for a particular project, increased dependence on key artists,
increasing marketing costs, oversupply of similar products in the market, piracy, etc.
To mitigate such risks, diversification in the projects could be maintained. Additionally, a strong and reliable
green lighting mechanism could also be put in place whereby the key management of the fund decides the
projects that should be green lit – based on factors such as budgeted costs, available distributorship arrangements,
sales estimates and so on.
D. Life cycle of a Film Fund

The life of a film fund in term of economic performance is generally in the range of 8 to 10 years depending upon
the sources of revenue. Typically, sources of revenue of a film are –
§ Domestic and international theatrical release of the film;
§ Domestic and international television markets; and
§ Merchandizing of film related products, sound track releases, home video releases, release of the film on mobile
platforms, and other such online platforms.
Generally, a major portion of income from a film project is expected to be earned at the time of theatrical release
of the film, or prior to release (through pre-sales). Consequently, the timing of revenue is generally fixed or more
easily determinable in case of film investments, when compared to other asset classes.
The box office proceeds of a film typically tend to be the highest source of revenue and also a key indicator of expected
revenue from other streams. Thus, keeping the timing of revenue flows in mind, film funds are often structured as
close ended funds having a limited fund life of 7 to 9 years. The term may vary depending on the number of projects
intended to be green lit or the slate of motion pictures or other media projects intended to be produced.
Typically, after the end of the life of the fund, all rights connected with the movie (including derivative rights) are
sold or alternatively transferred to the service company or the fund manager on an arm’s length basis. Derivative
rights including rights in and to prequels, sequels, remakes, live stage productions, television programs, etc. may
also be retained by the investment manager (also possibly playing the role of the producer). Such transfer or
assignment of residual rights is of course subject to the nature of and the extent of the right possessed by the fund
or the concerned project specific SPV.
E. Sources of income of a film fund and tax treatment

§ Distributorship Arrangements
The fund or the project specific SPV, as the case may be, may license each project to major distributors
across territories in accordance with distribution agreements. Pursuant to such distribution agreements, the
fund could expect to receive net receipts earned from the distributions less a distribution fee payable to the
distributor (which typically consists of distribution costs and a percentage of net receipts). Income of this

Annexure I
nature should generally be regarded as royalty income. If the distributor is in a different jurisdiction, there
is generally a withholding tax at the distributor level. The rate of tax depends on the DTAA between the
countries where the distributor is located, and where the fund / its project specific SPV is located.
§ Lock Stock and Barrel Sale
The project exploitation rights may be sold outright on a profit margin for a fixed period or in perpetuity
(complete ownership). This amounts to the project specific SPV selling all its interest in the IP of the movie for
a lump sum consideration.
§ Use of an Appropriate Intermediary Jurisdiction
Fund vehicles have historically been located in investor friendly and tax neutral jurisdictions. The unique
nature of film funds adds another dimension i.e. intellectual property (“IP”) while choosing an appropriate
jurisdiction. Generally, an IP friendly jurisdiction is chosen for housing the intellectual property of the fund
or specific project. Further, since considerable amount of income earned by the fund may be in the form of
royalties, a jurisdiction that has a favourable royalty clause in its DTAA with the country of the distributor
may be used. This assumes greater importance because the royalty withholding tax rate under the ITA is 10%.
Due to its protective regime towards IP, low tax rates and extensive treaty network, Ireland has been a preferred
jurisdiction for holding media related IP.
F. Role of Services Company

In a film fund structure, certain acquisition, development, production and related services may be performed by a
separate entity (“Services Company”). The Services Company may have a contractual relationship with the fund or
its project specific subsidiaries, during the term of the fund. Depending upon circumstances of each project, the fund
may engage the Services Company directly or through a special purpose subsidiary to provide production services. In
respect of these services, the Services Company receives a fee which can be included within the fund’s operational
costs. The role of the Services Company / fund may also be fulfilled by the fund manager. The Services Company /
manager may also hold the intellectual property associated with each project that may be licensed to or acquired
by the fund or its project specific subsidiaries.
G. Role of the Fund Manager

The fund manager may take up the responsibilities of the Service Company as indicated above. Once a specific
project is selected and green-lit by the manager, all underlying rights necessary to produce and / or exploit the
project may be transferred to the fund. In addition to such role, the manager would also be expected to play the
role of the traditional manager of a pooled investment vehicle and expected to discharge its fiduciary obligations.
To an extent, the same may require observing specific ‘conflict of interest’ mechanisms considering the multiple
functions that may be performed in the context of a film fund.

Annexure I
III. Special Situation Funds

A. Introduction
SEBI in an attempt to address the stressed assets woes of the banking and finance industry has recently introduced
SSFs as a new sub-category of AIF called Special Situation Fund under Category I AIFs under the AIF Regulations.
SSFs are defined as Category I – AIFs that invest in ‘special situation assets’ in accordance with its investment
objectives and such SSF may act as a ‘resolution applicant’ under the IBC.
Given that AIFs manage and raise privately pooled funds from sophisticated investors who are open to high-risk
investments, they can effectively serve as a source of risk capital to deal with the issue of stressed loans. Such a
move is expected to bring in a new set of investors in the stressed asset space and create a more efficient market for
buying distressed assets.
Prior to the introduction of SSFs, AIFs were only permitted to invest in debt by way of investment in debt
securities and were prohibited from lending. Therefore, the AIFs currently tend to invest in distressed
assets through investing in securities of stressed companies and Security Receipts (“SRs”) issued by Asset
Reconstruction Companies (“ARCs”).
B. Special Situation Assets

Notably, Category I AIFs invest, inter alia, in sectors which the Government or regulators consider as socially
or economically desirable and which are generally perceived to have positive spillover effects on the economy.
Further, SEBI or Government or other regulators in India might consider providing incentives or concessions to
such AIFs. SSFs are allowed to invest in special situation assets which include-
§ Stressed loans available for acquisition in terms of Reserve Bank of India (Transfer of Loan Exposures)
Directions, 2021 (“Transfer Directions”) or as part of a resolution plan approved under IBC;
§ Security receipts issued by ARCs;
§ Securities of investee companies (i) whose stressed loans available for acquisition in terms of Transfer
Directions or as part of a resolution plan approved under IBC; (ii) against whose borrowings, security
receipts have been issued by an ARC; (iii) whose borrowings are subject to corporate insolvency resolution
process under Chapter II of IBC; (iv) who have disclosed all the defaults relating to the payment of interest/
repayment of principal amount on loans from banks / financial institutions; and
§ Any other asset/security as may be prescribed by SEBI from time to time.
With the introduction of such provisions, SSFs will be able to provide much needed capital to companies in
distress, which are unable to function optimally and generate value for stakeholders due to over-leveraging, but
may have potential of a turnaround.
C. Key Features of SSFs

§ No investment concentration limits: SEBI has exempted the SSFs from the diversification norms as applicable
under the AIF Regulations thereby allowing SSFs to invest up to 100% of their investable funds in a single
special situation asset. Unlike asset reconstruction companies, an SSF, is not subject to limits for restructuring
support finance.

Annexure I
§ SSFs can set up specific schemes targeting specific special situations asset. In order to provide adequate capital
for revival of the distressed company, SEBI has mandated that the SSFs should have a minimum corpus of INR
100 crores with a minimum commitment of INR 10 crores from each investor (AIs can commit a minimum of
INR 5 crores).
§ SSFs are allowed to invest in units of other SSFs, however it is prohibited from investing in (i) associates; (ii)
SSFs managed or sponsored by the same manager/ sponsor or associates; or (iii) units of non-SSF AIFs; (iv)
overseas investments.
§ SEBI while providing for SSFs to acquire stressed loans has effectively barred acquisition of stressed loans
from individual lender since Clause 58 of the Transfer Directions contemplates acquisition of loans only
pursuant to a resolution plan as approved by the lenders under the Reserve Bank of India (Prudential
Framework for Resolution of Stressed Assets) Directions, 2019.
§ Stressed loans acquired by SSF in terms of Clause 58 of the Transfer Directions are subject to a minimum
lock-in period of six months. However, the lock in period shall not be applicable in case of recovery of the
stressed loan from the borrower. Moreover, in order to ensure that there is no regulatory arbitrage in respect
of the due diligence requirements mandated for ARCs, SSFs acquiring the stressed loans are required to
comply with the same initial and continuous due diligence requirements for its investors, as those mandated
by for ARCs.
SEBI by permitting SSFs to act as a ‘resolution applicant’ under the IBC has provided for a way through
which the SSF can acquire the debt as well as securities, including shares of stressed companies undergoing
a corporate insolvency resolution process under the IBC. Considering that investment in Special Situation
Assets would require extensive monitoring and managerial support from the SSFs, such provisions allow the
SSFs to provide a complete exit to the lenders and control the revival of the stressed company, without any
restriction on investment concentration.

Annexure II
Summary of Tax Treatment for Mauritius, Singapore

and Netherlands Based Entities Participating in Indian
Opportunities
The following table summarizes the (i) requirements for eligibility under the India- Mauritius DTAA, India-
Singapore DTAA and the India; (ii) the substance requirements that companies in Mauritius, Singapore and
Netherlands will have to demonstrate in order to claim benefits under the two DTAAs and (iii) the tax rates that
should be applicable to companies under the relevant DTAAs read with the provisions of the domestic tax law.
Parameter Mauritius Singapore Netherlands

General
Eligibility to DTAA A person is considered a resident of Mauritius for The management and control The management and
benefits relief under the DTAA, as long as it is liable to tax of business of the pooling control of business of
in Mauritius by reason of domicile, residence or vehicle must be in Singapore. the pooling vehicle must
place of management. The Indian tax authorities Tax resident companies are be in Netherlands. Tax
issued a Circular (789 of 2000) stating that a TRC eligible for DTAA benefits resident companies are
issued by the Mauritius tax authorities constitutes subject to (as a practical eligible for DTAA benefits
sufficient proof of residence in Mauritius and matter) being able to obtain a subject to (as a practical
entitlement to DTAA relief. TRC from the Inland Revenue matter) being able to
Authority of Singapore. obtain a TRC from the
The landmark decision of the Indian Supreme Dutch tax authorities.
Court in Union of India v. Azadi Bachao Andolan 89
, upheld the validity of the aforesaid Circular 789.90
Substance The GBC would be required to carry out the core The India-Singapore DTAA (i) At least half of the
Requirements income generating activities: (i) employing, either itself states the Substance total number of directors
directly or indirectly, a reasonable number of requirement. Subsequently and other persons
suitably qualified persons to carry out the core negotiated protocol to the with decision-making
activities; and (ii) having a minimum level of India-Singapore DTAA requires power should qualify
expenditure, which is proportionate to its level of that the Singapore entity must as a tax resident in the
activities. Further, while determining whether the not be a shell or a conduit Netherlands (“Dutch
activities constitute as core income generating entity. A shell / conduit Resident Directors”). (ii)
activities, the FSC will take into consideration entity is the one which has Dutch Resident Directors
the nature and level of core income generating negligible or nil business should have the required
activities conducted (including the use of operations or has no real and professional knowledge
technology) by the GBC. to properly perform their
duties.
89. [2003] 263 IT 707 (SC)

90. Following this case, a number of cases have confirmed DTAA benefits for Mauritius based investors including: Dynamic India Fund I (AAR
1016/2010 dated July 19, 2012) ; DDIT v. Saraswati Holdings Corporation [(2009) 111 TTJ 334]; In re, E*Trade Mauritius Limited [(2010) 324 ITR 1
(AAR)]; In re, Castleton Ltd [(2012) 348 ITR 537]; Zaheer Mauritius v. DIT [(2014) 270 CTR (Del) 244]; D.B.Zwirn Mauritius Trading [(1997) 228 ITR
268]; HSBC Bank (Mauritius) Ltd. v. DCIT [(2018) 96 taxmann.com 544 (Mumbai – Trib.)]. However, certain Courts have also taken contrary views
specifically challenging the beneficial ownership of shares of the Indian company by the Mauritian taxpayer and alleging that the transaction
of acquisition of shares of Indian company was a colourable device and an impermissible tax avoidance arrangement for deriving DTAA benefit
[“AB” Mauritius, In re AAR No. 1128 of 2011]. With the revision of the India-Mauritius DTAA, and introduction of anti-abuse rules, courts in
India have also been challenging the availability of treaty benefits for investments dating prior to April 1, 2017. Recently, the Mumbai bench of
the Authority for Advance Rulings in Bidvest [In Re: Bid Services Division (Mauritius) Ltd. 2020 (2) TMI 1183] rejected capital gains tax benefit
under Article 13(4) of the India–Mauritius DTAA to a Mauritian entity, on sale of shares of an Indian joint venture company.

Annexure II
Under the Protocol, India shall tax capital gains continuous business activities (iii) The duties of the
arising from the sale of shares acquired on or after that are being carried out board include decision-
April 01, 2017 in a company resident in India with in Singapore. A Singapore making in respect of
effect from financial year 2017-18. resident is deemed not to transactions to be
be a shell or conduit if it is entered into by the
listed on a recognized stock company, on the basis of
exchange or if its annual the own responsibility of
operational expenditure the company and within
is at least SGD 200,000 the ordinary course of
per year in the two years group involvement, and
preceding to the transfer of a proper handling of the
shares which are giving rise transactions entered into.
to capital gains. (The term (iv) Cooperative (“Coop”)
“annual expenditure” means avails of qualified
expenditure incurred during employees for proper
a period of twelve months. implementation and
The period of twenty-four registration of the
months shall be calculated transactions to be
by referring to two blocks of entered into by it.
twelve months immediately (v) The management
preceding the date when the decisions should be
gains arise.) taken in the Netherlands.
(vi) The main bank
Accordingly, if the affairs accounts of Coop shall
of the Singapore entity are be maintained in the
arranged with the primary Netherlands. (vii) The
purpose of taking benefit of bookkeeping of Coop has
capital gains relief, the benefit to be conducted in the
may be denied even if the Netherlands.
Singapore entity is considered
to have commercial (viii) The Coop has to have
substance under the GAAR an office space available,
provisions or incurs annual located in the jurisdiction
operational expenditure of of establishment, for the
SGD 200,000. duration of at least 24
months.
(ix) Salary costs of
at least (gross) EUR
100,000 per year has to
be incurred by the Coop.
MLI Mauritius has not included India in its definitive India-Singapore DTAA notified
notification, accordingly, India-Mauritius DTAA is as CTA.
not considered a CTA.
Preamble of India-Singapore
In case Mauritius notifies India-Mauritius DTAA DTAA modified to include clear
as CTA, there would be a significant change in statement of intent.
tax positions from investments made through the
Mauritius route. 91 LoB contained in Article 24A
superseded by PPT, which will
need to be satisfied to avail
benefits. 92
91. From news reports, it appears that India and Mauritius may bilaterally re-negotiate the India-Mauritius DTAA to adopt the minimum standards
emanating from the MLI; https://www.business-standard.com/article/markets/talks-on-to-adopt-beps-minimum-standards-in-tax-treaty-mauri-
tius-minister-120051800772_1.html
92. The other specific tests under the LoB in Article 24A of the India-Singapore DTAA relating to shell / conduit companies not being entitled to
benefits, minimum expenditure requirements etc. will continue to be applicable as they are not incompatible with the PPT.

Annexure II
Tax Implications under the Relevant DTAA

Dividends Taxable at rate of 5%, if Mauritian shareholder Taxable at rate of 10%, if the Taxable, at the rate
is beneficial owner holding directly at least 10% Singaporean shareholder is of 10%, if the Dutch
share capital of Indian company; otherwise 15% a company being beneficial shareholder is a
.93 owner of at least 25% share company being beneficial
capital of Indian company; owner of share capital of
otherwise 15%. 94 Indian company.95
Capital Gains No local tax in Mauritius on capital gains. No local tax in Singapore Exemption from Indian
Till April 1, 2017, Mauritius residents were not on capital gains (unless capital gains tax if a
taxed in India on gains resulting from the transfer characterized as business Dutch shareholder holds:
of shares in an Indian company. income). a) less than 10% in
After April 1, 2017 post amendment of India- Till April 1, 2017, Singapore an Indian company; b)
Mauritius DTAA: residents were not taxed in in case of the sale of
India on gains resulting from shares to a non-Indian
i. No tax on capital gains on alienation of shares the transfer of shares in an resident purchaser; or,
acquired by Mauritian residents before April 1, Indian company. (c) as a corollary from a
2017.96 After April 1, 2017 post group restructuring.
ii. 50% of applicable Indian tax rate on capital amendment of India- Non-exempt Long – term
gains arising to Mauritian residents from Singapore DTAA: capital gains taxed at the
alienation of shares between April 1, 2017 to rate of 10% (excluding
April 1, 2019, subject to PPT and LoB rule.97 i. No tax on capital gains surcharge and cess).
iii. The LoB rule states that a shell / conduit on investments made by No Limitation of Benefits
company 98shall not be entitled to the Singapore residents before Clause. (limit the ability
concessional tax rate under Article 13(3B). April 1, 2017, subject to PPT of third country residents
iv. Capital gains arising on alienation of shares and LoB rule. 100 to obtain benefits under
acquired by Mauritian residents after April 1, ii. 50% of applicable Indian tax the DTAA).
2019 taxable in rate on capital gains arising Indirect transfer tax
India. 99 to Singapore residents from exemption available.
alienation of shares between
April 1, 2017 to April 1,
2019, subject to PPT and
LoB rule.101
The LoB rule states that a
shell / conduit company 102
shall not be entitled to the
benefits under points i. and
ii. above.
Capital gains arising on
alienation of shares acquired
by Singapore residents after
April 1, 2019 taxable in
India.103
93. Article 10(2) of India-Mauritius DTAA.

94. Article 10(2) of India-Singapore DTAA.
95. Article 10(2) of India-Netherlands DTAA.
96. Article 13(3A) of India-Mauritius DTAA.
97. Article 13(3B) read with Article 27A of India-Mauritius DTAA.
98. A shell /conduit company is defined to mean any legal entity falling within the definition of resident with negligible or nil business operations
or with no real and continuous business activities carried out in that Contracting State. Article 27A of India-Mauritius DTAA also elaborates
cases wherein an entity will be deemed or will not be deemed to be a shell / conduit company.
100. Article 13(4A) read with Article 24A of India-Singapore DTAA.
101. Article 13(4A) read with Article 24A of India-Singapore DTAA.
102. Article 24A of India-Singapore DTAA elaborates cases wherein an entity will be deemed or will not be deemed to be a shell / conduit company.
103. Article 13(4B) of India-Singapore DTAA.

Annexure II
Interest 7.5%, subject to satisfaction of beneficial 10 % of the gross amount of 10%, subject to
ownership test.104 the interest if such interest satisfaction of beneficial
is paid on a loan granted by ownership test 106
a bank carrying on a bona
fide banking business or by
a similar financial institution
(including an insurance
company); 15%, subject to
satisfaction of beneficial
ownership test. 105
Tax Implications if the non-resident investor is not eligible to claim benefits under the relevant DTAAs
Capital Gains Nature of securities Short-term capital gains Long-term capital gain
Sale of listed equity shares on the floor of the 15% 10% without foreign exchange
recognized stock exchange fluctuation benefit (capital gains
in excess of INR 0.1 million)
(Securities Transaction Tax paid)
Sale of other listed securities 40% 10% without indexation benefit
Sale of unlisted shares and securities 40% 10% without foreign exchange
fluctuation benefit

105. Article 11(2)(b) of India-Singapore DTAA
106. Article 11(2) of India-Netherlands DTAA.

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NDA Insights
TITLE TYPE DATE
Supreme Court Clears The Air on The Pledge of Dematerialised Shares Dispute Resolution May 2022
Singapore Court of Appeal Allows a Non-Party to Enforce an Award Dispute Resolution May 2022
Delhi High Court’s Guidance on Conversion Rate For Foreign Currency Dispute Resolution May 2022
Denominated Arbitral Awards
NCLT Approves Scheme of Amalgamation and Rejects Tax Department’s Tax May 2022
Objection on Loss of Tax Revenue and Invocation of Gaar
Beneficial Ownership Test Cannot Be Read Into Article 13 (Capital Tax May 2022
Gains) Of The India-Mauritius Tax Treaty, Without Specific Language
To Such Effect
Withdrawal of Amount Deposited in Escrow Account by Buyer Tax May 2022
Deductible From Sale Consideration
CERT-In Releases Faqs Explaining the Direction on Cybersecurity Technology Law May 2022
Cyber Security: India Revamps Rules on Mandatory Incident Reporting Technology Law May 2022
& Allied Compliances
Employment Generation in India: Prioritise Service Sector - If Speed is HR Law April 2022
the Essence
India’s New Labor Codes - Reduced Direct Liability of Directors? HR Law April 2022
New Labour Codes In India Delayed HR Law April 2022
What Does Liberalisation Of Drone Laws Mean For The Technology Law March 2022
Pharmaceutical Industry?
The Rbi Stand On Crypto Lacks Balance Technology Law March 2022
The Data Protection Bill: In Search Of A Balanced Horizontal Data Technology Law March 2022
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Research @ NDA
Research is the DNA of NDA. In early 1980s, our firm emerged from an extensive, and then pioneering, research
by Nishith M. Desai on the taxation of cross-border transactions. The research book written by him provided the
foundation for our international tax practice. Since then, we have relied upon research to be the cornerstone of
our practice development. Today, research is fully ingrained in the firm’s culture.
Our dedication to research has been instrumental in creating thought leadership in various areas of law and
public policy. Through research, we develop intellectual capital and leverage it actively for both our clients and
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on jurisprudence, and ultimately deliver superior value to our clients. Over time, we have embedded a culture
and built processes of learning through research that give us a robust edge in providing best quality advices and
services to our clients, to our fraternity and to the community at large.
Every member of the firm is required to participate in research activities. The seeds of research are typically sown
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issue under the guidance of seniors and put it through our “Anticipate-Prepare-Deliver” research model.
As the first step, they would conduct a capsule research, which involves a quick analysis of readily available
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issue for the involved associates, who in turn would disseminate it to other associates through tacit and explicit
knowledge exchange processes. For us, knowledge sharing is as important an attribute as knowledge acquisition.
When the issue requires further investigation, we develop an extensive research paper. Often we collect our own
primary data when we feel the issue demands going deep to the root or when we find gaps in secondary data. In
some cases, we have even taken up multi-year research projects to investigate every aspect of the topic and build
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and energy sector practice have emerged from such projects. Research in essence graduates to Knowledge, and
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Over the years, we have produced some outstanding research papers, articles, webinars and talks. Almost on daily
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Global, Regulatory and Tax Environment impacting India focused funds
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Diagnostics and Structuring

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2. CHOICE OF JURISDICTION FOR SETTING UP AN INDIA-FOCUSED FUND 04

I. Why Offshore Investors are Pooled Outside India 04

3. STRUCTURAL ALTERNATIVES FOR INDIA-FOCUSED FUNDS 11

I. Structuring India focused Offshore Funds 11

4. ALTERNATIVE INVESTMENT FUNDS IN INDIA 18

5. TRENDS IN PRIVATE EQUITY 39

I. Trending fund terms 39

I. At the Offshore Fund Level 44

9. INTERNATIONAL TAX CONSIDERATIONS 61

I. Association of Persons (AOP) Risk 61

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Sector Focused Funds 69

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GAAR General Anti-Avoidance Rules

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PAN Permanent Account Number

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2. Choice of Jurisdiction for Setting up an

I. Why Offshore Investors are Pooled Outside India

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2. Choice of Jurisdiction for Setting up an India-Focused Fund

II. Why Onshore Investors are Pooled in India

III. Which Jurisdictions are Typically Considered for

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2. Choice of Jurisdiction for Setting up an India-Focused Fund

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2. Choice of Jurisdiction for Setting up an India-Focused Fund

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2. Choice of Jurisdiction for Setting up an India-Focused Fund

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2. Choice of Jurisdiction for Setting up an India-Focused Fund