A new global gateway has opened for Indian retail investors.
A GIFT City-based subsidiary of an Indian mutual fund has launched the country’s first open-ended retail fund under the International Financial Services Centres Authority (IFSCA) regulations.
While this opens up a new route for Indian resident investors to access global equities, the absence of specific tax provisions for such funds makes it essential to understand how both the fund and its investors will be taxed under Indian law.
The fund, which is neither a mutual fund nor an alternative investment fund (AIF), is structured as a trust and designed for resident Indians. Investors will contribute in US dollars via the Liberalised Remittance Scheme (LRS), remitting funds from their Indian bank accounts to the fund’s GIFT City account. The fund will offer daily redemptions but impose a 1% exit fee for withdrawals within one year.
Also read: GIFT City is changing how—and where—Indians invest
TCS on LRS contributions
Investors must route their contributions through the LRS window, which allows up to $250,000 annually. However, any remittance exceeding ₹10 lakh in a financial year will attract a 20% tax collected at source (TCS) on the excess. This TCS is aggregated across all LRS remittances and can later be claimed as tax credit in the investor’s income tax return.
Although GIFT City is treated as an overseas jurisdiction under exchange control rules (FEMA)—requiring investors to use their LRS limit—it is considered part of India for income tax purposes. As a result, both the Fund and its investors must comply with Indian tax regulations.
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How the Fund may be taxed
Since the fund is structured as a trust with Indian tax residency, it does not qualify for tax exemptions that are extended to funds with only non-resident investors. Therefore, standard trust taxation rules apply.
The taxation of trusts and their beneficiaries depends on whether the trust is classified as a specific (or determinate) trust or a discretionary (or indeterminate) trust. Under Indian tax law, tax is levied at only one level—either at the trust level or at the beneficiary level:
- In a specific trust, where the beneficiaries’ share of income and capital is clearly defined, the tax liability generally falls on the beneficiaries. However, tax authorities do have the discretion to tax the trust instead, at the same rate applicable to the beneficiaries.
- In contrast, a discretionary trust, where the shares are not pre-determined, is taxed entirely at the trust level.
In this case, the fund would likely qualify as a specific trust, since each investor’s share in income and capital is known. However, an explanation under Indian tax law requires that such shares be explicitly specified in the trust deed as on the date of its creation. Citing this, tax authorities have often classified similar investment trusts as discretionary trusts, despite court rulings to the contrary.
To avoid potential litigation, the fund may choose to classify itself as a discretionary trust.
Tax rates and treatment
As a discretionary trust, the fund will be taxed at the trust level at the maximum marginal rate. However, courts have ruled that special incomes like capital gains or dividends will still be taxed at their applicable preferential rates:
Long-term capital gains: 12.5% + surcharge + cess = ~14.95%
Dividends: 30% (with surcharge capped at 15%) = ~35.88%
Interest and other income: taxed at the highest marginal rate
For investors, any income distributed by the trust is tax-exempt, and hence not subject to TDS. However, unlike regular mutual funds where the net asset value (NAV) is calculated without accounting for tax impact, this fund must factor in potential tax liabilities while determining its NAV. Specifically, it must provision for taxes that would arise if the investments were sold at the current NAV. If this is not done, investors who exit before sale of investments by the Fund would not bear their share of the tax payable by the Fund.
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Need for clarity
Since this retail fund format under IFSCA is new, there is no explicit taxation guidance under the Indian Income Tax Act. To avoid confusion and potential disputes, it may be prudent for the government to amend tax laws to provide clear, fund-specific rules.
A well-defined tax framework would reduce ambiguity and boost investor confidence in GIFT City’s evolving retail fund offerings.
Gautam Nayak is a partner at CNK & Associates LLP. Views are personal.