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14 December, 2016
In March 2015, the Securities and Exchange Board of India (SEBI) constituted a standing Alternative Investment Policy Advisory Committee (AIPAC) under the chairmanship of Shri. N. R. Narayana Murthy. AIPAC submitted its first report in January 2016 and its second report was released by SEBI on December 1, 2016 (Report 2) for public comments.
The Alternative Investment Fund (AIF) industry has been growing exponentially. The cumulative funds raised increasing from Rs 3,841 crores (approximately, USD 568 million) in September 2013 to Rs 29,016 crores (approximately, USD 4292 million) in September 2016[1]. In approximately four years since the introduction of SEBI (Alternative Investment Funds) Regulations, 2012 (Regulations), the number of AIFs registered has reached 268[2].
The AIF industry is thus poised to make its next leap of growth. Guided by this, Report 2 makes several recommendations to unshackle the AIF industry and lead the way into Phase II of its evolution. Some of the key recommendations that will facilitate growth are highlighted below.
“Accredited investor” Concept; Operationalised Digitally: Extant Regulations limit investments in AIFs to “sophisticated investors” by imposing a minimum investment obligation of Rs 1 crore. In line with international practice, Report 2 suggests that this criteria is misplaced and introduces the concept of an “accredited investor” viz. an investor with reported total income exceeding Rs. 50 lakhs. Report 2 also recommends that investors could register themselves as such and their status verified through online processes. This recommendation, if implemented, will not only expand the universe of domestic eligible investors but will also eradicate avoidable delays in fund raising.
Channelling Domestic Savings Pools: across the world, insurance companies and pension funds are significant investors in funds. However, existing Indian regulations impede Category II AIFs (mainly private equity and debt funds) from tapping into these large pools of domestic savings. The committee recommends clarifying that pension funds and insurance companies will be permitted to invest in Category II AIFs so long as such AIFs invest primarily in unlisted investee companies and in accordance with the Regulations. These recommendations, if implemented, will benefit the capital seekers as well as these capital providers by facilitating diversification and improving overall returns.
New AIF Category: Report 2 recommends the addition of a new sub-category, Category II-A AIF, under Category II AIFs, called Mid Market Permanent Capital Vehicle (MMPCV). Styled like the Business Development Companies in the US, MMPCVs will focus on the capital needs of mid-corporate and micro, small and medium-sized enterprises. MMPCVs are proposed to be listed funds (alternatively, start as unlisted but list later or create exit path) with an obligation to distribute a minimum of 90% of cash profits to investors. The AIPAC further recommends that MMPCVs be permitted to leverage up to 1x of capital. Whether MMPCVs take off or not would depend to a large extent on their tax regimes because MMPCVs are hybrid vehicles that do not squarely fall within the existing pass-through regime for AIFs.
Enhanced disclosures: With a larger footprint, comes greater responsibility is the mantra for disclosures under Report 2. Report 2 proposes that AIFs that raise capital from retail investors with ticket size of less than Rs 10 crores should make: (i) additional disclosures in the private placement memorandum; (ii) increased financial data reportings; and (iii) a higher commitment to governance by forming an Investor Advisory Committee. While at first blush these proposals appear to be painstakingly prescriptive, in the long run these will increase transparency and equip investors to make better informed decisions. In addition, this will improve competitiveness in the AIF industry based on performance comparables and demonstrably better practices and policies.
Taxation reforms: Tax recommendations, rightly, consume significant space in Report 2, the key proposals being:
- Characterise all income of an AIF as capital gains;
- Make losses available for set off in the hands of the investors;
- Allow gains from the sale of unlisted shares, with or without control and management of the underlying business, to be characterised as capital gains;
- Allow proportionate exemption for service tax on management fees, in relation to investments by non-residents;
- Extend pass-through status to Category III AIFs;
- Revise safe harbour provisions to encourage onshoring of asset management activities;
- Exempt AIF investments from the rigours of the deemed income provisions in relation to acquisition of primary / secondary shares at value higher / lower than FMV, respectively;
- Exempt foreign investors investing directly into an AIF from the rigours of obtaining a permanent account number and income tax filings;
- Permit AIF investors to capitalise the management fee as a cost of improvement, thereby enhancing their post tax returns;
- Extend the mutual fund-like taxation regime for listed AIFs;
- Last but not the least, Report 2 also provides an alternative taxation regime for AIFs through “securities transaction tax” platform. This bold recommendation clearly depicts the AIPAC members’ vision to think beyond the obvious and examine even seemingly disruptive solutions for the long term growth and health of the AIF industry.
Do note that this is not an exhaustive analysis of all the recommendations in Report 2. The AIPAC makes several other recommendations, structural and otherwise, to iron out irregularities in the AIF regime.
Christmas cheer and festivities turn December into a joyful month. And the AIF industry’s celebrations have surely started from December 1. As evidenced by the above, the wish list has been drawn up and the AIF industry is now waiting with bated breath!
So, let’s go carolling: it’s the season to be jolly… Santa Claus is (fingers crossed) coming to town!
[1] http://www.sebi.gov.in/cms/sebi_data/attachdocs/
[2] http://www.sebi.gov.in/cms/sebi_data/attachdocs
For further information, please contact:
Shagoofa Rashid Khan, Partner, Cyril Amarchand Mangaldas
shagoofa.khan@cyrilshroff.com
