With the income-tax department on Monday clarifying that tax pass-through status would be available to hedge funds, private equity funds and similar entities, other than venture capital funds, only if names and beneficial interest of the investors are specified in their charter.
Since many investors join hedge funds and PEs subsequent to their formation, they face difficulties in having their names and beneficial interests specified in the charter of these non-charitable trusts, which may lead to denial of pass-through status to these entities.
However, VC funds do not face that threat as they are accorded pass-through status under the Income Tax Act. An entity having a pass-through status is not liable to pay tax on the profits or gains it makes, which will be taxed only in the hands of its investors.
As per a circular issued by the department on Monday, pass-through status would not be available to an entity if investors’ name and beneficial interest are not specified in its deed and the entire income of this entity shall be taxed at the maximum marginal rate of 30% in the hands of the trustees.
“This is a blow to the industry as many investors in such funds may be in the lower tax brackets or may not be liable to tax at all. To avoid being taxed at the highest rate, investors in these funds have been seeking pass-through status,” said Amit Maheshwari, partner, Ashok Maheshwary & Associates.
Foreign investors in entities not having tax pass-through status will find difficulties in claiming tax credit in their home country as the profits are taxed in the hands of the trustees, not in the hands of the investors.