While purchasing jeans or a t-shirt, you should have checked the price tag, but most of us ignore the tax bifurcation. But when it comes to buying something big like a house or a car, most of us analyse the tax bracket before purchasing. What about when you are looking to invest in Alternative Investment Funds largely known as AIFs?  

When we invest in an Alternative Fund, we are supposed to know the tax implications that come with it. In this blog, we will discover the tax criteria of alternative investment funds. But first, let’s briefly understand the alternative investment funds.

What are Alternative Investment Funds?

An alternative investment fund is different from traditional investment options. It invests in a variety of investments, such as private equity funds, hedge funds, venture capital funds, and a few more. It allows investors to invest in a dynamic range of investments and is usually managed by professional fund managers. 

AIFs can be a great tool used by HNIs to diversify their portfolios. It has the potential to generate returns that may be more than what we see in a conventional equity market. But as an investor, you must understand the tax implications associated with it. This plays a vital role in choosing the right AIF category to invest in.

Now, let’s understand the tax implications of different alternative investment funds’ categories.

Category I and II AIFs:

The Finance Act of 2015 announced a taxation rule for Category I and II AIFs. These investments have been granted a pass-through, which means the money generated by the fund is taxed at the investor’s level, not at the fund’s level. The investor is responsible for paying the tax on the income he has generated. 

The fund is not subject to any tax on the income generated from the investment. But, if the funds’ income is measured as business income, then the same amount is taxed on the fund.

Let’s understand different scenarios, like long-term capital gains, short-term capital gains, dividends, and income.

• Long-term capital gains – If an investment has been held for more than a year in Category I and II, it is termed as Long-term Capital Gains (LTCG). These investments are taxed at the rate that applies to long-run capital gains. Usually, long-term capital gains are taxed at 10% and are listed on stocks, and unlisted stocks are taxed at 20%.
• Short-Term Capital Gains – Investors who invest while aiming at short-term capital gains under Alternative Investment Funds Category I and II are subjected to a 15% tax, but it also depends on their tax bracket.
• Dividend Income – Dividend income under AIFs is taxable as per the investor’s individual tax-rate.
• Interest Income – Any interest income gained through Category I and II is also taxable as per the tax slab of an investor.

Category III AIFs:

 In this category, AIFs are subject to taxation for all income, whether it is investment income, capital gain, or business income. The pass-through system has not been implemented in category III alternative investment funds. All four types of income are taxable but at different rates.

You can read in detail about AIFs categories, here.

Conclusion

Alternative Investment Funds have become quite popular in the current Indian landscape as they offer diversification and have the potential to generate higher returns. But, it is important for any investor to be informed about the tax implications associated with AIFs. It helps the investor make better and informed decisions while they are aware of the tax implications.

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The scenario of investing in alternative investment funds in India is a captivating tale waiting to unfold, and let this blog be your user manual on this transformative journey.

What are Alternative Investment Funds (AIFs)?

A unique type of investment that is distinct from traditional investment instruments is an alternative investment fund. It is a privately pooled fund. As significant investments are needed, institutions and HNIs generally invest in AIFs.

Alternative investment funds (AIFs) have become a well-liked type of investment vehicle over the past few years. AIFs are now more investor-friendly as a result of recent regulatory changes and shifting social norms.

There are 3 categories of AIFs, let’s have a look:

Category 1 – These funds are invested in start-ups, small businesses, and medium-sized enterprises that have the potential to grow financially. Examples of this category are:

• Infrastructure Funds
• Angel Funds
• Venture Capital Funds
• Social Venture Funds

Category 2 – Funds that are invested in both debt and equity securities fall under this category. Included are any funds that don’t already fall under Categories 1 and 3, respectively. Examples of this category are:

• Fund of Funds
• Debt Funds
• Private Equity Funds

Category 3 – AIFs in category 3 are those that offer returns in a short amount of time. To achieve their objectives, these funds employ a wide range of intricate trading strategies. There is no information regarding any special government incentives or concessions for these funds. Examples of this category are:

• Hedge Funds
• Private Investment in Public Equity Funds

Now, let’s discuss some of the steps to invest in AIFs.

Steps to invest in Alternative Investment Funds in India: 

1. Be familiar with the various AIF types – AIFs are divided into three groups: Category I, Category II, and Category III. The risk profiles and investment strategies vary for each category. Before making an investment, it’s critical to comprehend how they differ from one another.
2. Fund manager selection – When selecting a fund manager, look for one with a solid track record and AIF management experience. Verify their fees, investment philosophy, and past performance.
3. Verify the minimum investment requirement – The minimum investment requirement for AIFs is typically high, ranging from ₹1 crore to ₹10 crores.
4. Finish the paperwork – Once you’ve made the decision to invest in an AIF, finish the required paperwork, which includes the subscription agreement and know-your-customer (KYC). 
5. Track your investment – Keep tabs on your investment and regularly check on how it is doing. This can assist you in early problem detection and any necessary investment strategy adjustments.

Conclusion

It is important to note that Alternative Investment Funds are considered high-risk investments, and investors should be prepared to bear the associated risks. Before you start your investment journey in AIFs, make sure you follow these steps, from choosing a fund manager to meeting minimum investment requirements to tracking your investment. It is also advisable to consult with a financial advisor before investing in AIFs to ensure that they are suitable for your investment goals and risk tolerance. ​

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AIFs are an interesting investment option for those investors, mostly HNIs, who aspire to receive high returns and are willing to take high risks. Investors can conduct thorough market research and invest in a category of AIF based on their financial goals and risk appetite. And when it comes to finding the right strategy for your AIFs, what should you look at first and what do you think about next, then, before investing in an AIF? Let’s talk about it in this blog.

What should you think about before making an AIF investment?

Begin by reviewing the investment strategy. Have you already been exposed to the proposed strategy through your current equity and debt portfolios? To prevent any overlap with your conventional investments, it is advisable to avoid strategies that are similar when allocating funds to “alternative assets”.

If it goes through the first filter, then dig deeper. You tend to look for a brand when finalising a wrist watch. You read, watch influencer videos, or do research about it. A 50-year-old brand or a comparatively new brand – who would you choose? Most people will go for a vintage brand for its record and experience. A track record and experience are critical.

Look for a skilled and specialised team to manage AIFs

When it comes to managing your alternative investment funds, particularly in India, it requires specialised skills, and the talent therefore resides in key individuals within the investment management teams. Look for team consistency and cohesion, as well as teams’ commercial alignment with the performance outcome of the fund. This is critical as these products tend to have long lock-in periods, and you want the management team to be there to achieve targeted outcomes.

Then, there are other factors like the vintage of funds and matters relating to related party transactions, etc., all of which need to be checked out. This is the reason why market regulator SEBI has rightfully put in a minimum requirement of ₹1 crore in commitment amount, which may be raised further.

While some of the distributors of AIFs do some diligence, there is much to be learned by the ecosystem as it evolves. Although investors must do as much research as possible, it may be better to rely on the advice of a qualified investment advisor who has a deep understanding of these products and also has rich data to evaluate performance. SEBI has also mandated performance records to be disclosed, but it is at a nascent stage of refinement, and hence the requirement for a deep dive by knowledgeable persons is necessary.

The last look: Conclusion

Prior to making an investment, investors should carefully consider the alternative investment funds option and conduct adequate due diligence on the platform. You should also avoid making decisions based solely on the interest rate that an alternative investment offers. Instead of concentrating your investment in one alternative investment fund, you should diversify it across a number of asset classes and begin investing in alternative investment funds in India. Review the investment strategy to determine if you are gaining access to genuinely unique assets that are not already included in your portfolio and cannot be easily achieved independently. Depend on an expert advisor and ensure to ask appropriate questions, while also seeking input from the advisor.

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The Indian climate has something to offer for everyone. Diverse weather conditions can be beneficial in various ways. People tend to enjoy every weather, many crops can be produced depending on the weather, a great destination for tourist attraction, good for economic growth, and many others. 

Diversification helps in growth and mitigating the risk. You must have heard the phrase, ‘Don’t put all your eggs in one basket.’ While in investment, when you keep money for future needs or emergencies, it is crucial to focus on investment opportunities that can yield attractive returns.

How alternative investment funds diversify your portfolio, lower volatility and enhance returns?  

Since alternative investment funds frequently behave differently from conventional equity and bond investments, including them in a portfolio may help to reduce volatility, provide greater diversification, and boost returns.

• Lower volatility

The alternative investment funds may potentially lower the overall risk of a portfolio because they rely less on general market trends and more on the strength of each individual investment.

• Diversification

Alternatives investment funds can be a significant way to diversify your portfolio with low correlation to traditional asset classes.

• Boost returns

Alternatives give investors access to a wider range of investments and investment strategies, which can improve a portfolio’s risk and return profile and increase total return.

Why are Alternative Investment Funds getting popular in India?

Asset managers invest in unlisted companies or private equity situations, which are essentially growth capital for businesses that aren’t quite ready to enter the public markets, through alternative investment funds. While a significant portion of their capital is already invested in the listed market, it gives them the chance to diversify their portfolio while also giving investors the chance to invest in the private market through these kinds of products.

There are many opportunities in alternative investment funds which includes investing in farmlands, agricultural products, artworks, etc. In the coming times, people will get an opportunity to consume products/services and invest and earn from what they use in their everyday lives.

Conclusion

Alternative Investment Funds can be a good option for investors whose risk appetite is high and who are willing to receive high returns over a period of time. Prior to making any investments in Alternative Investment Funds (AIFs), it is highly recommended to engage in comprehensive market research. By doing so, investors can make informed decisions and strategically allocate their funds with the objective of attaining their financial goals.