Alternative Investment Fund Setup In GIFT City GujaratOver the past few months, there has been a flurry of developments involving the Gujarat Internal Finance Tech-City (“GIFT City”). New guidelines are being issued and MOUs executed with financial institutions on a weekly basis, all with the aim of incentivizing overseas financial institutions and overseas branches /subsidiaries of Indian financial institutions to bring to Indian shores those financial services transactions that are currently carried on outside India. The underlying key to this incentivization is the International Finances Services Centre (“IFSC”) which is set up in the special economic zone (“SEZ”) within GIFT City. While the IFSC is physically on Indian territory, it is treated as an offshore jurisdiction for foreign exchange reasons, allowing investors to engage in IFSC firms without having to comply with India's foreign exchange regulations. To encourage foreign investment and bring the IFSC in GIFT City up to par with IFSCs across the world, special tax advantages have been offered to units located within the IFSC.

The RBI, SEBI, PFRDA, and IRDAI used to regulate financial services providers in the IFSC; however, as of April 27, 2020, the International Financial Services Centres Authority (“IFSCA”) has been established as a unified authority for the development and regulation of financial products, financial services, and financial institutions in the IFSC.

The creation of IFSCA to act as a single window for regulating activities in an IFSC has already proven to be an effective tool for quickly implementing stakeholder requests, and it should help build investor confidence as GIFT City develops by ensuring consistency, transparency, and clarity in policy measures. The IFSCA's ability and ambition to develop rules that would soon bring the IFSC at GIFT City in line with IFSCs across the globe is a crucial factor for both international and Indian GPs to consider when deciding on the appropriate jurisdiction for their fund platform.

As further detailed below, the IFSC at GIFT City already has a robust regulatory and tax framework in place that provides GPs and their investors with ease of doing business and tax incentives comparable to those found in Singapore and Mauritius, while allowing Indian GPs to manage their funds from within India without incurring the financial burden of Indian taxation.

In GIFT City, there is a legal framework for AIFs.

The SEBI (International Financial Services Centre) Guidelines for Alternative Investment Funds (“AIFs”) in an IFSC (“IFSC AIF”) provide a wide framework for establishing AIFs in an IFSC (“IFSC AIF”). SEBI also published a Circular dated November 26, 2018 (the "2018 Circular") to further explain AIF activities inside the IFSC, based on discussions with the Alternative Investment Policy Advisory Committee and engagement with stakeholders. Following its establishment as a unified authority governing the IFSC at GIFT City, the IFSCA responded to stakeholder concerns by issuing a Circular dated December 9, 2020 (“2020 Circular”), which provides IFSC AIFs with additional benefits such as leveraging, co-investment opportunities, and relaxation of diversification norms.

As a result, the 2015 Guidelines, in conjunction with the 2018 Circular and the 2020 Circular (collectively, the "IFSC AIF Regulations"), establish the legal framework under which IFSC AIFs operate in GIFT City. The following are some of the most important controlling characteristics:

Investors who are eligible

An IFSC AIF may receive capital from the following categories of investors in foreign currency:

  1. A person residing outside of India; non-resident Indian;
  2. Institutional investor residing in India who is qualified under FEMA to invest money abroad to the degree that outward investment is authorised;
  3. A person residing in India to the extent that the Liberalized Remittance Scheme (“LRS Route”) allows.

The IFSC AIF's permissible investments

  1. Investments in the following are authorised under an IFSC AIF:
  2. Securities listed on the IFSC;
  3. securities issued by a business established in the IFSC;
  4. securities issued by firms incorporated in India or in a foreign jurisdiction;
  5. units of other AIFs;
  6. and other acceptable investments as defined by the SEBI (AIF) Regulations, 2012. (ie. LLP, REIT, InvIT, Derivatives, SPV)

It has been clarified that an IFSC AIF can engage in Indian equities through the foreign venture capital investment (FVCI) route, the foreign portfolio investor (FPI) route, or the foreign direct investment (FDI) method. Previously, IFSC AIFs could only invest through the FPI channel. This decision by SEBI allows overseas investors to invest through IFSC AIFs and take advantage of the IFSC regime's perks.

At the same time, IFSC AIFs can invest internationally without the constraints imposed on domestic AIFs by the AIF Regulations, such as the need for SEBI permission prior to making an overseas investment and the inability to invest more than 25% of their investible funds overseas.

The IFSCA recently issued the 2020 Circular in response to stakeholder concerns that the IFSC AIF framework be brought closer to international norms. The following table summarises the major benefits given by the 2020 Circular:


Domestic AIF

IFSC Benefit

The IFSC AIF is allowed to co-invest in a portfolio company through a segregated portfolio by issuing a separate class of units to certain investors, as long as the terms are not better than those offered to the IFSC AIF's common portfolio and adequate disclosures are made in the placement memorandum.

Domestic AIFs are typically prohibited from allowing any group of investors to raise their allocation to a single transaction on an individual basis.

This will make the transaction structure easier and provide IFSC AIFs and investors more flexibility in allocating funds to profitable opportunities.

Along with other legal investments, IFSC AIF is allowed to invest in domestic AIFs registered with SEBI.

While the AIF Regulations allow Category-I AIFs to invest in units of other Category-I AIFs and Category-II AIFs to invest in units of other Category-I AIFs, the AIF Regulations also provide that the AIF should only invest in such units and not in units of other Funds of Funds. As a result, it's unclear whether a domestic AIF may invest in both a fund and a portfolio at the same time.

This will make transaction structuring easier and provide IFSC AIFs more flexibility in executing investment strategies that include both local and international fund units as well as portfolio firms.

The IFSC AIF is allowed to invest without having to adhere to the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) diversification criteria.

AIF regulations restrict CAT I/II AIFs from investing more than 25% of their investible capital in a single business, and CAT III AIFs from investing more than 10%.

Because offshore funds are frequently set up to invest in a few specific firms or sectors, this easing allows IFSC AIFs to compete with other offshore fund vehicles.

Borrow money or participate in leveraging operations, subject to I placement memorandum disclosures, (ii) investor approval, and (iii) the maintenance of a thorough risk management system.

Domestic CAT I/II AIFs are banned from borrowing money directly or indirectly or participating in any leverage, with the exception of satisfying temporary funding requirements for no more than thirty days, four times per year, and no more than ten percent of investable funds. Domestic CAT III AIF funds are authorised to use leverage, but only with investors and to a maximum of 2 times the AIF's Net Asset Value.


The IFSCA's commitment to onshoring the fund management business to India is demonstrated by the 2020 Circular, which is a very welcome development for the fund industry. These exemptions for IFSC AIFs should make deal structures easier to understand, as they often involve multiple layers and offshore entities to accommodate domestic AIF co-investment and diversification restrictions, as well as complex investment strategies that target both funds and portfolio companies. These improvements, along with the IFSC AIF's capacity to leverage capital and the tax benefits (described below), bring the IFSC AIF system closer to parity with international offshore.

The entity that serves as a sponsor or manager

IFSC AIF management is anticipated to be physically based within the IFSC at GIFT City, keeping in mind the IFSC's objective of becoming a financial services centre. While an existing sponsor/manager entity of a domestic AIF may establish a branch or subsidiary in the form of a company or LLP, foreign exchange control provisions, such as the Foreign Exchange Management (Transfer or issue of any foreign security) Regulations, 2004 (“TIFS Regulations”), and the requirement of RBI approval for investing in an overseas company engaged in financial services should be a consideration. Of course, these regulations may make it more difficult for Indian doctors to handle IFSC AIF from their present locations outside of the IFSC. However, it should be emphasised that domestic investors participating in an offshore fund established up in a jurisdiction like Singapore or Mauritius would face the same foreign exchange control concerns. Given that the GIFT City IFSC is governed by Indian regulators, the need for getting previous RBI permission for the creation of a management/sponsor company in the IFSC and for meeting the sponsor commitment requirements should be eased at the very least. This would encourage fund managers to select IFSC AIFs over offshore fund structures, with all other criteria being the same.

General Tax Framework for AIFs in GIFT City

While every unit in an IFSC, including an IFSC AIF and its manager/sponsor entity established up in the IFSC, is classified as a person living outside India for the purposes of foreign exchange control, such entities are considered people resident in India for income tax reasons. However, the Income-tax Act of 1961 (“ITA”) provides several incentives to units located in the IFSC, including IFSC AIFs and their Investment Managers, including a 100 per cent tax holiday on business income for any consecutive 10 years out of the unit's first 15 years in the IFSC under Section 80LA of the ITA. The fund sector is now susceptible to the danger of carrying being reclassified as business income, particularly in the case of income generated by investment managers (instead of capital gains). However, for management companies established within the IFSC, this risk is minimised because the tax break given under section 80LA should apply to performance fees paid by the IFSC AIF. The GIFT City management structure is an appealing model because of this, as well as the GST exemption. The ITA also gives various tax benefits to units located in an IFSC, such as a lower minimum alternative tax, a lower withholding tax on interest income, and a capital gains tax exemption on the transfer of certain securities, among other things. Non-resident investors' income from off-shore investments routed through a Category-I or Category-II AIF, which is a considered direct investment outside India by the non-resident investor, is not taxable in India, according to the Central Board of Direct Taxes. As a result, non-resident investors' income from foreign investments made through Category-I or Category-II IFSC AIFs should not be taxed in India. Non-residents with income from investments in an IFSC AIF that is taxable under the ITA are also excluded from submitting an income-tax return in India, according to the CBDT. However, such an exemption is only possible if tax has been properly deducted and submitted to the government by the IFSC AIF in accordance with the ITA's rules. In the same vein, the CBDT has granted non-residents an exemption from acquiring a Permanent Account Number (“PAN”), as long as certain requirements are met.

Transferring money from offshore to the IFSC

The Finance Act of 2021 has recently revised numerous provisions of the ITA to facilitate tax neutrality when it comes to the transfer of overseas monies to the IFSC. When the shares and assets of the ‘original fund' are ‘relocated' to a ‘resultant fund' in India, such provisions apply. In this context, an "original fund" is defined under the ITA as a fund founded, incorporated, or registered outside of India that receives monies from its members for the purpose of investing for their benefit and meets the following criteria:

  1. the fund is not a person resident in India;
  2. the fund is a resident of a country or a specified territory with which an agreement referred to in sub-section (1) of section 90 or subsection (1) of section 90A has been entered into or is established or incorporated or registered in a country or a specified territory as may be notified by the Central Government in this behalf;
  3. the fund and its activities are subject to applicable investor protection regulations in the country or specified territory where it is established or incorporated or is a resident; and
  4. fulfils such other conditions as may be prescribed;

Furthermore, the term "relocation" has been defined as the transfer of assets from the original fund, or its fully owned special purpose vehicle, to a resultant fund on or before March 31, 2023, when compensation is paid in the form of a share, unit, or interest in the resulting fund to,

  1. In place of their shares, units, or interests in the original fund, a shareholder, unitholder, or interest holder of the original fund in the same proportion as the share, unit, or interest owned by such shareholder, unitholder, or interest holder in the original fund; or
  2. The original fund, in the same proportion as in subclause I for which the resultant fund does not provide a share, unit, or interest to its shareholder, unitholder, or interest holder;'

The ITA further states that the ‘resultant fund' must be a trust, corporation, or LLP founded or incorporated in India, registered with SEBI, and have a CAT – I, CAT – II, or CAT – III AIF and be situated in an IFSC.

The ITA has also been modified by the Finance Act of 2021 to include the following measures for guaranteeing tax neutrality:

  1. Capital gains tax exemption on capital asset transfers in migration by the original fund to the IFSC AIF. This clause effectively aims to exclude capital gains accruing from an offshore fund's transfer of shares of Indian businesses and other Indian securities to an IFSC AIF. The consideration for such a transfer, however, must be paid in the form of allocation of shares/units in the AIF based in the IFSC to the shareholder/unitholder of the offshore fund in the same proportion as such shareholder/unitholder had in the offshore fund.
  2. Exemption from capital gains tax for a shareholder/unitholder who transfers a capital asset, such as a share/unit in the original fund, in exchange for a share/unit in the resulting fund, in a relocation. Due to indirect transfer laws, this clause aims to exclude the transfer at the shareholder level from capital gains tax.
  3. Exemption from capital gains tax arising or received by a non-resident investor as a result of the IFSC AIF's transfer of shares of an Indian company that were acquired by the IFSC AIF as a result of relocation, and where the capital gains on such transfer would not have been subject to tax had the relocation not occurred. This provision aims to equalise the treatment of non-resident investors departing from an offshore fund that is not subject to tax in India (for example, due to grandfathering under the terms of a favourable tax treaty) and exiting from an IFSC AIF.
  4. Section 79 has also been changed to provide the firm with the advantage of set-off and loss carry-forward to the extent that the change in ownership occurred as a result of relocation.