Taxmen really have no chill. They can’t just let somebody make a little money without having to take their own big bite out of it. Take, for instance, PE (or private equity) fund managers. They’re the latest group to attract the notice of the infamous tax goblins.
Most PE fund managers that work outside of India have received notices that they are under investigation by the income tax department. They are asking them to provide details of their income & assets abroad. Most of these managers have lawyered up to deal with the notices, which is a smart move on their part.
PE fund managers usually take a share of 20-30% of the profit made when a PE fund sells. This is called a carry fee, carried interest, or carry. This can add up to hundreds of crores when a big fund does really well. This is in addition to the management fees they get, which is a fixed percentage of the assets, regardless of how a fund performs.
The tax department wants these PE managers to show how they are bringing these foreign profits back to India, so they can extract their pound of flesh. Many funds have structures in place that pay the manager in non-taxable foreign jurisdictions, while paying an Indian company a service fee. This means that the majority of the carry is held outside India, while sending the manager a small portion of it in-country, so they pay taxes based on that amount.
One of the problems with these funds is how the carry fees are accounted for. Global PE’s follow International Financial Reporting Standards (IFRS), where the carry fee is recorded in the profit & loss account (or P&L) when it is allotted, not when it is dispersed to the manager. Often, the manager may not receive the funds for another year or two. Instead of challenging these notices, many managers have decided to just pay the taxes on these funds, even without having seen the money for them.
The tax department still has not declared how much they are expecting in taxes from these carry fees. Some managers are paying 20% tax on these profits, while some have paid up to 40%. There is also much confusion on how to look at these funds. In India, the tax on foreign earnings can be over 40%. In the US, though, carry fees are considered capital gains, so they are taxed at a lower rate than regular income.
Because of these issues, many managers feel they have grounds to challenge the tax notices. They have asked managers to provide detailed records of sources of income & earnings outside India. They also want to see assets & investments outside India that the manager holds or is a part of.
Many managers aren’t happy about suddenly being investigated in this manner. Many are fighting to keep the money they have chosen to invest in, largely for this exact purpose. But, one thing is for certain. The tax department is always going to figure out how to take their part.
