Gift City IFSCA AIF: Setup, LRS Investment by Residents, and Tax Neutrality Under Section 10(4D)

The Gift City IFSCA AIF Opportunity

The International Financial Services Centre Authority (IFSCA) in Gift City, Gandhinagar, has created a regulatory sandbox for Alternative Investment Funds (AIFs) that allows Indian residents to invest abroad legally through their Liberalised Remittance Scheme (LRS) allocations while claiming tax neutrality under Section 10(4D) of the Income Tax Act, 1961. This is not a loophole--it is deliberate policy design to internationalise Indian capital and build Gift City as a global financial hub.

What is an IFSCA-Registered AIF?

An AIF registered with IFSCA is an investment fund domiciled in the International Financial Services Centre (IFSC) at Gift City. It is not an onshore AIF under SEBI's purview. Instead, it operates under IFSCA regulations and foreign fund management norms.

For an Indian AIF to register with IFSCA:

• The fund manager must be incorporated in India or the IFSC itself.
• The fund structure can be a trust, company, or LLP.
• The fund must have minimum commitments of USD 1 million (or equivalent), though some categories allow lower minimums.
• The fund must comply with IFSCA's Know Your Client (KYC) and Anti-Money Laundering (AML) rules.
• The fund must file regular disclosures with IFSCA and comply with Gift City's regulatory requirements.

The key advantage: an IFSCA AIF can solicit investments from Indian residents using their LRS quota without being classified as an onshore security.

LRS Investment by Resident Indians

Under the Liberalised Remittance Scheme, any Indian resident individual can remit up to USD 250,000 per financial year for any current or capital account transaction. This includes:

• Direct equity investments abroad.
• Deposits in overseas banks.
• Life insurance premiums outside India.
• Investment in IFSCA-registered AIFs.

When a resident Indian invests in an IFSCA AIF using LRS funds:

• The remittance is reported to the Authorised Dealer (AD) bank under LRS reporting.
• The investment is treated as an offshore investment, not an onshore investment.
• The fund becomes responsible for managing capital into global asset classes (equities, fixed income, real estate, private markets abroad).
• Dividends, interest, and capital gains earned remain offshore and are subject to Indian tax only when repatriated or on accrual (depending on residency status).

This creates a tax-efficient conduit: residents can diversify globally within their LRS limits without violating Liberalised Remittance Scheme rules or triggering deemed accrual taxation at the fund level.

Section 10(4D) Tax Neutrality: The Critical Exemption

Section 10(4D) of the Income Tax Act, 1961 provides exemption of income earned by an AIF registered with IFSCA. This is the cornerstone of the Gift City strategy.

Specifically:

• Income earned by an IFSCA-registered AIF is fully exempt from Indian income tax, provided:
• The AIF is registered with IFSCA.
• The income is earned on investments held in the IFSC.
• The AIF complies with IFSCA transparency and reporting norms.

This means:

• A resident Indian investor does not pay tax on dividends declared by the IFSCA AIF (at the fund level). The fund pays zero tax.
• Capital gains earned by the fund are also exempt at the fund level.
• Tax deferral is automatic: the investor is taxed only when they repatriate proceeds to India or receive distributions.
• If the investor remains a non-resident for the year of repatriation, the distribution may enjoy treaty benefits or non-resident withholding treatment.

This is fundamentally different from onshore AIFs, where income is taxed in the hands of unit holders under normal income tax rules (20% long-term capital gains, 30% short-term capital gains, slab rates on ordinary income).

Practical Setup: Step-by-Step

1. Fund Registration with IFSCA

• Appoint a fund manager (domestic or IFSC-incorporated).


• Draft the fund deed, subscription agreement, and investment strategy.


• Submit to IFSCA for registration (AIF Category I, II, or III depending on strategy).


• IFSCA approval typically takes 4-6 weeks.

2. Opening the IFSC Investor Account

• The resident investor opens a dedicated account with an AD bank in Gift City.


• KYC, anti-money laundering, and LRS eligibility checks are conducted.

3. LRS Remittance

• The investor remits up to USD 250,000 per FY through their AD bank.


• The remittance is reported under Schedule 3 of the ECB Master Direction.

4. Investment in the Fund

• The investor subscribes units in the IFSCA AIF.


• The fund invests capital into target assets (global equities, bonds, hedge strategies, PE funds, real estate abroad).

5. Income and Tax Compliance

• The IFSCA AIF earns income abroad; the fund pays no Indian tax (Section 10(4D)).


• The fund files annual financial disclosures with IFSCA.


• The investor reports the investment in their ITR Schedule FA (Foreign Assets) if applicable.


• Distributions or repatriations are reported as and when received.

Key Compliance and Audit Considerations

• Substance in IFSC: The fund must maintain genuine presence in Gift City (office, investment committee, record-keeping).
• Transfer Pricing: If the fund manager is offshore-related to the investor, arm's length management fees must be documented.
• Schedule FA Reporting: Residents must disclose foreign investments exceeding Rs. 2.5 lakhs in their ITR.
• FEMA Compliance: The remittance must strictly comply with LRS circulars (currently A.P. (DIR) Series Circular No. 14/2022).
• Return of Investment: Capital repayment on exit is generally not taxed (being a return of investment), but gains must be tracked separately.

Why This Matters

For high-net-worth individuals and family offices, IFSCA AIFs represent a sanctioned, tax-neutral offshore investment platform. You are not hiding money abroad; you are deploying capital through a regulated fund in a government-designated financial centre, claiming statutory tax exemption.

This is especially valuable for residents seeking currency diversification, exposure to private equity or hedge funds, or structured allocation to global real estate without triggering Indian capital gains tax at the fund level.

Red Flags to Avoid

• Using LRS for investment in non-IFSCA funds (not exempt under Section 10(4D)).
• Underreporting investments in Schedule FA.
• Treating the IFSCA AIF as a tax haven (full transparency is required; IFSCA reports to Income Tax authorities).
• Mixing LRS funds with unreported income (LRS eligibility is strict; source of funds must be documented).

I'm CA Harun Raaj, Visakhapatnam.

Reach out to discuss how Gift City AIFs fit into your investment and tax strategy--especially if you are an HNI or promoter planning offshore diversification within regulatory boundaries.

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