A proposed amendment in the Corporate Laws (Amendment) Bill, 2026, could let Category III AIFs convert into LLPs to lower their tax burden. This change aims to reduce tax rates for these funds from up to 39% to 30%, though it may require greater public disclosure of investor identities.
Detailed Coverage
The Corporate Laws (Amendment) Bill, 2026, has introduced a proposal that could reshape how Category III Alternative Investment Funds (AIFs) manage their tax liabilities. If the bill passes, these SEBI-regulated entities, which are currently structured as trusts, would be permitted to convert into Limited Liability Partnerships (LLPs).
Addressing Tax Disparities
Currently, Category III AIFs operate under a significant tax disadvantage compared to Category I and II funds. While other categories enjoy pass-through taxation—meaning income is taxed at the investor level—Category III funds are taxed at the fund level. A 2014 CBDT circular forces these funds to pay the Maximum Marginal Rate (MMR) of tax because they are classified as indeterminate trusts, resulting in effective tax rates as high as 39%. By converting to an LLP structure, these funds could move to a flat 30% tax rate, offering a potential tax saving of 3-5%.
The Confidentiality Trade-Off
While the prospect of lower taxes is attractive, the LLP structure introduces a notable hurdle: transparency. Unlike trusts, LLPs are required to disclose the identities of their partners in public filings. For many investors who prioritize privacy, this requirement may be a significant deterrent. Because of this, industry experts believe that a wholesale shift to the LLP model is unlikely. Instead, many fund managers are expected to conduct a cost-benefit analysis, weighing the potential tax savings against the loss of confidentiality, the costs of restructuring, and the ongoing operational complexities.
Lingering Uncertainty on Carried Interest
Despite the proposed changes, the bill leaves a major area of concern unaddressed: the taxation of carried interest. This performance-based fee, which fund managers earn based on the profits they generate for investors, has long been a source of ambiguity in Indian tax law. Fund managers had hoped the government would provide clear guidance on whether carried interest should be taxed as capital gains or business income. As it stands, the current bill remains silent on this issue, leaving managers to navigate the existing uncertainty.
Future Monitorables for Investors
The most important update for stakeholders will be the final version of the bill passed by Parliament. Investors should watch whether the government introduces any clauses to protect investor confidentiality during the transition or if it provides further clarification on the tax treatment of carried interest. Until these details are finalized, fund managers are likely to adopt a wait-and-see approach, with many maintaining their current trust structures to avoid unnecessary administrative and tax risks.