Assignment of profits of AIF from fund to Investment Manager, Goods and Services Tax - GST

[Bhavesh Suthar]

A is a sponsor as well as Investment Manager (IM) of AIF (Alternate Investment Fund) upto Aug' 2023. The sponsor is the initial capital contributor and further investments are made by other investors. Profits from redemption of units shall be divided between the sponsor and investors. From Aug' 2023, the IM was changed from A to B (sponsor being unchanged i.e. A). Now 100% profits from redemption of units (carried interest) shall be transferred from the Fund to the new IM i.e. B . B also receives fixed management fees from the Fund irrespective of the performance of the Fund. Will this transfer of profits attract GST, being a return on investment. Since distribution of carried interest is dependent on performance of Fund, can it be construed as 'actionable claim'.

Posts / Replies

[YAGAY andSUN]

Your query raises nuanced legal and tax issues under Indian GST law concerning:

• Carried interest paid to the new Investment Manager (IM) B,
• The nature of this payment — whether it is a return on investment or a supply of service, and
• Whether it may qualify as an actionable claim (and hence, outside GST scope).

Let’s address each aspect within the legal framework.

✅ Background Summary

• A was both Sponsor and Investment Manager (IM) of the AIF till August 2023.
• From August 2023, IM was changed from A to B.
• A remains the Sponsor (i.e., capital contributor).
• B (new IM):
  • Receives carried interest from the Fund — 100% of profits on redemption of units, linked to fund performance.
  • Also receives fixed management fees (unconditionally, not linked to performance).

🔍 Issue: Is carried interest paid to IM B liable to GST, or is it a return on investment or an actionable claim (hence not taxable)?

⚖️ Legal Analysis Under GST Law

🔹 1. Management Fees vs. Carried Interest

Component	GST Applicability	Reasoning
Management Fees	✅ Taxable @ 18% (SAC 997152 – Fund Management Services)	It is a fixed, contractual fee for fund management — falls squarely under “supply of service” per Section 7 of CGST Act.
Carried Interest	⚠️ Contested – Depends on structure	The nature of carried interest determines taxability — whether it is: (a) return on investment, or (b) performance-linked remuneration.

🔹 2. What is Carried Interest?

Carried interest is typically a share of the fund’s profits (usually 20%) given to the IM/sponsor once investors receive a minimum return (hurdle rate). It is performance-based, often seen as remuneration, not investment return, unless contractually structured otherwise.

🔍 If IM B has not contributed capital, but receives profits only as a function of its role as fund manager, then carried interest = reward for services rendered, and is taxable under GST.

🔹 3. Return on Investment – Exempt from GST?

If the carried interest is structured as a return on actual capital contributed by IM B (i.e., equity investment), then it may be viewed as capital appreciation — not a supply under GST.

However, in your case:

• IM B did not make any capital contribution (as per facts).
• IM B receives fixed fees + performance-based share.

👉 This indicates that carried interest is compensation for fund management, and not investment income.

Hence, it will be taxable under GST as part of composite or mixed supply of fund management services.

🔹 4. Can Carried Interest Be Treated as an Actionable Claim?

An “actionable claim” is defined in Section 2(1) of CGST Act and excluded from the scope of supply except for lottery, betting, and gambling.

To qualify, the payment must represent a right to a debt not yet realized, transferable by action (suit). Courts have typically interpreted this narrowly.

Carried interest does not fall within this scope, because:

• It is not a debt owed.
• It is a share in future profits, dependent on performance.
• It arises from a contractual service arrangement, not a claim enforceable under general civil law.

📌 Hence, carried interest is not an actionable claim, and cannot escape GST on that basis.

🧾 Judicial/Industry Reference:

• Circular No. 102/21/2019-GST clarified that performance-based incentives paid to mutual fund distributors are taxable, even if linked to fund’s performance.
• Similar logic applies to carried interest — if paid for fund management functions, it’s consideration for services, not investment income.

✅ Conclusion:

🔹 Carried interest paid to IM B is taxable under GST, as it constitutes consideration for fund management services, not a return on investment.
🔹 It does not qualify as an actionable claim.
🔹 Fixed management fees are separately and clearly taxable.
🔹 IM B must charge GST on the carried interest portion under SAC 997152 at 18%.

Disclaimer -This discussion is only for the knowledge enrichment and does not constitute any Legal Opinion in any manner.

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[YAGAY andSUN]

In continuation to aforesaid revert, please do check a sample clause for the IM agreement to clearly distinguish between taxable and non-taxable components.

✅ 1. Sample Clause for the Investment Management Agreement

To clearly distinguish between taxable and non-taxable components (i.e., fixed management fees vs carried interest):

📄 Suggested Clause – Investment Management Fee & Carried Interest

Section X: Compensation to Investment Manager

1. Management Fee
The Fund shall pay to the Investment Manager (IM) a fixed Management Fee, calculated at the rate of [●]% per annum of the Assets Under Management (AUM), payable quarterly in arrears, irrespective of the performance of the Fund.

The Investment Manager shall raise a tax invoice for such Management Fees, and all applicable indirect taxes, including Goods and Services Tax (GST) under the Central Goods and Services Tax Act, 2017 and related laws, shall be charged and remitted by the Investment Manager in accordance with the law.

2. Performance Fee / Carried Interest
In addition to the fixed Management Fee, the Investment Manager shall be entitled to a performance-linked incentive, commonly referred to as "Carried Interest", calculated as [●]% of distributable profits exceeding the hurdle rate of [●]% per annum, in accordance with the Fund’s waterfall mechanism.

It is expressly agreed that the Carried Interest represents consideration for performance-based investment management services, and the same shall be subject to applicable GST, as per prevailing tax law.

No part of the Carried Interest shall be treated as a return on investment unless the Investment Manager has made a separate identifiable capital contribution to the Fund, in which case only the profits attributable to such contribution shall be treated as investment return and not liable to GST.

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[YAGAY andSUN]

✅ 2. Briefing Note for Tax Positions (For Internal Audit or GST Audit)

📋 Briefing Note: GST Position on Investment Manager Compensation (Including Carried Interest)

Subject: Taxability of Fixed Management Fee and Carried Interest under GST – Positioning & Compliance

1. Context:

The AIF (Alternate Investment Fund) has appointed Investment Manager B effective from August 2023. The IM receives:

• Fixed Management Fee – For fund administration and operational support.
• Carried Interest – A performance-based profit share, subject to fund achieving a hurdle rate.

2. GST Position:

A. Management Fee

• Considered a contractual fee for fund management services.
• Taxable under SAC 997152 – Portfolio/Fund Management Services.
• GST @18% is applicable.
• IM issues tax invoice quarterly. Reverse Charge not applicable as IM is registered.

B. Carried Interest

• Structured as a performance-linked incentive, not linked to capital contribution.
• Treated as consideration for services, since the IM has not made any financial investment into the Fund.
• Not a return on investment, hence not exempt.
• Not an actionable claim under Section 2(1) of CGST Act.
• GST @18% applies, and IM issues tax invoice at the time of distribution.

3. Supporting Legal Basis:

• Section 7 of CGST Act – Supply includes all forms of consideration for services.
• Section 15 – Includes bonuses, commissions, or incentives linked to performance.
• Circular No. 102/21/2019-GST – Incentives based on fund performance are taxable.
• No Judicial Precedent treating carried interest as “actionable claim” where no capital is invested.

4. Accounting & Documentation:

• Separate invoicing for fixed fee and carried interest.
• Management Agreement distinctly identifies taxable components.
• GST returns (GSTR-1, GSTR-3B) correctly report both supplies.
• Cross-referenced with Fund accounting and NAV calculations.

5. Audit Risk Mitigation:

• Maintain signed IM agreement showing service nature of carried interest.
• Maintain detailed calculation sheets for carried interest allocation.
• Clarify capital structure of IM in Fund documentation (no capital invested).
• Ensure timely issuance of invoices and GST payment to avoid interest/penalty.

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