How IFSC Fund Taxation Works for NRI Family Offices and Overseas Investors

Why Tax Structuring in GIFT City IFSC Matters

The GIFT City IFSC, India's premier International Financial Services Centre, has rapidly evolved from a regulatory concept to a functioning global financial hub. With dedicated regulations from IFSCA, a growing ecosystem of fund managers, and robust tax incentives, GIFT IFSC now competes directly with established jurisdictions such as Singapore, Cayman Islands, Luxembourg, and the Dubai International Financial Centre (DIFC).

Yet, the true value of GIFT City IFSC for investors, particularly GIFT City NRI participants and international capital, lies in understanding the nuanced tax framework that governs different fund structures. Tax is not an afterthought; it is the central variable that determines the net return profile of any investment structured through GIFT IFSC.

This article provides a structured overview of the key income tax considerations applicable to Category I, II, and III AIFs, Family Investment Funds (FIFs), and Offshore Banking Units (OBUs) within GIFT City IFSC.

Section 1: Alternative Investment Funds in GIFT City IFSC

1.1 Fund Structures and Categories

Under the IFSCA (Fund Management) Regulations, 2022, AIFs in GIFT IFSC are classified into three categories based on their investment mandate. Category I AIFs focus on startups, early-stage ventures, and infrastructure. Category II AIFs cover funds that do not meet Category I or III criteria, typically private equity and debt funds. Category III AIFs are set up for complex or diverse trading strategies, including listed and unlisted derivatives.

Each category can be structured as a trust, LLP, or company. The trust structure involving a settlor, trustee, and beneficiary investors is the most widely adopted form, offering operational flexibility and compatibility with most investor types seeking Investment Advisory in GIFT City.

1.2 Tax Pass-Through for Category I and II AIFs

Under Sections 115UB and 10(23FBA) of the Income Tax Act, investment income (excluding Business Income / PGBP) of Category I and II AIFs is exempt at the fund level and taxed directly in investors' hands on a pass-through basis. The character of income, whether capital gains, dividends, or interest, is preserved when attributed to investors.

Business Income, however, is taxed at the AIF level. Crucially, Section 80LA provides a 100% tax holiday on Business Income for 10 assessment years within a 15-year block, making GIFT City IFSC AIF structures one of the most compelling propositions for fund managers considering GIFT City registration.

For GIFT City funds for NRI investors, non-resident participants pay tax at treaty-preferential or domestic rates and are exempt from obtaining a PAN or filing a return in India if the only Indian income is from an IFSC-based AIF, subject to conditions under Rule 114AAB.

1.3 Category III AIF - The Concessional Regime for Non-Residents

Category III AIFs comprising exclusively non-resident investors benefit from a unique tax framework. Investors are entirely exempt from Indian tax on their income from such funds under Section 10(23FBC). At the AIF level, several income streams, including gains on bonds, GDRs, rupee-denominated bonds, derivatives traded on IFSC exchanges, and securities of non-resident issuers, are fully exempt under Section 10(4D).

Dividend income and interest from Indian securities are taxed at a flat 10% (no surcharge or cess), while long-term capital gains on equity shares in Indian companies attract 10% (plus surcharge and cess). This regime positions GIFT City IFSC as a genuinely competitive alternative for global fund managers and NRI family offices exploring tax-optimised India exposure.

Section 2: Family Investment Funds India's Emerging Family Office Hub

FIFs are self-managed funds pooling capital from a single family defined broadly to include lineal descendants, spouses, and family-controlled entities. Recognising the potential for FIFs to supplant Singapore and Mauritius as preferred GIFT City incorporation destinations for Indian HNW families, IFSCA has created a regulatory framework that allows FIFs to be set up as trusts, companies, or LLPs.

Unlike AIFs, FIFs do not benefit from tax pass-through status under the IT Act. Income is taxed at the FIF entity level. If structured as an LLP, profits distributed to partners are tax-free, a significant advantage. For families considering GIFT City NRI investment consolidation, the LLP structure offers a particularly tax-efficient distribution mechanism.

For Investment Advisory in GIFT City practitioners, the FIF framework opens significant advisory mandates from structuring multi-generational wealth vehicles to integrating overseas investment portfolios under a single IFSC-domiciled structure.

Section 3: Offshore Banking Units and ODI Taxation

OBUs in GIFT City IFSC, registered as Category I FPIs, may now issue Offshore Derivative Instruments (ODIs) to non-resident investors, directly connecting global capital to Indian securities markets. This development is particularly relevant for IIBX GIFT City market participants and foreign institutional investors seeking direct exposure to Indian debt and equity markets.

Income earned by non-residents from ODIs entered into with an OBU in GIFT IFSC, including distributed interest, dividends, and capital gains, is fully exempt under Section 10(4E). Business income derived by the OBU itself qualifies for the 100% tax holiday under Section 80LA for 10 consecutive assessment years out of 15.

Section 4: Critical Structuring Considerations

Several cross-cutting issues must be addressed during the structuring stage for any GIFT City IFSC fund:

• Income characterisation (Business Income vs. Capital Gains) remains a key litigation-risk area. CBDT circulars and judicial precedent provide guidance but are fact-specific.

• Indirect Transfer Tax provisions apply where offshore feeder funds derive substantial value from Indian assets, subject to small shareholder and FPI exemptions.

• TCS at 20% applies to LRS remittances by Indian residents investing in GIFT IFSC funds from 1 October 2023, though credit can be claimed against tax liability.

• Offshore fund relocation to GIFT IFSC on a tax-neutral basis was available under Sections 47(viiac) and 47(viiad) until 31 March 2025, subject to prescribed conditions.

Conclusion: Building the Case for GIFT City IFSC

GIFT City IFSC is not merely a tax-advantaged destination; it is a strategically positioned jurisdiction offering regulatory depth, global connectivity, and a sophisticated tax framework. For GIFT City NRI investors, family offices, global fund managers, and financial institutions, the question is no longer 'why GIFT City?' but 'how to structure it correctly?'

Early movers who engage experienced advisors for GIFT City registration, fund structuring, and ongoing compliance will be best positioned to capture the full spectrum of benefits available within this dynamic financial ecosystem.

The new IFSCA TCSP framework could play a significant role in strengthening GIFT City’s leasing ecosystem for aircraft, ship, and oilfield equipment financing. As GIFT IFSC continues evolving into a globally competitive financial jurisdiction, businesses and investors may find new opportunities in structured leasing and cross-border finance.

To understand how GIFT IFSC structures may support leasing activities and international investment opportunities, connect with CA Gaurav Kanudawala, Founder of GIFT CFO: 91 9726372715 | info@giftcfo.com