Assignment of profits of AIF from fund to Investment Manager

[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'.

[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.

***

[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.

*** 

[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.

***

[Bhavesh Suthar]

Thank you for the detailed reply.

[Bhavesh Suthar]

What shall be the GST implication in case:

The sponsor enters into an agreement with the Investment Manager confirming that the additional proceeds from redemption of the units shall be received by the sponsor and subsequently shall be assigned to the Investment Manager (no actual provision of service). Will GST be leviable in this case since there is no actual service rendered, merely transfer of profits.

[Shilpi Jain]

This would require further research and analysis based on a deeper understanding of the factual aspects and functioning of this sector. Though prima facie it looks like the profits will not be liable to GST 

[YAGAY andSUN]

You're raising a very relevant and technically complex question that hinges on the legal nature of the arrangement between the Sponsor and the Investment Manager (IM) when carried interest (profits) is routed through the Sponsor and then transferred to the IM without a direct contractual linkage between the Fund and IM for those profits.

Let's break this down.

🔍 Scenario Recap:

• Fund redeems units and distributes profits to the Sponsor (not directly to IM).
• Sponsor then assigns these profits to IM, based on a separate agreement between Sponsor and IM.
• Claim: Since IM is not directly rendering service to the Fund in relation to the transferred profit share, can GST be avoided?

⚖️ GST Implications – Key Issues

✅ 1. Substance Over Form Principle

Even if the profits are routed through the Sponsor, GST law looks at the substance of the transaction:

• If the IM is receiving profits solely due to performance of fund management services, then routing it through the Sponsor doesn't change the underlying nature as a consideration for service.
• Mere change in payment mechanics (i.e., via Sponsor) will not exempt the income from GST, if it is in substance linked to the IM’s role in managing the Fund.

🔸 Example: If the carried interest arises as a result of IM’s service in generating returns (i.e., not due to IM’s capital), GST authorities are likely to see it as a deferred or contingent service fee — hence taxable.

✅ 2. No “Investment Return” or “Gift” Defense

You mention “no actual service rendered” — but if the IM has not invested capital, then the receipt of profits:

• Is not a return on investment, and
• Cannot be treated as a gratuitous transfer or gift, as it is contractually tied to Fund performance and IM’s role.

✅ 3. Assignment of Rights by Sponsor – Taxable Service?

Even if:

• The Sponsor has a right to receive profit from Fund redemption, and
• It “assigns” a portion to the IM (via contract),

👉 the assignment of an income stream linked to a service performed by the IM may be construed as a taxable supply under:

• Entry 5(e), Schedule II of CGST Act – “Agreeing to the obligation to refrain from an act, or to tolerate an act or to do an act” — can bring assignments and conditional transfers within the GST net.

🚫 Not an Actionable Claim

As before, since there’s:

• No enforceable civil claim for a debt,
• No investment underlying the payment,
• No “uncertain right” litigated in court,

...it does not qualify as an actionable claim under Section 2(1) of CGST Act.

🧾 Conclusion – GST Likely Applicable

Even in your revised structure where:

• Sponsor receives profits, and
• Transfers them to IM under a side agreement,

GST would likely still apply if the IM’s entitlement to those profits stems from their role as a service provider, and not as an investor.

The indirect route does not change the character of the consideration under GST law. Tax authorities are likely to disregard the form and focus on the substance — i.e., carried interest = reward for fund management.

✅ Recommendation:

To avoid disputes, consider:

• Explicitly documenting that the IM receives the profit share as compensation for services (not as investment return or unrelated gift).
• Issuing tax invoice for the carried interest (even if routed via Sponsor).
• Charging and remitting GST on the carried interest portion.

***

[YAGAY andSUN]

Here's a suggested structure and sample clause to reflect the assignment of carried interest from the Sponsor to the Investment Manager (IM), while maintaining transparency and GST compliance.

✅ Suggested Structure for Assignment of Carried Interest (with GST Compliance)

Parties Involved:

1. Sponsor (A) – Capital contributor to the AIF, receives profits upon unit redemption.
2. Investment Manager (B) – Provides fund management services, entitled to a performance-based share of profits (carried interest).
3. AIF (Fund) – The investment vehicle that generates returns for unit holders, including the Sponsor.

Key Structural Features:

• The carried interest is linked to the IM’s performance, even though it is initially paid to the Sponsor.
• A separate agreement is executed between the Sponsor and the IM (Assignment Agreement).
• IM raises a tax invoice on the Sponsor for the carried interest amount.
• GST @18% is charged and remitted by the IM on the invoice value.

This route ensures that the true nature of carried interest (performance fee) is preserved and GST obligations are met, even if the Fund does not pay it directly to the IM.

📄 Sample Clause – Assignment of Carried Interest Agreement

Clause Title: Assignment of Carried Interest by Sponsor to Investment Manager

1. Background

The Sponsor has contributed capital to the Alternative Investment Fund ("Fund") and, in such capacity, is entitled to receive distributions from the Fund upon redemption of units, including a share of the profits attributable to such units.

The Investment Manager ("IM") has been engaged under a separate Investment Management Agreement to provide fund management and advisory services to the Fund.

2. Assignment of Rights

The Sponsor hereby irrevocably agrees and undertakes to assign and transfer in favour of the Investment Manager, from time to time, the portion of profits received by the Sponsor from the Fund as specified herein, which corresponds to the "Carried Interest" entitlement of the Investment Manager as per the Fund's Distribution Waterfall.

3. Nature of Payment

It is expressly agreed that the payment of Carried Interest by the Sponsor to the Investment Manager under this Agreement is made in consideration of the investment management and performance-related services provided by the Investment Manager to the Fund. Accordingly, such payment constitutes taxable consideration for supply of services under the Central Goods and Services Tax Act, 2017.

4. GST Compliance

The Investment Manager shall raise a tax invoice on the Sponsor for the Carried Interest amount assigned under this Agreement, and applicable Goods and Services Tax (GST) shall be levied and remitted in accordance with prevailing law.

The Sponsor shall make payment of the invoiced amount (inclusive of applicable GST) within [●] days of receipt of the tax invoice, subject to actual receipt of the relevant profits from the Fund.

5. No Investment by IM

It is acknowledged that the Investment Manager has not made any capital contribution to the Fund in respect of the assigned profits and is not receiving the Carried Interest as a return on investment.

6. Miscellaneous

This Agreement is supplemental to, and shall be read in conjunction with, the Investment Management Agreement entered into between the Investment Manager and the Fund.

✅ Next Steps:

1. Ensure proper board or trustee resolutions approving the assignment arrangement.
2. Maintain audit-ready documentation showing the link between fund performance, carried interest allocation, and services rendered.
3. Have the IM charge GST on the assigned carried interest amount, backed by tax invoice and assignment agreement.

*** 

AI Summary

Investment Managers' Carried Interest Faces 18% GST as Service Fee, Not Investment Return Under Taxation Rules A discussion forum explores the GST implications of carried interest paid to an Investment Manager (IM) in an Alternate Investment Fund (AIF). The key issue is whether the transfer of profits from fund redemption to the new IM attracts GST. Legal analysis suggests that carried interest is likely taxable as a service fee at 18%, not qualifying as an investment return or actionable claim, especially when the IM has not contributed capital to the fund.