Sophisticated investment funds marketed to the rich will now have to pay higher taxes.

New norms introduced in the Budget but effective from April 1 make it unclear who would bear the brunt of the higher outgo for investors who may have already exited these funds before the Budget announcement, according to experts.

The Union Budget on July 5 mentioned an increase in the taxation of trusts and associations of persons. Such structures comprise 65-70 per cent of funds in the AIF-III category, according to experts. This means that they would also have a higher outgo. Fears over the effect on similarly structured foreign portfolio investors led to a 792.82 points decline in the BSE Sensex.

The benchmark index ended 2.01 per cent lower to close at 38,720.57 on Monday. Like foreign investors, category-III AIFs follow strategies which mean that any income over Rs 5 crore will see a 6.8 percentage point increase in tax rate from 35.9 to 42.7 per cent.

“The increase in surcharge will impact investors’ net returns as the net asset value of funds will get impacted because of the higher tax outgo. Long-short funds may resultantly lose their attractiveness among investors because the question for investors is whether they are better off investing in other investment products that provide comparable or better after tax returns,” said Subramaniam Krishnan, partner, EY Private Equity & Financial Services.

Vaibhav Sanghavi, co-chief executive officer at Avendus Capital Public Markets Alternate Strategies, runs a category-III AIF. He said such funds were already at a disadvantage tax-wise, and this would further affect end-investor returns.

“We are hopeful that the government of India would consider the implications of this and address the situation,” he said. Tax experts said the norms are effective from April 1. This would also mean that there is a cloud over the taxes owed by investors who exited after the date, but before the Budget announcement.

Rajesh H Gandhi, partner at Deloitte Haskins & Sells, said this could create a headache for foreign and local fund managers where investors exited after April 1 but before the Budget announcement. Recovery of additional taxes from such investors would be challenging, according to him.

“If the investors have already exited, their tax burden will have to be borne by other current investors. It is unlikely that the fund manager would absorb the cost. AIFs will face a similar situation,” he said.

AIFs under category-III had investments of Rs 30,801.8 crore as of March 2019. It is up over 20 times from the Rs 1,528.0 crore managed as of March 2015.