Note on Tax Issues Faced by CAT I Special

Situation Funds (SSFs)

Table of Contents
MATTER 1: SPECIAL SITUATION FUNDS (SSF) INCOME FROM SPECIAL SITUATION ASSETS BEING
CLASSIFIED AS “PROFITS AND GAINS FROM BUSINESS AND PROFESSION” ................................... 1
ISSUE: .............................................................................................................................................. 1
REQUEST: ......................................................................................................................................... 2
MATTER 2: CLASSIFICATION OF SPECIAL SITUATION FUNDS AS “SECURED CREDITORS” UNDER
SARFESI ....................................................................................................................................... 2
ISSUE: .............................................................................................................................................. 2
REQUEST: ......................................................................................................................................... 3
ANNEXURE A................................................................................................................................ 4

Matter 1: Special Situation Funds (SSF) Income from

Special Situation Assets being classified as “Profits and
Gains from Business and Profession”
SSFs invest into special situation assets, which are defined under the SEBI AIF Regulations,
2012 under Annexure A. The summary of the definition is as follows:

1. stressed loan available for acquisition in terms of Clause 58 of Master Direction –

Reserve Bank of India (Transfer of Loan Exposures) Directions
2. security receipts issued by an Asset Reconstruction Company registered with the Reserve
Bank of India;
3. securities of investee companies as provided under the SEBI AIF Regulations

Issue:

1. In case of a securitisation trust, the income (interest as well as upside on

acquisition price of the loans) on the SRs is generally classified as “profits and
gains from business or profession“ on the basis that the securitisation trust is
engaged in the reconstruction and recovery of debt and accordingly, any income
from such activity should be business profits in nature.
 2. Section 115TCA states that the income of an investor in a Securitization Trust has
tax pass-through status, i.e., the income arises as though the investors directly
invest in the underlying asset
3. Due to this, the CAT I – SSF income arising from Security Receipts will be treated
as “profits and gains from business or profession“, which will cause the SSF to
lose their tax-pass through status under Section 115ub of the Income Tax Act,
1961

Request:
1. Classify securities held by an AIF to be a capital asset under section 2(14) of the
Income Tax Act, 1961
a. This will ensure that “Special Situation Assets” as defined under the SEBI
AIF Regulations and associated income shall not be considered as profits
and gains from business or profession“
2. Add an explanation Section 56(2)(id) of the Income Tax Act, 1961 as follows
(inserts in yellow):
a. (id) income by way of interest on securities, if the income is not chargeable
to income-tax under the head "Profits and gains of business or profession";
b. Explanation: It is clarified that income arising from Security Receipts held
by investment funds as defined under Section 115UB without transfer of
the Security Receipts shall be deemed as interest income and shall not be
charged under the head "Profits and gains of business or profession";

Matter 2: Classification of Special Situation Funds as

“Secured Creditors” under SARFESI

Issue:
Secured creditors are defined under The Securitisation And Reconstruction Of Financial
Assests And Enforcement Of Security Interest Act, 2002 (SARFESI) as follows:

(zd) "secured creditor" means any bank or financial institution or any consortium or group of banks or
financial institutions and includes—

1. (i) debenture trustee appointed by any bank or financial institution; or

2. (ii) securitisation company or reconstruction company, whether acting

as such or managing a trust set up by such securitisation company or reconstruction

company for the securitisation or reconstruction, as the case may be; or

(iii) any other trustee holding securities on behalf of a bank or financial institution,
in whose favour security interest is created for due repayment by any borrower of any financial
assistance;

The definition excludes CAT I – SSFs as defined in the SEBI AIF Regulations, which invest in special
situation assets as defined in the SEBI AIF Regulations.

SEBI released a consultation paper on Nov 28, 2023 (link) which stated:

Extract of the SEBI Circular

While amendments to Clause 58 of the RBI Master Directions were made, amending
SARFESI to include CAT I – SSFs will ensure that SSFs can play the role envisioned in the
creation of SSFs.

Request:

Amend Section 2(zd) of SARFESI 2002 as follows (inserts in yellow)

(zd) "secured creditor" means any bank or financial institution or Alternative Investment Fund as defined
in the SEBI Alternative Investment Fund Regulations, 2012 or any consortium or group of banks or
financial institutions or AIFs and includes—

1. (i) debenture trustee appointed by any bank or financial institution; or

2. (ii) securitisation company or reconstruction company, whether acting

as such or managing a trust set up by such securitisation company or reconstruction

company for the securitisation or reconstruction, as the case may be; or

(iii) any other trustee holding securities on behalf of a bank or financial institution,

in whose favour security interest is created for due repayment by any borrower of any financial
assistance;
Annexure A

(2) “special situation asset” includes,-

(a) stressed loan available for acquisition in terms of Clause 58 of Master Direction – Reserve
Bank of India (Transfer of Loan Exposures) Directions, 2021 as amended from time to time or as
part of a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 or in terms
of any other policy of the Reserve Bank of India or Government of India issued in this regard
from time to time;

(b) security receipts issued by an Asset Reconstruction Company registered with the Reserve
Bank of India;

(c) securities of investee companies,

(i) whose stressed loans are available for acquisition in terms of Clause 58 of the Master
Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 as
amended from time to time or as part of a resolution plan approved under the Insolvency
and Bankruptcy Code, 2016 or in terms of any other policy of the Reserve Bank of India
or Government of India issued in this regard from time to time;

(ii) against whose borrowings, security receipts have been issued by an Asset
Reconstruction Company registered with the Reserve Bank of India;

(iii) whose borrowings are subject to corporate insolvency resolution process under
Chapter II of the Insolvency and Bankruptcy Code, 2016;

(iv) who have disclosed all the defaults relating to the payment of interest/ repayment of
principal amount on loans from banks / financial institutions/ Systemically Important
Non-Deposit taking Non-Banking Financial Companies/ Deposit taking Non-Banking
Financial Companies and /or listed or unlisted debt securities in terms of the Securities
and Exchange Board of India (Issue of Capital and Disclosure Requirements)
Regulations, 2018 and such payment default is continuing for a period of at least ninety
calendar days after the occurrence of such default:

Provided that in case of sub-clauses (iii) and (iv), the credit rating of the financial
instruments or credit instruments or borrowings of the company has been downgraded to
“D” or equivalent;

(d) Any other asset as may be specified by the Board from time to time;