Operations, accounting, taxation and ethical/professional conduct
What this domain tests
The back-office and tax treatment that most distinguishes Category III, plus the conduct standards expected of the manager.
Operations and accounting
- Units issued at NAV; subscriptions and redemptions per the scheme's terms (open-ended schemes allow periodic redemptions, closed-ended ones do not).
- Annual audit; NAV at fair value; fees accrued, not deducted at the manager's discretion.
- Typical fee stack: management fee around 2% of NAV plus a performance fee, often 20%, over a hurdle and subject to a high-water mark.
Taxation
- Category III AIFs do not get the section 115UB pass-through available to Categories I and II. Income is taxed at the fund level at the maximum marginal rate - 30% plus surcharge and cess, about 34.94% for a non-corporate fund.
- Securities transaction tax applies to secondary-market trades; GST applies to management fees; the manager's own income is taxed separately.
Conduct
Fiduciary duty, fair allocation of trades across schemes, best execution, no front-running or misuse of material non-public information, conflicts disclosed and managed, no assured returns.
Worked example
A scheme reports taxable income of Rs 10 crore. Fund-level tax at 34.944% is about Rs 3.49 crore, leaving Rs 6.51 crore distributable, with no pass-through credit to investors. Separately, on NAV that grew from Rs 100 crore to Rs 120 crore, a 2% management fee (Rs 2 crore) and a 20% performance fee on the Rs 12 crore above an 8% hurdle (Rs 2.4 crore) leave Rs 115.6 crore before tax - a very different investor outcome from a Category II fund with the same gross performance.
Traps
Assuming pass-through for Category III; forgetting GST on management fees; paying a performance fee without a high-water mark; ignoring STT when computing net returns.