INTRODUCTION
Setting up a venture capital fund in the Dubai International Financial Centre (DIFC) involves navigating DIFC’s fund regime and coordinating with international regulations. This article provides a step-by-step guide on creating and registering a VC fund from scratch in the DIFC, with a focus on establishing a Qualified Investor Fund (QIF), and addresses critical cross-border issues involving Indian and U.S. laws. We’ll cover the DIFC Collective Investment Law and DFSA rules, the licensing process and timeline, with a focus on how to manage Indian and U.S. regulatory requirements (SEBI AIF rules, FEMA/RBI regulations) and tax treaties in the fund structure.
VENTURE CAPITAL (Collective Investment Rules 3.1.13)
A venture capital fund is either an exempt fund or a qualified investor fund (QIF) with a primary investment goal of at least 90% of its committed capital in unlisted business ventures that are privately held and have been incorporated for no more than 10 years of the funds initial investment in each business through financial instruments like shares, convertible debt or other instruments that include equity participation rights or rewards.
PROFESSIONAL CLIENT (Conduct of Business Module 2.3.3)
An individual may be called a professional client if they meet certain requirements. Professional clients are divided into 3 categories:
1. Deemed professional client (COB Rule 2.3.4)
The person is a ‘deemed’ Professional Client if that Person is:
a. An international organisation whose members are either countries, central banks, or national monetary authorities;
b. A constituted government, government agency, central bank, or other national monetary authority of any country or jurisdiction;
c. State investment body or a public authority;
d. An authorised market institution, regulated exchange or regulated clearing house;
e. An authorised firm, a regulated financial institution or the management company of a regulated pension fund;
f. A collective investment fund or a regulated pension fund;
g. A body corporate whose shares are listed or admitted to trading on any exchange of an IOSCO (International Organisation of Securities Commissions) member country.
h. Entities that mainly invest in financial instruments, such as those involved in asset securitisation
i. A trustee of a trust which has or had during the previous 12 months, assets of at least $10 million; or
j. Licensed family offices operate solely for the benefit of the family office.
k. Large Undertakings: The business is considered a large undertaking if at least 2 out of the 3 conditions are met, which are:
a. Balance sheet total (aggregate of the amounts shown as assets) of at least $20 million;
b. Net annual turnover of at least $40 million; or
c. Own funds (cash and investments shown in the balance sheet) or called-up capital (all the amounts paid-up on allotted shares, minus any amounts owing on allotted shares) of at least $2 million
2. Service-based professional client (COB Rule 2.3.5, Rule 2.3.6 or Rule 2.3.6A)
A person is a service-based professional client if;
a. Where a corporate entity uses loan or investment crowdfunding to raise funds from investors or lenders.
b. A business receiving services such as advising on financial products, arranging investment deals, or arranging and advising on credit, specifically for corporate structuring or financing, includes advice relating to an acquisition, disposal, or arranging credit for a purpose, etc.
c. Additionally, providing credit to a business is permitted if the credit is used for:
i. its business activities,
ii. those of its controller,
iii. any member of the group to which the person belongs, or
iv. a joint venture.
The controller is an individual who owns the majority of shares of the undertaking, can appoint or remove a majority of the board members of the undertaking, or controls a majority of the voting rights of the undertaking, or those of a holding company of the undertaking.
3. Assessed professional client (COB Rule 2.3.7 or Rule 2.3.8)
A person is an assessed professional client if:
a. The individual has net assets, own funds, or called up capital of at least $1 million that is calculated as:
i. Excluding the value of the primary residence of that person
ii. Excluding crypto tokens belonging to that person that are not recognised as crypto tokens
iii. Including only 33% of the market value of the recognised crypto tokens belonging to the person; and
iv. Including any other assets held directly or indirectly by that person
b. An individual is or has been in the past 2 years an employee in a relevant professional position of an Authorised Firm or a Regulated Financial Institution; or
c. The individual appears, on reasonable grounds, to have sufficient experience and understanding of relevant financial markets, products, or transactions and any associated risks.
DIFC FUND REGIME: LAWS, FUND TYPES AND QIF
LEGAL FRAMEWORK
Investment funds in DIFC are governed by the Collective Investment Law 2010 (DIFC Law Number 2 of 2010) and the DFSA’s Collective Investment Rules (CIR) module, under the umbrella of the DIFC’s Regulatory Law. Dubai Financial Services Authority (DFSA) regulates all financial services in DIFC, including fund management and fund registration. The DIFC’s funds framework is designed to align with international standards (IOSCO principles) and offers various fund categories with varying levels of regulation, catering to both retail and sophisticated investors.
TYPES OF FUNDS IN DIFC
DOMESTIC & FOREIGN FUNDS
DOMESTIC FUND:
A domestic fund is either established or domiciled in the DIFC, or it is an external fund that is domiciled outside the DIFC but is managed by a licensed fund manager authorised to operate in the DIFC. There are three types of domestic funds in DIFC: Qualified Investor Funds (QIFs), Exempt Funds, and Public Funds. These differ in their investor eligibility, regulatory stringency, and time-to-market:
1. Qualified Investor Fund (QIF) Article 16 (5) of the Collective Investment Law (DIFC Law Number 2 of 2010):
A QIF is the least regulated category meant for sophisticated investors. QIF units can only be offered via private placement to professional clients (institutional or high-net-worth investors meeting DFSA’s criteria). Each investor must invest a minimum of $500,000. The DFSA imposes fewer ongoing obligations on QIF, for example, simpler offering disclosure, no mandatory investor meetings, and less frequent reporting. Launching a QIF can be quick, as the fund manager simply notifies the DFSA 14 days before offering to issue the fund, and the DFSA typically acknowledges the notification within 2–4 business days, after which subscriptions can be accepted. This light-touch approach makes QIFs very popular for VC and hedge funds targeting professional investors.
2. Exempt Fund Article 16 (4) of the Collective Investment Law (DIFC Law Number 2 of 2010):
Like a QIF, an Exempt Fund is open only to professional clients, and they are offered via private placement. The minimum subscription is $50,000. The fund manager must notify the DFSA at least 14 days before the initial offer to issue the fund. In practice, an Exempt Fund has a 5-day authorisation timeframe.
3. Public Fund Article 16 (1) of the Collective Investment Law (DIFC Law Number 2 of 2010):
A domestic fund is a public fund which is the only type that can be offered to retail investors via a public offering. These funds have no limit on the number of investors or the amount of investments to be made. They serve retail markets. Public Funds include a full DFSA review and approval (which can take up to 40 business days), a detailed prospectus requirement, an independent investment oversight committee, borrowing and investment limits, etc.
FOREIGN FUNDS:
A foreign fund is a type of fund that has its units offered to persons who meet the criteria of professional clients, requiring an initial subscription of at least $50,000 to be paid by the person to become a unit holder in the fund. The units can be offered only by way of private placement.
REQUIREMENTS FOR ALL FUND TYPES
All DIFC funds, regardless of type, must have a written constitution (fund agreement or partnership deed) and appoint a DFSA-registered auditor. An independent fund administrator is required for each fund (to ensure proper valuations and record-keeping). DIFC funds are generally tax-neutral; the DIFC itself imposes no income tax on fund vehicles (only 5% VAT on services).
Structurally, a DIFC fund can be set up as an investment company, an investment partnership, or an investment trust, under DIFC Companies Law, Limited Partnership Law, or Trust Law, respectively. For example, a VC fund might use an investment company (corporation) or a limited partnership model. Each structure has specific formalities, e.g. an investment company requires DFSA consent before incorporation and a licensed corporate director, whereas an investment partnership requires a corporate general partner authorised as the fund manager. These factors influence the setup but not the overall regulatory classification of the fund.
WHO IS A FUND MANAGER ?
A. As per Article 20 of the Collective Investment Law (DIFC Law Number 2 of 2010), the following are the conditions a person must meet to manage a domestic fund:
a. That person is a body corporate
b. He is an authorised firm that is authorised to manage funds in the DIFC as a fund manager.
c. The person is an external fund manager (who manages a domestic fund)
B. As per Article 22 of the fund manager’s duties and functions include
a. Manage the fund, including the fund's property, according to the fund’s constitution and its most recent prospectus
b. Perform all the functions conferred on it by the fund’s constitution or by or under this law
c. Comply with any conditions and restrictions imposed by the DFSA
d. Comply with any requirements or limitations imposed under this law or rules
STEPS FOR APPLYING FOR A DIFC FUND MANAGER LICENSE
To create a VC fund in DIFC, you must establish a DFSA-authorised fund manager. The DFSA license for managing collective investment funds falls under a Category 3C firm license (financial service: “Operating a Collective Investment Fund”).
1. DIFC entity setup:
You need a DIFC-incorporated entity (e.g., company or partnership) to act as the fund manager. This involves the DIFC Registrar of Companies for incorporation and then the DFSA for regulatory approval. The fund manager can be 100% foreign-owned.
2. Base capital requirement:
Category 3C fund managers must maintain a minimum capital of $70,000 (base capital) if managing only Exempt Funds or QIFs. This is the regulatory capital that must be funded by the entity. The DFSA also requires that at any time, the manager must hold this amount or 13 weeks of operating business expenses, whichever is higher.
3. Governance:
FSA will expect certain mandatory appointments in the fund manager’s DIFC entity, scaled to the business. Minimum required roles include:
a. a Senior Executive Officer (SEO) (a senior person with 10+ years of experience, resident in the UAE),
b. a Finance Officer,
c. a Compliance Officer/MLRO (can be combined, also resident in the UAE),
d. a Risk Officer, and
e. An internal and external auditor.
f. The Board of Directors should have non-executive and preferably independent directors.
These roles ensure proper governance and compliance (some roles, such as internal audit or group-level appointments, can be outsourced with DFSA approval).
4. DFSA Fees:
To apply for the fund manager license, the DFSA’s application fee is $5,000 for a QIF fund manager, $2,000 for a pure VC fund manager, and $10,000 for an Exempt Fund manager. Once licensed, the annual fee for the fund manager of a QIF fund, an exempt fund, or a venture capital fund is the same as the license application fees. Additionally, the annual fee per fund is $4000 for QIF and an exempt fund, and $1000 for venture capital.
SETTING UP A VC FUND IN DIFC AS A QIF
The Fund Manager plays a central role and must be licensed by the Dubai Financial Services Authority (DFSA); the fund vehicle itself also needs to be properly incorporated and registered within the DIFC.
Once the Fund Manager is licensed or in parallel with that process, the next step is to establish the fund vehicle, typically an Investment Company, under DIFC law. The fund is then registered as a Domestic Fund with the DFSA, and can either operate as a standalone entity or as part of a fund platform via an Incorporated Cell Company (ICC). The steps for setting up a VC fund as QIF are as follows:
1. Incorporation of funds:
In parallel with or after the manager is sorted, establish the fund entity in the DIFC. Commonly, this will be an Investment Company (a special-purpose company for the fund). The DIFC Registrar of Companies handles the incorporation. The Steps include:
a. Choosing a fund name which should not be misleading as per the DFSA
b. Submit documentation and pay the registration fee
c. The shareholders or partners of the fund will initially be the fund managers or the nominee
d. By submitting a notification, the fund will be registered as a domestic fund with the DFSA
e. No formal license for the fund, but the DFSA will issue an acknowledgement of registration
f. If the fund is structured as an Investment Company, it can either be externally managed by the DFSA-licensed manager via a management agreement or internally managed by its board.
2. Preparation of Documents:
a. The PPM (Private Placement Memorandum) is the key disclosure document. There is no prescribed DFSA format, but it should still describe the investment strategy, risks, fees, fund structure, governance, and investor qualifications. It should also state that the fund is only for professional investors and is subject to DFSA regulations.
b. The Limited Partnership Agreement or subscription agreement in the LP structure is a contract with investors and covers capital commitment obligations, capital call procedures, distributions, the GP/manager’s powers, fee structure (management fee, carried interest), and representations that the investor is qualified as a professional client.
c. The fund manager should ensure at all times that the fund complies with the Anti-Money Laundering procedures.
d. At least 14 calendar days before offering interests to any investor, the Fund Manager must file a Fund Notification with the DFSA for the QIF launch, providing the fund name, structure, investment strategy, and compliance with QIF criteria.
e. Once the 14-day notification lapses, the fund is ready to be offered to the investors via private placement.
3. Post-launch ongoing compliance:
After the launch, the fund will operate for a term (e.g. a 10-year closed-ended VC fund). The duties of a fund manager are as follows:
a. The manager will source deals like investing in start-ups across geographies, in line with the fund’s mandate.
b. If any material change in strategy or service providers occurs, an update to investors and possibly a DFSA notification is needed.
c. Annual audited financial statements should be provided to the investors and the DFSA.
d. The DFSA may require periodic filings from the fund manager, not fund-specific, but e.g. annual compliance return, AML returns, etc.
e. To ensure that all new investors (if additional closings occur) meet the $500k/professional criteria.
f. The fund manager must act honestly, with due skill and care, in the best interest of the fund holders.
g. At the end of the fund’s life, the manager will liquidate holdings and distribute proceeds to investors. A QIF can be closed-ended (typical for VC) or even open-ended in structure if desired.
INDIAN REGULATIONS: SEBI AIF (ALTERNATIVE INVESTMENT FUND) CATEGORIES AND CROSS-BORDER PARTICIPATION
Many DIFC funds (especially venture capital and private equity funds) have linkages to India, whether through Indian investors or plans to invest in Indian start-ups. It’s important to understand India’s domestic fund regime under SEBI’s AIF Regulations, 2012, and how Indian entities can participate in an offshore DIFC fund.
In India, Alternative Investment Funds (AIFs) are privately pooled investment vehicles regulated by the Securities and Exchange Board of India (SEBI). The SEBI (AIF) Regulations, 2012 categorise AIF into three categories:
1. Category I AIF:
Invests in areas that are socially or economically beneficial, like venture capital funds for start-ups, SME funds, social venture funds, and infrastructure funds. They get certain incentives (like tax pass-through for venture capital funds) and are subject to tighter government oversight to ensure they invest in target sectors. Leverage is not permitted except for temporary funding.
2. Category II AIF:
The default category for private equity funds, debt funds, etc., that do not fall in Category I or III. These can invest in unlisted companies, real estate, etc. They cannot borrow funds (other than for day-to-day operational needs) and include most private equity or VC funds formed onshore in India. Category I and II AIF must be close-ended with a minimum tenure of 3 years. Both Category I and II enjoy pass-through taxation in India for most income (except business income), i.e. tax is paid by investors, not at the fund level.
3. Category III AIF:
Funds employing diverse or complex trading strategies, such as hedge funds or liquid trading funds. They may be open-ended or closed-ended and can employ leverage (subject to SEBI limits) to take positions in public markets or derivatives. They do not get pass-through tax treatment. Category III funds are taxed in India at the fund level, as a company, since they often generate business income or short-term gains.
All AIFs (except Angel Funds) require a minimum investment of INR 1 crore ($125k) per investor and an overall fund corpus of at least INR 20 crore ($2.5M). Investors in AIFs can be Indian, foreign or NRI. SEBI allows AIFs to raise funds from foreign investors freely, as long as they commit to the minimum amount. In other words, a foreign investor (or a DIFC fund as an investor) can subscribe as a Limited Partner in an Indian AIF, which is a common route to get exposure to India.
A DIFC fund is an offshore entity, so it cannot register under SEBI AIF regulations (those apply only to funds domiciled in India). However, there are two main interfaces with the Indian regulatory regime:
1. Direct Investment into Indian Companies (FDI):
The DIFC fund may invest directly in Indian portfolio companies. These investments must comply with India’s Foreign Direct Investment (FDI) policy, governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. Most sectors for start-ups (technology, services, etc.) allow 100% FDI under the automatic route, but a few sensitive sectors have caps or approval requirements. The key is to ensure the target company’s sector is open to FDI and all filings (like RBI’s business user portal filings) are done. The DIFC fund itself would be considered a foreign investor. It may need to register as a non-resident investor with Indian authorities (for instance, obtain a PAN for tax, file inbound remittance forms). No SEBI approval is needed for the fund to invest; only compliance with the RBI’s FEMA rules is required.
2. Investing via or alongside Indian AIFs:
Some offshore funds choose to invest in India by pooling money through a domestic AIF vehicle (for example, an Indian Category II AIF that co-invests in deals, or a feeder). In such cases:
a. Foreign investment in the AIF is permitted under the automatic route. AIFs are treated as “Capital Instruments” under FEMA, and 100% foreign ownership in an AIF is allowed. The AIF needs to file a report of the foreign inward investment with the RBI, but no separate FDI approval is required.
b. If an Indian AIF has foreign investors, its investments into portfolio companies are considered indirect foreign investment. The FEMA NDI Rules, 2019 specify that if the manager or sponsor of an AIF is foreign-owned or controlled (FOCC), then all investments by that AIF will be treated as indirect foreign investment (and must comply with the sectoral FDI caps). However, if the AIF is sponsored/managed by Indian owned-and-controlled entities (IOCC), then even foreign LP money may not taint the AIF’s investments as foreign, except in Category III AIFs. Category III AIFs with any foreign ownership must invest only in sectors where foreign portfolio investors (FPIs) are allowed, essentially treating all their investments as foreign.
c. The typical scenario for a DIFC fund manager is directly investing under FDI. But if you team up with an Indian AIF (say, you create a parallel AIF in India to accept Indian institutional capital), you need to carefully structure control so that the Indian AIF’s downstream investments remain compliant.
FEMA (FOREIGN EXCHANGE MANAGEMENT ACT), ODI (OVERSEAS DIRECT INVESTMENT) & RBI REGULATIONS.
When money flows across Indian borders as part of fund formation or investment, India’s foreign exchange laws (governed by the Foreign Exchange Management Act, 1999 – FEMA) come into play. Key considerations include Foreign Direct Investment (FDI) rules for investments into India, Overseas Direct Investment (ODI) rules for Indian investments abroad, and other capital account transaction regulations.
1. DIFC Fund Investing into India (Inbound FDI):
If the DIFC VC fund uses its pool to invest in Indian companies (say it buys equity in an Indian start-up), that is a foreign investment into India. India allows FDI in most sectors under the “automatic route” up to 100%, except certain regulated sectors (like telecom, media, defence, etc., which have caps or approval requirements). A VC fund typically invests in equity of unlisted tech companies, which is generally permitted 100% automatically. The Indian company receiving the investment must comply with the FEMA (Non-Debt Instruments) Rules: for instance, issuing shares to the foreign fund at or above fair valuation (as per valuation norms), and filing the required reports (Form FIRMS/FC-GPR) with the RBI within 30 days of allotment.
The DIFC fund itself doesn’t need RBI approval if it invests in a sector under the automatic route, but it does need to register as a foreign investor with Indian authorities (obtain a Permanent Account Number for tax, etc.) if it will hold Indian securities. Often foreign funds invest via a Mauritius or Singapore holding company into India for tax reasons, but the UAE (DIFC) has become attractive with its treaty (more on that later).
From an Indian perspective, a foreign fund would be classified as a Foreign Portfolio Investor (FPI) if it buys listed securities under certain thresholds, or it could come in as direct FDI for unlisted stakes. VC funds usually come under FDI. There is also the concept of a Venture Capital Fund (VCF) under FEMA – previously, foreign investors could invest in SEBI-registered Category I VC Funds under a specific route. But since the advent of the AIF regime, foreign investment in AIFs is considered FDI into the AIF and then the AIF makes downstream investments. In our case, the DIFC fund is a foreign entity investing directly in Indian companies, so it is straightforward FDI.
The Indian start-up or its lawyers typically handle compliance: ensuring the investment is within sectoral limits, pricing is per internationally accepted valuation, and filing Form FC-GPR (for issuing shares to a foreign investor) on the RBI’s FIRMS portal within 30 days of share issuance. The company will also need to adhere to annual reporting of foreign liabilities and assets. If the DIFC fund exits by selling shares to another foreign investor or back to an Indian, Form FC-TRS would be filed to report that transfer. These are mechanical FEMA compliance steps, but missing them can lead to penalties. The VC fund manager should thus coordinate with portfolio companies to make sure all FDI norms are met. Generally, so long as the fund’s investment is genuine equity at fair value and not in a prohibited sector (like agricultural land, real estate trading (except development), etc.), Indian law welcomes foreign capital.
2. Indian Investors investing in the DIFC Fund (Outbound ODI):
For an Indian person or company to send money abroad to a DIFC fund, ODI rules apply. As noted, resident individuals have the Liberalised Remittance Scheme limit of $250k/year. They do not need separate ODI approval for portfolio investments within that limit. If an individual wants to invest more than that in an offshore fund, they would need specific RBI approval. Indian companies, LLPs, or funds investing abroad follow the Overseas Investment Rules, 2022. Under the automatic route, they can invest up to 400% of their net worth (as per last audited financials) in equity or fund commitments abroad.
For example, an Indian asset management company with a net worth of $5 million could invest up to $20 million in setting up or contributing to an overseas fund vehicle under the automatic route. If the amount exceeds that, or if the investment is in a financial services sector when the Indian entity itself is non-financial (or other sensitive sectors like gambling, real estate), then prior RBI approval is required.
Recent reforms have simplified ODI; Indian entities no longer need profitability track records for ODI under the automatic route (earlier, a company needed 3 years of profitability to invest abroad; that requirement has been removed for most cases). Also, ODI can now be made in foreign funds or start-ups, even by Indian start-ups or LLPs. The Indian investor must file an ODI Form (via Form FC in the online ODI application) at the time of remittance to the foreign entity, and an Annual Performance Report (APR) each year to report on the status of that overseas investment. If an Indian sponsor sets up a wholly-owned subsidiary in DIFC to act as a fund manager/GP (General Partner) that is an ODI investment, it must be reported accordingly.
A critical restriction is that an ODI cannot be used to invest in an entity engaged in real estate or banking business without special approvals, and an ODI entity generally should not invest back into India. The new rules have eased some conditions but still maintain the Principal Purpose Test. If the primary purpose of the offshore entity is to route funds back to India, it can be challenged (especially under the GAAR – General Anti-Avoidance Rule) in Indian tax law or under FEMA if it circumvents capital controls. Therefore, if Indian parties are significant contributors to a DIFC fund which will invest in India, it’s wise to ensure the structure has commercial justification.
3. Repatriation and Earnings:
When the DIFC fund eventually exits investments in India and wants to distribute proceeds back to investors (some of whom may be Indian), FEMA again plays a role. From the Indian side, if the fund sells shares in an Indian company and makes a profit, it can freely repatriate the sale proceeds out of India after paying any applicable Indian taxes. There is no restriction on the repatriation of capital gains or dividends by foreign investors as long as taxes are paid and reporting is done. Dividends paid by Indian companies to the DIFC fund can be repatriated as well, subject to dividend distribution tax, which India has now shifted to classical withholding on dividends. Indian exchange control is quite liberal for outward remittance of genuine investment returns – profits, dividends, and sale proceeds are all remittable in foreign currency through authorised dealer banks, post-tax clearance.
For an Indian resident investor in the DIFC fund, their share of profit from the fund will come as foreign-sourced income (e.g. the fund may distribute dividends or redemption proceeds to them outside India). Under FEMA, Indian residents are required to bring back and/or declare foreign assets appropriately. An individual using the LRS (Liberalised Remittance Scheme) can retain and reinvest earnings abroad, but any funds they bring back must be routed via banking channels. If an Indian company invested in the fund via ODI, it is required to repatriate any realisations (disinvestment proceeds) from the foreign entity within 90 days of sale/liquidation, unless it has permission to reinvest. Also, any dividends or income should ideally be repatriated, though the new rules allow some flexibility in using those earnings for further investment abroad under the overall cap.
To summarise, the Indian law does not prevent a well-structured India–DIFC fund relationship, but demands adherence to reporting and certain limits. By following RBI’s notification framework and sticking to the automatic routes, one can largely avoid needing case-by-case approvals, making the India-DIFC fund workflow relatively smooth.
DTAA IMPLICATIONS BETWEEN UAE-INDIA, US-INDIA & UAE-US
Tax considerations can greatly influence the fund’s structure and the net returns to investors. By situating the fund in the UAE (DIFC) and investing internationally, one can take advantage of Double Taxation Avoidance Agreements (DTAA) that the UAE has with other countries. The focus is on the tax treaty dynamics between the UAE–India, US–India, and UAE–US, given the scenario of a DIFC fund connecting these jurisdictions.
1. UAE–India DTAA:
The UAE and India have a comprehensive tax treaty (DTAA) that can be very beneficial for investment funds. Notably, this treaty allocates taxation rights for certain incomes in a way that can eliminate or reduce Indian taxes on the DIFC fund’s income:
a. Capital gains:
Under the India–UAE DTAA, capital gains derived by a UAE resident from the sale of Indian securities may be taxable only in the UAE (resident state), except in specific cases (like gains from shares of a company principally holding immovable property in India) as per Article 13 of the Agreement for avoidance of double taxation and the prevention of fiscal evasion with the UAE.
b. Dividends:
Under India’s domestic law, dividends paid to foreign investors are subject to a 20% withholding tax (plus surcharge and cess). The UAE–India DTAA limits the tax on dividends to 10% of the gross amount, provided the UAE resident is the beneficial owner of the dividend as per Article 10 of the Agreement for the avoidance of double taxation and the prevention of fiscal evasion with the UAE.
c. Interest:
If the DIFC fund extends any debt or invests in interest-bearing instruments in India, interest paid to it would normally have a 5%–15% withholding (depending on the type of debt, since India has reduced rates for certain foreign debt investments). The treaty limits interest rate withholding at 5% for interest paid by Indian banks on loans, and 12.5% in other cases.
The DIFC fund, being a UAE-incorporated vehicle managed and controlled in the UAE, qualifies as a UAE tax resident and can invoke the treaty when investing in India. Thus, when structuring exits, the fund will ensure to obtain a Tax Residency Certificate (TRC) from the UAE and comply with any Indian paperwork (such as Form 10f and declarations) to claim treaty benefits. The impact is potentially 0% Indian capital gains tax vs 10-15% that would otherwise apply (for unlisted shares, long-term gains are 10% in India without a treaty). This can enhance LP returns significantly.
2. US-India DTAA:
Considering the U.S.–India tax treaty, it comes into play if the fund’s investors or investments involve the U.S. For instance, what if a U.S. investor in the DIFC fund is ultimately exposed to Indian assets? Or what if the fund itself invests in U.S. assets or receives U.S.-sourced income with Indian connections?
a. Dividends and interest:
The treaty generally limits Indian tax on dividends paid to U.S. residents to 15% (or even 5% in some cases if the U.S. company owns a large stake, though that scenario is more for corporates). Similarly, U.S. tax on dividends to Indian residents is limited to 15%. The treaty often limits Interest withholding to 10% or 15%. However, these treaty benefits apply only if an investor is directly receiving income from the other country.
A U.S. LP investing in the DIFC fund does not directly receive Indian dividends; the fund does, as a UAE entity. So the India-UAE treaty is what governed that dividend. By the time the cash goes from the fund to the U.S. LP, it could be in the form of a partnership distribution or dividend from the fund (depending on structure), which is UAE-sourced (no UAE tax).
b. Capital gains:
The U.S.–India treaty, unlike the UAE’s, does not give a blanket exemption for capital gains. It generally allows source-based taxation for gains, meaning India can tax gains on Indian shares even if the seller is a U.S. resident (subject to domestic law). Conversely, the U.S. can tax U.S.-source gains. But again, the treaty ensures no double taxation by providing foreign tax credits. If a U.S. investor directly held Indian stock and sold, they’d pay Indian tax (say 10%), then get credit for that against their U.S. tax on that gain (the U.S. taxes its citizens on worldwide income). In the scenario of the DIFC fund, India didn’t tax the gain, and so the U.S. investor would face U.S. tax on their share of gain without any Indian credit to utilise. Investing via the UAE fund could be tax-neutral or even beneficial for a U.S. investor as well.
3. UAE-US Treaty
The UAE and the United States do not have a comprehensive income tax treaty. This means there is no reduction in U.S. withholding taxes for UAE residents via treaty. As a result, when the DIFC fund receives U.S.-source income:
a. U.S. interest that qualifies as “portfolio interest” might be exempt from withholding under U.S. domestic law (portfolio interest exemption) if structured properly; otherwise, interest has 30% WHT (withholding tax) as well (or lower if specific exemptions like short-term bank deposit interest, which is 0% by U.S. law).
b. U.S. capital gains (e.g. selling U.S. equities), the U.S. generally imposes 0% tax on capital gains for foreign investors on stocks, except if the asset is U.S. real property or a business asset. So the fund likely pays no U.S. tax on gains from selling U.S. securities, treaty or not (the absence of a treaty doesn’t matter since U.S. domestic law itself doesn’t tax those gains).
CONCLUSION
Setting up a venture capital fund in the DIFC involves an interplay of multiple legal frameworks – the DIFC/DFSA funds regime provides the container to pool global capital quickly (especially through a QIF), while Indian and U.S. regulations govern how that capital can move to and from India or the U.S. By carefully adhering to DIFC’s licensing and fund formation requirements, and structuring cross-border investments in compliance with SEBI, FEMA rules, a fund manager can successfully create a vehicle that taps into international investor pools and deploys money in India (and other markets) legally and efficiently. The process requires detailed planning: obtaining a DFSA fund manager license or partnering with a platform; preparing comprehensive fund documents and ensuring only eligible investors participate; coordinating RBI filings for any ODI/FDI transactions; and utilising tax treaties to optimise returns.
From a broader perspective, the DIFC–India corridor is growing stronger: DIFC’s strong legal system (based on common law) and India’s booming startup ecosystem complement each other. Funds set up in one can greatly facilitate investment in the other. With the information in this article, stakeholders – be it a legal professional structuring a fund, a compliance officer ensuring all boxes are ticked, or a global investor evaluating the setup- should have a clearer roadmap of the legal steps and considerations to successfully launch a VC fund in DIFC and navigate the cross-border landscape.
