Broad-based criteria for safe harbour to apply to category-II FPIs

Under 20% of FPIs currently fall under category-II | Illustration: Binay Sinha
The requirement to meet broad-based conditions, so as to qualify for a safe harbour under Indian tax laws, will also apply to category-II foreign portfolio investors (FPIs) even though category-I investors remain exempt, the government has clarified in a notification.

This may dissuade category-II FPIs, especially funds from Cayman Islands, British Virgin Islands, and West Asia, from delegating fund management responsibilities to Indian fund managers, said experts.

Less than 20 per cent of FPIs fall in category-II. This category is already at a disadvantage because it has to abide by indirect transfer provisions. Such provisions apply to funds that have deployed over 50 per cent of their portfolio investments in India.

“The notification was necessitated by the change in the FPI regime. Category-I FPIs desirous of a safe harbour need not comply with the investor diversification rules prescribed. 

Category-II FPIs may have a few more hurdles to cross and would need to evaluate the delegation of fund management to Indian asset managers,” said Tushar Sachade, partner at PwC India.
In 2017, the government had exempted category-I and category-II FPIs from meeting the broad-based rules under sub-section 3 (e), 3 (f) and 3 (g) of section 9A of the income tax rules.


Last year, the Securities and Exchange Board of India (Sebi) had integrated three FPI categories into two. The regulator also did away with the broad-based criteria altogether.

“It would have been better if the CBDT had harmonised the tax law in section 9A with the new FPI Regulations, by providing exemption from meeting the broad-based criteria in section 9A to both Category I & II FPIs. By requiring Category-II FPIs to meet the broad-based conditions in section 9A, the tax law limits the ability of Indian fund managers to manage even regulated funds set up in non-FATF member countries,” said Tejas Desai, partner at EY India.

“The safe harbour provisions are the equivalent of ‘Make in India’ for the asset management industry. The CBDT should have taken a cue from Sebi and extended the concession from investor diversification to both Category-I and Category-II FPIs,” added Sachade.

Aravind Srivatsan, partner at Nangia Andersen, believes the latest notification, along with the recent rules prescribing minimum remuneration to be earned by fund managers to enjoy the safe harbour exemption, provides clarity to fund managers for actively evaluating India as a jurisdiction.

The Finance Act, 2015, had introduced Section 9A to encourage fund management activity from India and provide a safe harbour to onshore management of offshore funds. 
The objective was to ensure that these funds did not pay incremental tax just because they were managed in India, and the risk of constituting a business connection or permanent establishment in India was mitigated. Without the benefit of this section, offshore funds managed in India become tax residents.

The government has been continuously relaxing norms since a few years. Yet, only a handful of funds have received a nod under Section 9A so far, which is why experts believe bolder reforms are required, and several restrictive conditions in the section need a re-look.

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