Managing offshore funds from India needs tax reforms

With assets under management (AUM) at the cusp of Rs 20 lakh crore for the mutual fund asset management companies (AMCs) and Rs 1.8 lakh crore for portfolio managers, “ more”.

 

Foreign portfolio investors (FPIs) have till date invested Rs 12.7 lakh crore in Indian capital markets with more than 8,500 FPIs registered with the Securities and Exchange Board of India (Sebi). These FPIs, especially India focused, are managed from abroad. This begs the question: Why can’t they be managed from within India? The question gains more importance in the light of the government’s stated intent of Make in India and a plethora of benefits that such local asset management can result in, including employment generation, creation of supporting infrastructure and a positive impact on India’s forex position. While Sebi has stepped in to create a regulatory framework that supports this, one key reason for the local management not happening was the Indian tax regime. Such management from India could lead to an FPI being regarded as a tax resident of India which, in turn, may have resulted in, amongst others:
  • Global income of the FPI being potentially taxable in India;
  • Additional tax of 10 per cent under section 115BBDA on dividends earned by them; and
  • Regulatory challenges, as FPIs are required to be non-residents under the Sebi’s FPI regulations
 

While tax “safe harbour” rules for fund management activities were introduced in the Indian income-tax law in 2015, they were accompanied by conditions that are challenging to comply. These included, amongst others, investor diversification and monitoring conditions and certain conditions related to asset managers themselves.

 

What has changed now?

 

Two changes have been made.

 

Firstly, the three investor diversification rules mentioned below are no longer required to be satisfied by Category I and Category II FPIs:
  • The fund should have a minimum of 25 members who are, directly or indirectly, not connected persons.
  • Any member of the fund along with connected persons shall not have any participation interest, directly or indirectly, exceeding 10 per cent.
  • Aggregate participation interest, directly or indirectly, of 10 or fewer members along with their connected persons in the fund, shall be less than 50 per cent. 
Secondly, there was a requirement for funds wanting to avail safe harbour to qualify as a tax resident of overseas jurisdictions. This condition proved to be a hurdle for funds in certain countries given the local taxation regimes. To address the same, 121 countries/specified territories have been notified from where an offshore fund can invest without it qualifying as a tax resident of that overseas country/specified territory.

 

Who would the above impact?

 

The above relaxations should benefit fund managers in India who can now approach Category-I and Category-II FPIs for management of their India assets. These would include domestic mutual fund houses as well as other portfolio management service (PMS) and alternative investment fund (AIF) asset managers with a track record of managing investments in the listed space. While AUMs have increased for these players, the current change provides a fresh look at growth opportunities.

 

Apart from this, the relaxation should also provide an incentive to asset managers situated overseas and who may be interested in relocating on-the-ground in India.

 

Have more “din” arrived?

 

The safe harbour journey that started couple of years ago may now be in its last lap. While the above relaxations help, some of the challenges that still need to be addressed include:
  • Direct or indirect investment in the offshore fund by Indian residents should not exceed five per cent of the corpus of the fund — there are practical challenges for asset managers in certifying the “indirect” investment condition.
  • The fund and the fund manager should not be “connected persons”
 

With investment diversification conditions continuing (not more than 26 per cent stake in underlying entities), the private equity industry is largely not expected to benefit as yet from the safe harbour rules.

 

Since Category-I and Category-II FPIs are Sebi regulated, as also private equity houses investing through AIFs, a simple way could be to exempt them from the above conditions as well.

 

Overseas regulations in certain jurisdictions such as Luxembourg and Japan may inhibit the ability of Indian fund managers being appointed as the fund manager to funds domiciled in these regions. These may be addressable in certain jurisdictions by approaching the local regulators to recognise the Indian regulator/asset managers.

 

Although the above may continue to be a deterrent to some players, the present changes hopefully brings “achhe din” to others! Mehra and Sampat are partner & leader and executive director, respectively, for Tax & Regulatory Services, PwC India

With inputs from Pavan Sonejee (The views expressed are personal)


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