Indian Red Carpet Welcome For Foreign Investors

Several pathbreaking and speedy changes to the framework for the International Financial Services Center (IFSC) in the state of Gujarat made in the last two years have already improved the IFSC’s rankings among global fund jurisdictions. Several sweeping changes are now proposed by the finance minister to provide another booster shot to make the IFSC more attractive to foreign investors.

One significant change relates to foreign funds located in countries like Mauritius or Singapore that are holding existing (grandfathered) investments qualifying for a capital gains tax exemption on equity shares under the respective tax treaties. Such funds can relocate to the IFSC. The relocation is envisaged to be a cashless transfer whereby the fund would transfer securities to the IFSC fund that will issue new units to investors in lieu of original units. The amendment proposes to make such a relocation of foreign funds to the IFSC tax neutral along the lines of provisions similar to other forms of corporate reorganization.

Currently if offshore funds from other countries were to relocate to the IFSC by way of transfer of Indian assets—although there may not be any tax on gains earned until the date of moving India shares to the IFSC fund due to treaty protection—such fund would lose the exemption provided under the tax treaties for any incremental gains on subsequent sale. The amendment proposes to make such a relocation from another country to the IFSC tax neutral for the fund as well as the investors in the fund. Such a relocated fund will continue to get a capital gains exemption otherwise available under the respective tax treaty. This change is pathbreaking and will make such a relocation seamless.

The Indian regulator the Securities and Exchange Board of India (SEBI), will hopefully make appropriate changes in relevant regulations depending on the category of investor registration, to make such transfer of assets seamless from a regulatory perspective. The investors of course need to be comfortable with making themselves subject to Indian regulations as compared to a tested offshore jurisdiction framework.

This change should be particularly relevant for Indian-focused funds or two-tier structures where a special purpose vehicle, as an intermediary investment holding company, is located in a third country. Such funds or SPVs could consider moving to the IFSC in India.

Another change relates to safe harbor rules for managing offshore funds from India. Currently the fund and the fund manager need to satisfy a host of conditions to get the structure approved by the revenue authorities. Once the structure is so approved, the offshore fund is protected from the risk of creating a place of effective management or a taxable presence in India and, thus, taxation of its global income in India. An amendment is proposed whereby a fund manager set up in the IFSC managing an offshore fund may not need to satisfy these conditions. One will have to wait for the government notifications to see which of these conditions are specifically waived.

While the safe harbor for managing funds from India has been in place for a number of years, not many have opted for this regime due to difficulty in meeting some of the conditions. One hopes that the change will attract at least the India-focused funds to be managed entirely from India thereby doing away with the need to have a dual structure of an offshore manager with an Indian advisory company providing non-binding recommendations and research on Indian stocks.

The tax holiday currently available to other businesses in the IFSC has been expanded to aircraft leasing companies. Global aircraft leasing companies currently have operating companies in certain countries like Ireland to lease aircraft to Indian companies, because of tax treaties that provide for exemption from withholding tax on lease payments from India. The companies use the IFSC to lease aircraft and enjoy a business income tax holiday on the sub-lease. Going forward such companies would also enjoy a tax holiday on profits they make on the sale of such aircraft to Indian companies. This should add a new dimension to the way aircraft leasing is structured, and new structures will emerge for aircraft leasing.

Further, a bank having an offshore banking unit in the IFSC investing in Indian debt and derivative segment shall be exempt from capital gains. Several of the offshore investing entities historically investing from their operating companies in a country like Singapore and availing of the capital gains exemption under the tax treaty for such securities can consider investing through their banking units in the IFSC with the same tax benefits.

Further, currently Indian companies paying dividends to foreign portfolio investors (FPIs) withhold tax at 20% even though the respective tax treaty may provide for a lower rate. The proposed amendment allows Indian companies to withhold tax at the treaty rates, ranging from 5% to 15% depending on the country of residence of the FPI, instead of the current rate of 20% provided under domestic law. This was strongly demanded by leading industry bodies and will certainly resolve cash flow and compliance issues for FPIs.

Last year significant tax exemptions were introduced for foreign sovereign wealth funds and pension funds investing in Indian infrastructure projects. Several conditions attached to such exemptions are proposed to be relaxed. This should provide much needed impetus to the Indian infrastructure sector.

Aforesaid changes could truly be game changer for the asset management industry.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Sunil Gidwani is a partner and Naitik Doshi is a manager at Nangia Andersen LLP.