Looking at Budget with hope for making offshore funds India-friendly

The Budget may tweak norms that aim to make it easier for fund managers overseeing offshore India-focused funds to relocate to the country. 

Section 9A of the Income Tax Act, introduced on April 1, 2016, provides for a special taxation regime to such funds. Under this, the fund management activity of an eligible investment fund does not constitute a business connection in India. The fund is not resident in India merely because its fund manager is located in India.

The objective of introducing this Section was to ensure offshore funds do not pay incremental tax just because those are managed out of India.

Without the benefit of this Section, an offshore fund that is managed from India becomes a tax resident of India. “In such a scenario, it could potentially lose all its treaty benefits, and would have to shell out an additional tax of 10 per cent for dividend income in excess of Rs10 lakh,” said Tushar Sachade, partner, PwC India.

“Section 9A has the potential to allow India focused venture capital (VC)/private equity (PE) funds domiciled overseas to be managed from India without adverse tax implications. A fund domiciled overseas allows the fund manager operational freedom as the 25 per cent investee company restrictions won’t apply and the overseas investment won’t require a Sebi (Securities and Exchange Board of India) approval. Further, GST is not applicable on management fee when paid by a fund domiciled overseas,” said Saumil Shah, partner, Dhruva Advisors.

The Budget last year relaxed two minor conditions under Section 9A. The time period for garnering the Rs100 crore corpus was relaxed to six months or the end of the previous year from the incorporation of the fund, whichever is later. The requirement that remuneration paid by the fund to the fund manager should not be less than the arm’s length price was dropped. Instead, it was proposed that the Central Board of Direct Taxes (CBDT) would prescribe a minimum remuneration.

Yet, only a handful of funds have got the nod under Section 9A. One of the onerous requirements is that the aggregate investment, directly or indirectly, by persons resident in India should not exceed 5 per cent of the corpus of the fund.

“Verifying participation by Indian residents in cases where the eligible investment fund is an open-ended fund or listed on overseas stock exchanges is practically impossible. Accordingly, the word ‘indirectly’ could be removed from existing guidelines to relieve the fund from tracking indirect participation by residents in the fund,” said Shah.

“Most of the offshore funds have non-Indians as investors and it is unlikely that the 5 per cent limit would be breached unless the fund is specifically marketed to NRIs,” added Sachade.

The current norms mandate that a fund-availing Section 9A has to have a minimum corpus of Rs100 crore within the first year of starting operations. Industry players want this time frame to be increased to three to five years.

“It is difficult for funds to garner Rs100 crore within a year if they do not have an established track-record overseas,” said Vaibhav Sanghavi, co-CEO, Avendus Capital Public Markets Alternate Strategies, which got the nod for a fund under Section 9A last year.

Experts believe if Section 9A imposes additional restrictions on foreign portfolio investors (FPIs) without giving specific tax advantages, FPIs will not opt for the services of Indian fund managers. “It should be clarified that the eligibility conditions will not be applicable to FPIs and appointment of an Indian fund manager by Sebi-registered FPIs will not alter the current tax structure prescribed for FPIs,” said Shah.

A fund manager should not be an employee of the eligible investment fund or a connected person of the eligible investment fund, according to the existing norms. This disqualifies Indian fund managers who want to set up offshore funds by making sponsor contributions to substantiate their “skin in the game”.

There are a significant number of India-focussed funds. Relaxing Section 9A norms would allow mutual funds and portfolio managers who currently provide advisory services to these funds to start managing them directly from India, and earn higher fees. Several offshore fund managers of Indian origin, who manage the India units of their global portfolios, are keen to shift to the country as it will help them locally connect with bankers, analysts, institutional investors, and the company’s management.

What is Section 9A?

*Section 9A of the I-T Act provides for special taxation regime to facilitate location of fund managers of offshore funds to India

*The regulations came into with effect from April 1, 2016 

*The rules were aimed at benefiting offshore fund managers of Indian origin who managed India units of their global portfolios

*This shift to India was supposed to open new avenues for investment fund managers and create new jobs

*Eligibility rules have been onerous and only a few funds have been granted approval under this regime