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The Indian Private Equity & Venture Capital Association (IVCA) has welcomed the notification of guidelines for application of Section 9A of the Income Tax Act.
These provide the eligibility criteria and detailed procedures for safe harbour rules (the term for a provision specifying that a defined conduct will be deemed not to violate a given rule) on foreign fund managers residing in India.
"This is a very progressive measure, as the government has further liberalised and clarified the rules it had introduced in the previous Union Budget of 2015. The government has responded very positively to the recommendations made by the (Infosys co-founder) N R Narayana Murthy-led report prepared by the Alternative Investment Policy Advisory Committee," stated the association.
Sanjay Nayar, chief executive of KKR and chairman of IVCA, said foreign investors, private equity (PE) and venture capital (VC) funds would certainly take note of these reforms and these changes would attract more capital.
Gopal Srinivasan, chairman of TVS Capital and vice-chairman of IVCA, said: "Beside the new safe harbour rules, the government has also made several other reforms in Union Budget 2016 which will help promote the domestic alternative investment fund (AIF) sector. These include further improvement of the withholding tax regime by allowing the applicability of rates in force for investors coming in through treaty nations."
Highlights of the notification include a pre-approval mechanism, under which a fund can seek approval for its option from the Central Board of Direct Taxes (CBDT) and once approved, the benefit of section 9A would not be denied (unless approval is withdrawn, under limited circumstances).
Determination of the number of members and participation interest in the fund is by looking through the entity where the investment has been made directly by an institutional entity. There is a relaxation from the investor diversification condition in the period of 18 months or final closing, whichever is earlier, in the setting-up phase and a one-year period in the winding-up phase.
Eligibility will not be impacted in case of temporary non-fulfilment of investor diversification conditions for a period up to 90 days. Additionally, in the case of any delay in furnishing the statement of activity, if this does not exceed 90 days.
A fund shall be said to be controlling or managing a business carried out by any entity if it directly or indirectly holds 26% of voting rights.
Eligibility of the fund will be impacted only if the remuneration paid or payable to the fund manager has been determined to be not at an arm's-length price for a period of three previous years in succession or for any three of the preceding four previous years. A chance transfer pricing adjustment will not impact the eligibility, said the association.
"These rules are a sign of the growing sophistication of the regulatory regime for PE, VC and AIFs in India," said IVCA.
However, the association said that while this liberalisation is a strong move in the right direction, some fine-tuning might be necessary to attract more offshore fund managers. For instance, the 26% control criteria might need to be removed, as the role of PE and VC funds is to protect the savings of limited partners invested in portfolio companies. For example, distressed companies may be helped by PE funds to the fullest extent permitted by foreign direct investment rules and this should not conflict with the new CBDT regulations.
