For years India has received the majority of its foreign investment from tax havens such as Mauritius, Singapore, Dubai, Cyprus and the Cayman Islands. These jurisdictions provide an excellent regulatory, tax and legal framework and protection for investors and fund managers to set up and operate private equity / venture capital funds (“offshore funds”).
The clarity of the fiscal and regulatory landscape, coupled with the availability of financial sector infrastructure (strong capital markets, intermediaries), experienced professionals and excellent social infrastructure have made these jurisdictions preferred by investors and managers. of funds.
In contrast, in India, the perception of “fiscal terrorism” and uncertainties over the government’s views on various tax issues have kept foreign investors at bay. These sentiments were reinforced by the Vodafone saga in the case of indirect transfers.
Amid the allotted limits, India’s private equity and venture capital fund industry has remained positive and has gained a solid foundation over the decade. India’s registered private equity / venture capital (“AIF”) alternative investment funds have grown from 121 in 2014 to 816 in 2021 since the start of the year, with a significant increase in funds raised.
The growth of the domestic fund industry could be largely attributed to the vibrant financial sector and investment professionals, entrepreneurship, as well as the strong start-up ecosystem and India, the ‘one of the largest markets in the world and the gradual opening up of the foreign direct investment (“FDI”) sectors by the government.
However, the increase in FDI did not reach its peak commensurate with direct pooling in India. The majority of AIFs are not yet directly mutualized in India, but special purpose vehicles / offshore funds.
Provide substantial clarity
The Indian government has, over the years, responded to the demands of the domestic AIF industry and introduced various tax and regulatory reforms providing substantial clarity regarding operations and tax implications for the national fund as well as foreign investors.
Some of the important reforms include the introduction of full tax transmission for domestic AIFs, allowing the pooling of funds from foreign investors on the automatic route, the treatment of pooled capital as a domestic investment under the Indian exchange control regulations and various regulatory reforms. for domestic AIFs.
However, despite all these efforts, FDI has eluded India due to certain limitations inherent in Indian tax and regulatory laws, mainly because India is unable to offer the flexibility of operations, investments and tax laws to compete with some of the financial centers and tax havens.
The introduction and establishment of the International Financial Services Center (‘IFSC’) in 2015 was envisioned as the answer to some of the above questions. With the IFSC, the Indian government has adopted the continent-hinterland model to develop a world-class financial services hub in India to compete with financial centers and offshore fund jurisdictions around the world. Almost six years after the IFSC began, after a slow start, a series of reforms in the recent past have helped the IFSC find a place in the comparative charts with offshore fund jurisdictions around the world.
Reforms and flexibility
Tax reforms include exemption for non-residents from obtaining a Permanent Account Number (PAN) or filing a tax return in India, clarification of taxation based on received in respect of the transfer of funds in IFSC making overseas investments, tax holidays for fund management companies, IFSC portfolio investments by funds benefiting from REIT taxation.
Regulatory reforms include the flexibility of co-investments, leverage, relaxation of investment diversification standards, and the ability for residents to sponsor funds registered as foreign portfolio investors (REITs). ) in the IFSC.
The proposed introduction of the open-ended company structure will allow funds incorporated within the IFSC to benefit from a flexibility comparable to that of any other competent jurisdiction.
In addition, the recent controversy around the applicability of the GST to performance fees to fund managers also has no impact on AIFs set up in IFSCs as there is a full exemption for fund management activities. management of funds domiciled in IFSC under the GST. In addition, tax havens such as Mauritius and Cayman which enter the FATF gray list give India more credibility and appeal as an offshore fund jurisdiction.
However, some pitfalls remain. India has ended bilateral investment agreements with 58 countries which are yet to be negotiated and revised.
In addition, Indian investors are largely limited and flexible to participate in the funds set up in the IFSC due to the current restrictions under India’s exit regulations, in particular the liberalized transfer regime and the problems of going. -return. The response from many development finance institutions (DFIs) has been timid to date.
There is a need for an IFSC authority to engage with foreign institutional investors, including DFIs, directly informing them about the IFSC, its products, benefits, credibility, addressing their concerns and inviting them to invest in India and abroad through the IFSC. based funds.
The author is a partner of Bhuta Shah & Co LLP