The FPI Regulations are a welcome move as this further simplifies portfolio investment in India. The Regulations merge all the existing Foreign Institutional Investors (FIIs), sub-accounts and the QFIs into a single class of investors known as Foreign Portfolio Investors (FPIs). While the eligibility criteria have been tightened, the process of applying for registration with Sebi has been done away with. FPI registration is now to be obtained from a Designated Depositary Participant (DDP) who shall follow a risk-based model for completion of Know Your Client (KYC) requirements.
Depending on the risk-profile, the FPIs have further been divided into three categories, where Category-I includes government and government related foreign investors, Category-II includes appropriately regulated broad-based funds (BBF) and persons, university funds, pension funds and BBFs that are not appropriately regulated but whose investment managers are regulated and registered as an FPI, and Category-III is the residuary.
The investment avenues available under the FPI regime are mostly in line with the current FII and QFI regime. Total investment by each FPI or an investor group is restricted to 10% of the issued equity capital of the company. Furthermore, where two or more FPIs have the same common beneficial owner (shareholding or voting rights or any other form of control in excess of 50% across the FPIs), the investment by all such FPIs will be clubbed together for the purpose of calculating the investment limit. Absence of clarity on the term control is likely to create challenge for the DDPs. Nevertheless, the investment limit of 10% may certainly bring some cheer for a few investor groups like foreign corporate, foreign individuals and QFIs who were otherwise allowed to invest only up to 5% of the total issued capital of a company.
The erstwhile prohibition on issue of Offshore Derivative Instruments (ODIs) by sub-accounts has been removed. Category-I and Category-II FPIs (except unregulated BBFs) are allowed to issue, subscribe or otherwise deal in ODIs directly or indirectly.
On the taxation front, FIIs were governed by a special tax regime which provides for special rates of taxes on income earned by FIIs. Post introduction of the FPI Regulations, there was a need to revamp the tax regime in line with the FPI framework. The Central Board of Direct Taxes has recently extended the benefits of section 115AD of the Income tax Act, 1961 to registered FPIs, something which was eagerly awaited.
While the FPI Regulations are a step in the right direction to boost investments in India, the new regime does throw up its share of interesting issues.
The FPI Regulations require the applicant to be a person resident outside India under the income-tax law whereas the FII Regulations referred to exchange control regulations for determining whether the person is resident outside India. This could result in interesting situations. The relaxation in the FII Regulations with respect to requirement of 20 investors in the case one of the investors was an institutional investor does not feature in the FPI Regulations. Furthermore, underlying investors shall now be considered only in the case of entities which have been set up for the sole purpose of pooling funds and making investments. These changes may warrant the need to revisit several existing FII/sub-account structures.
On the registration front, each FPI is mandated to obtain a Permanent Account Number (PAN) from the tax department. This requirement seems onerous to the investment managers of unregulated BBF who would now have to obtain a PAN even though they do not intend to make investments in India. Further, in the case of multi-managed fund structures, the regulations are not clear on whether registration is to be sought at the scheme/manager level or at the fund level. Under the current FII Regulations, each of the scheme/manager of a multi-managed fund is registered with Sebi and income earned by all the managers is consolidated at the fund level at the time of filing annual tax return. Sebi is currently working with the custodians and it is expected that operational aspects of the FPI Regulations would be streamlined soon.
To conclude, the introduction of the FPI regime is a good move to increase and attract foreign investment in the country. However, speedy synchronisation with other laws and more clarity on the Regulations is imperative to make the foreign investors actually bite the bait.
Assisted by Siddharth Ajmera, Manager, PwC India
The author is executive directorTax & Regulatory, PwC India