India is transforming from a developing economy into developed at a dawdling pace. For boosting and sustaining economic growth, development of the infrastructure sector is indispensable. India needs over $1.5 trillion of investment in the next 10 years to bridge the infrastructure gap and realise its dream of becoming a superpower. Infrastructure projects require long-term funding with gestation period as high as 20-25 years. Hence, participation of the private sector in the long-term infrastructure development of the country is crucial.
Non-banking financial companies (NBFCs) and banks, particularly in the public sector, have been providing the necessary funding and bearing the risks associated with the long gestation infrastructure projects. But their increasing exposure to the infrastructure sector has resulted in asset-liability mismatch and increased level of stressed assets. Also, from the perspective of efficient deployment of funds, private financing has demonstrated tangible results. This is where the concept of Infrastructure Debt Funds (IDFs) was introduced as an alternative source for fuelling the infrastructure growth in the country.
IDFs are regulated investment vehicles that not only create headroom in banks’ balance-sheets to implement fresh lending, but also provide borrowers with a low-cost financing alternative. In November 2011, the Infrastructure Debt Fund-Non-Banking Financial Companies (Reserve Bank) Directions, 2011 (RBI directions), were notified by the central bank and the accompanying framework for taxation and foreign investment has since followed. Currently, IDFs can be set-up either as a trust or as a company. A trust-based IDF would be a mutual fund, regulated by Sebi, while a company-based IDF would be an NBFC, regulated by RBI.
IDF-NBFCs can raise funds from domestic as well as offshore investors through issue of either rupee- or dollar-denominated bonds, subject to minimum original maturity, residual maturity and lock-in conditions as prescribed by RBI. Such funds can be invested only in post-commencement operation date infrastructure projects that have completed at least one year of satisfactory commercial operations. Such projects can be in public-private partnership (PPP) or non-PPP. In April 2016, RBI also permitted IDF-NBFCs to raise funds from the domestic market by way of shorter tenor bonds and commercial papers.
IDF-NBFCs set up in accordance with the guidelines prescribed in Rule 2F of the Income-tax Rules, 1962, enjoy tax exemption in relation to any income earned by them, as per Section 10(47) of the Income-tax Act, 1961. Unfortunately, this regime has not kicked-off as expected.
i. At times, funds raised by IDF-NBFCs remain idle before they are deployed in the target projects. In order to improve the return on investment, there is an obvious need for interim or temporary deployment of such funds. The RBI directions are silent on such interim or temporary deployment of funds.
ii. RBI directions do not clearly state the nature of instruments by way of which IDF-NBFCs can invest in target projects. Given this and considering that the model tripartite agreements indicate bonds as the investment instrument, a question arises whether IDF-NBFCs can provide refinance in a form other than by way of bonds—say, by way of plain vanilla rupee term-loans? Clarifications with regard to the above by RBI will be much appreciated.
Corporate tax issues
i. IDF-NBFCs earn interest income from the investments made in project special purpose vehicles (SPVs). Hence, the operational tax issue linked with IDF-NBFCs is the withholding tax implications applicable on interest payments made by the project SPVs. While Section 10(47) of the I-T Act exempts any income of an IDF-NBFC, there is no corresponding section under the I-T Act that exempts the person making payments to IDF-NBFCs from withholding tax obligations. Consequently, IDF-NBFCs will either have to claim a refund in the return of income or incur time and effort in procuring a ‘nil’ withholding certificate from the Indian revenue authorities on an annual basis, both of which is unwarranted.
ii. While RBI has allowed IDF-NBFCs to raise funds through commercial papers from domestic investors, in order to claim a tax exemption, Rule 2F of the I-T Rules allows IDF-NBFCs to issue only bonds in accordance with the RBI directions and the relevant foreign exchange control regulations.
ii. Currently, there is ambiguity with regard to the tax treatment of income earned through interim/temporary deployment of excess funds in the hands of IDF-NBFCs.
iii. The masala bonds regime has caught the fancy of Indian corporates as it facilitates access to low-cost funding from offshore investors and helps in keeping forex exposure at bay. While IDF-NBFCs are eligible to raise funds through the issuance of masala bonds, Rule 2F of the I-T Rules must be amended to specifically include the masala bond issuances to avoid any sort of uncertainty around the availability of tax exemption to IDF-NBFC issuing such bonds.
Over the years, Rule 2F has not kept pace with the RBI directions.
i. Rule 2F prescribes original maturity period of minimum five years for the bonds issued by IDF-NBFCs at the time of first investment by a non-resident investor, subject to a lock-in period of a minimum three years. While RBI has relaxed original maturity and lock-in conditions for specified non-resident investors, conditions prescribed in Rule 2F have not been amended.
ii. RBI directions allow IDF-NBFCs to take a maximum single project exposure up to 75% of its total capital funds computed as per the prescribed method, subject to certain irritants. However, as per Rule 2F, single project exposure by IDF-NBFCs is restricted to only 20% of its corpus.
ii. Rule 2F does not permit IDF-NBFCs to invest in a project where its sponsor, group of sponsors or associate enterprise has substantial interest. But RBI directions do not stipulate any such investment condition.
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iii. Although RBI directions allow IDF-NBFCs to raise funds from the domestic market by way of shorter tenor bonds and commercial papers (CPs), Rule 2F is silent about such a fund-raising exercise. It is desired that Rule 2F is aligned with the RBI directions (as and when amended) to avoid any disparity between tax provisions dealing with the exemption and the regulations governing IDF-NBFCs.
As the Sensex and Nifty chart new highs, one hears more noise on market-focused vehicles like alternate investment funds and portfolio management schemes. Though IDFs in general and IDF-NBFCs in particular may not be the current flavour, their importance in infrastructure development cannot be undermined.
The success of IDF-NBFCs depends on a number of factors. The dominant amongst these is a comprehensive yet simple and certain tax and regulatory regime. Therefore, it is imperative to align the tax and regulatory framework for encouraging setting-up of more IDF-NBFCs for attracting investors from domestic as well as overseas markets.
(With inputs from Ankush Bhutra & Nidhi Badamwala)
Co-authored with Jimit Shah, director, BMR & Associates LLP.