For too long, India has exported its financial markets due to its uncertain, unstable, confusing and convoluted tax policies that eventually result in creation of India-focused offshore funds.
For too long, India has exported its financial markets due to its uncertain, unstable, confusing and convoluted tax policies that eventually result in creation of India-focused offshore funds. Today, the rupee is impacted by trades in the non-deliverable forward (NDF) markets of Singapore and Dubai, the Nifty indices by trade in Singapore and gold prices by Dubai and London. Almost all fund managers of overseas capital invested in India are located outside due to perverse tax rules. It is time we get the financial markets back and develop the skills associated with the global financial markets in India.
The last decade has seen unprecedented growth in India’s financial services sector. It employs over 6 million people, constitutes about 8% of India’s GVA at current prices and our stock market has an estimated market capitalisation of over $2 trillion. As India experiences continued economic growth, the financial sector could generate about 10-11 million jobs and a GDP contribution of $350-400 billion by 2025.
Several developed countries have successfully established high-tech financial hubs. These centres provide suitable regulatory regimes and create a business environment that promotes talent and increases capital flows. As they develop, they create significant value for their respective economies—London and New York account for 10% of their countries’ GDP and about 5% of jobs. Emerging financial services centres like Singapore, Dubai and Hong Kong have achieved similar levels of concentration of economic activity over short periods of time.
India is trying to adopt a similar model. The Gujarat International Finance Tec-City (GIFT) is being developed as a global financial and IT services hub at Gandhinagar, a first of its kind in India. GIFT SEZ Limited has been formed for development of a multi-services special economic zone (SEZ) with the prime focus on development of IFSC and allied financial services. GIFT SEZ is the only IFSC in India. Hopefully, Mumbai will get its own IFSC SEZ that will make the city a global financial centre.
GIFT-IFSC seeks to bring to India those financial services that are currently carried out overseas by financial institutions and branches/subsidiaries of Indian financial institutions. The IFSC offers them a physical location in India with the same ecosystem as their present offshore locations. The strategic objective of setting up the IFSC are:
i. To create high value jobs in financial services in India, and
ii. To create an avenue for financial globalisation that benefits the Indian economy and gives policymakers an enhanced set of instruments.
Various capital market intermediaries operating within the GIFT-IFSC can provide financial services, investment advisory or portfolio management services to a person not resident in India, a person resident in India, eligible under FEMA to invest funds offshore, to the extent allowed under RBI’s Liberalised Remittance Scheme, or to a financial institution resident in India who is eligible to invest funds offshore to the extent of outward investment permitted under FEMA. A portfolio manager or an alternative investment fund or a mutual fund operating in GIFT-IFSC can invest in securities listed in the IFSC, securities issued by companies incorporated in the IFSC or belonging to a foreign jurisdiction.
Units in GIFT-IFSC enjoy a tax-holiday for 10 years and exemption from long-term capital gains tax, dividend distribution tax, security transaction tax and commodity transaction tax. The minimum alternative tax is reduced from 18.5% to 9% for IFSC units.
One part of getting our financial markets back has now come into force with this, what remains is getting back the fund managers! One of the biggest challenges faced by foreign portfolio investors (FPIs) and India-focused offshore funds is the indirect transfer tax impact on sale of its investments in India. The finance minister—through the Finance Bill, 2017—has exempted Category I & II FPIs from indirect transfer tax provisions retrospectively from FY12, providing a finality to this challenge.
Another long pending tax challenge for the FPIs and offshore funds is the presence of its fund managers in India, leading to a business connection and creation of a permanent establishment (PE) for the FPIs and offshore funds in India. These funds have a strong desire to place their fund managers in India to manage their India-focused investments. To mitigate this PE risk, the Finance Act, 2015, provided safe harbour rules to encourage offshore fund managers to relocate to India without creating a PE status for the funds. These safe harbour rules are to be fulfilled by the funds and the fund managers to qualify as an ‘eligible investment fund’ and an ‘eligible fund manager’. Some of these conditions are so onerous and vague that the funds and fund managers are unable to fulfill them and mitigate the PE risk. Consequently, fund managers continue to operate outside India.
You might also want to see this:
India is losing a large amount in potential tax on the fund management fees paid to asset management companies located abroad. At present, about $400 billion of stocks and more than $100 billion of private equity and venture capital invested in India are managed outside. Even considering an annual fees of 1.5% for managing these funds, about $7.5 billion of fees is earned outside on such investments in India. We need to create rules that enable the fund managers to relocate to India to create jobs and pay taxes here. This will also enable GIFT and other cities to attract overseas financial market professionals. Similar to resolving the indirect transfer tax challenge for FPIs, the government should categorically and unambiguously provide the following:
i. Presence of fund managers of FPIs and India-focused offshore funds in India shall not result in a business connection or create a permanent establishment in India for the FPIs and the offshore funds, and these funds shall not be taxable in India. The existing classification of fund structure and registration by Sebi shall be accepted for tax purposes with no modifications.
ii. Asset management companies located in India shall be liable to taxation here on the net income earned from management fees and the individual fund managers shall also be taxable here based on their residential status.
Such clarification will put to rest all the uncertainty surrounding this issue. India will then be able to attract foreign capital and talent having global expertise in fund management and enable Ahmedabad/Mumbai to become to become one of the global financial centres.
Mohandas Pai & S Krishnan
Pai is chairman, Aarin Capital Partners, and Krishnan is a tax consultant.