Giving financial services a boost: Budget FY23 needs to focus on passporting rights for IFSC funds

Generally, any cross-border financial services activity, including marketing of such activity, requires establishment or registration in the other jurisdiction.

IFSC is key to the growth of the financial services sector in India.
IFSC is key to the growth of the financial services sector in India.

By Bahroze Kamdin & Alifya Hakim

In this article, we discuss some of the expectations India’s financial services sector has from the upcoming Budget.

Generally, any cross-border financial services activity, including marketing of such activity, requires establishment or registration in the other jurisdiction. For example, if an Indian fund manager markets to a resident of Singapore, then we understand that the Indian fund manager, subject to the prescribed thresholds and conditions, needs to incorporate an entity in Singapore, and be registered and regulated by the Singapore financial services regulators. This is true for brokers, banking, insurance players, etc. To eliminate such additional requirements, the EU has notified the passporting regime, whereby a regulated financial services firm registered in one of the European Economic Area (EEA) can do business in any other EEA state without the need for further authorisation from that country.

Similarly, the Memorandum of Cooperation on the Establishment and Implementation of the Asia Region Funds Passport (ARFP) (MOC) is a multilateral agreement that aims to facilitate cross-border distribution of managed fund products across the Asian region. Australia, New Zealand, Japan and Korea have signed the MOC which allows collective investment products offered in one participating economy to be sold to investors in another participating economy.

Recently, the setting up of alternative investment funds (AIFs) in the International Financial Services Centre (IFSC) has gained a lot of momentum. Based on media articles, close to 25-30 AIFs were at advanced stages of discussion with the International Financial Services Centres Authority (IFSCA) for issuance of license and a few more were expected to apply. There are several tax benefits provided to the non-resident investors in the AIFs in the IFSC GIFT City.

The IFSCA has become an associate member of the International Organisation of Securities Commissions (IOSCO). IFSC is key to the growth of the financial services sector in India. So, similar passporting arrangements for cross-border financial services by entities in IFSC will help the IFSC sector’s growth. India could look at similar passporting arrangements for all financial services, especially for the fund and capital markets sector inter alia with neighbouring and other countries where India has trade agreements and also with ARFP.

Next, version 2 of the equalisation levy (EQL) was introduced vide Finance Act, 2020. Subject to certain exceptions, EQL @ 2% is chargeable on the amount of consideration receivable by a non-resident e-commerce operator (who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services or both) from the e-commerce supply or services made or provided or facilitated by it to resident of India; or a non-resident in the specified circumstances; or to a person using IP address located in India.

The scope of the terms “online sale of goods” and “online provision of services” covers any of the following activities, if undertaken online: acceptance of offer for sale, placement of purchase order, acceptance of purchase order, payment of consideration, and supply of goods or provision of services, partly or wholly.

With the advancement of technology and internet penetration, the majority of the regulated financial services such as banking, insurance, and broking are rendered online. Non-resident financial services companies that offer financial products through the use of innovative digital platforms, software, etc. to the tax residents of India, either directly or through intermediaries, could be regarded as e-commerce operators and thus be subjected to EQL. There is no clarity to exclude such financial services entities as they are e-commerce operators from the perspective of EQL.

The in-scope companies referred to in the “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy” under the OECD BEPS project exclude regulated financial services from the applicability of such tax on digital service under Pillar 1.

Thus, there is a need to clear the ambiguity and uncertainty vis-à-vis taxation and compliance requirements for such financial services companies.

The report of the Working Group (WG) on ‘Digital Lending, including Lending through Online Platforms and Mobile Apps’ was published on November 18, 2021. The WG suggested that such activities should be regulated on various aspects.

As per the WG, there were approximately 1,100 lending apps available for Android users in India, across 80+ application stores, but as many as 600 are illegal. Also, it has been observed that lending through digital mode relative to physical mode is still at a nascent stage in case of banks (Rs 1.12 lakh crore via digital mode vis-à-vis Rs 53.08 lakh crore via physical mode) whereas, for NBFCs, significant lending (Rs 0.23 lakh crore via digital mode vis-à-vis Rs 1.93 lakh crore via physical mode) is happening through the digital mode. The overall volume of disbursement through digital mode for the sampled entities has exhibited a >12X growth between 2017 and 2020 (from Rs 11,671 crore to Rs 1,41,821 crore).

Simplified regulations for such technology companies may be considered in the Budget as it has the (i) potential to propel the economy to the desired growth rate, and (ii) capability of driving financial inclusion for the underserved population, especially in rural India. Like priority sector lending, banks and NBFCs should be required to ensure minimum lending digitally through such technology platforms.

The authors are, respectively, partner and director, Deloitte India. Views are personal.

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