When Sebi has tackled the issue of P-Notes, why can’t the same KYC conditions be applicable for offshore funds?
It has been over a year since the finance ministry announced its intentions to bring India’s offshore fund management industry onshore into India. In fact, the tax reform was heralded in the Budget FY16 by the finance minister, who expressed his desire to encourage offshore fund managers to move onshore. But good intentions are lost in fine print and resulted in a consultation process that has confounded all stakeholders. A constant refrain from our peers is that it’s hard enough being a fund manager and dealing with the volatility of the capital markets but facing an uncertain tax regime makes it worse. We believe that an uncertain taxation and regulatory regime is keeping out 95% of the India focused fund management industry. They have no choice but to be domiciled outside India.
Currently, most fund managers of offshore funds manage their investments from offshore locations such as Singapore, Hong Kong etc. This is a disadvantage to both them and India. Fund managers lose the benefit of being close to the market they cover and may lose on deal flow. The country loses high paying jobs and talent and the development of a highly desirable segment of the asset management industry onshore. The government also loses tax revenues of a larger India-based fund management industry. When the government wants to make Mumbai a global financial centre, these bad tax laws drive away fund management from India.
In order to attract fund managers to locate back to India and bring in larger capital flows, India needs to provide ‘safe harbour’ for the fund, so that it is not taxed in India even while the fund manager resides in India. The fund managers operations in India should not be treated as “permanent establishments” under double taxation avoidance agreements (DTAAs). It is a simple enough concept understood globally, but treated with suspicion by tax authorities in India.
While the current government tried to deal with the issue by enacting section 9A of the Income-Tax Act, the provisions are not sufficient and very restrictive in providing a safe-harbour to fund managers of offshore funds. The fact is there are too many eligibility conditions relating to annual reporting requirements, investor diversification, tax residence and so on which muddy the waters and negate the good intentions of the government. In fact there are 13 eligibility requirements for the fund and four for the fund manager to qualify for ‘safe harbour’ in the proposed Section 9A amendment in addition to annual reporting requirements, creating a nightmare for those who want to try. The result is, no one is moving back to India. One more good policy negated by bad unworkable rules.
If a fund manager resides in India and manages an offshore fund registered with Sebi, meeting the regulatory requirements of an FPI, the government may tax the income of the investment management company and not the profits of the offshore fund. When a fund is registered with Sebi, it has already completed full KYC and international anti-money laundering requirements. The Income-Tax Act should provide ‘safe harbour’ for the fund, which should always be thought of as a non-resident entity for Indian tax purposes. This simple intent should be expressed with no-holds barred, no restrictions so that it encourages thousands of jobs and millions of dollars of tax revenues to come to India’s shores and rejuvenate India’s asset management industry and risk capital.
It is frustrating that the policy announcements of our finance minister in Parliament are negated by the rules drafted to make this happen. For far too long we have suffered from bad drafting, unworkable conditions and perverse tax assessments. When Sebi itself has tackled the issue of P-Notes and made it transparent and workable, why cannot the same KYC conditions be applicable for investors in offshore funds, with no other restriction, to enable the fund to be managed from India and only the fund managers fees being taxable in India. This will bring in at least $4 billion of fees into Indian fund managers resident here.
We recommend that Sebi registered offshore funds and other overseas funds with KYC akin to investors in P-Notes be provided ‘safe harbour’ under Section 9A of the Indian Income Tax code, without any restrictions, so that India encourages this industry to move onshore without further delay.
Pai is the chairman, Aarin Capital Partners and Parker is founder, Karma Capital Management LLC Views are personal