Need to eliminate tax and regulatory hurdles to lure foreign investors to India based funds
New Delhi, 3 June 2013: A significant portion of the private equity (PE) funds raised that are dedicated for investments in India is currently pooled in offshore countries, such as Mauritius and Singapore. This can be attributed to the attractive tax and regulatory frameworks prevalent in those countries for fund raising by asset managers and the relative tax and regulatory hurdles/uncertainties in India for such pooling. If India needs to compete with global financial hubs, it is imperative for the Government to formulate a conducive foreign investment policy that gives foreign investors a sense of comfort while choosing India as a location for pooling such funds, suggests EY report - Private equity: breaking borders.
PE investments in India outplayed all sources of capital in the first decade of the 21st century. This is evident from the fact that only US$1.3billion was raised through IPOs (excluding IPOs by public sector undertakings) in 2012, compared with US$7.6 billion through PE investments. With India poised to become the second largest economy in the world by 2050 and with the country requiring about USD 1 trillion to be spent on infrastructure in the next five years, PE investments need to be encouraged to bridge the gap between the need of the Indian economy and the ability for public funds to meet the same. The report also highlights that PE firms have invested about US$ 7,537million in India over 415 deals in 2012, compared to US$9,641million they invested across 446 deals during the previous year, a fall of 21.8% in terms of value. The total investment by PE firms over the past five years in India now stands at about US$39.8billion across 1,820 transactions. (Source: VCCEdge, AVCJ, Factiva, BSE, Chittorgarh.com, EY research)
Sudhir Kapadia, National Tax Leader, EY said, “The current regulatory and tax framework for PE funds needs suitable amendments to facilitate the smooth inflow and repatriation of capital from the country. The Government needs to put in place a simple and robust framework that does not cast unnecessary compliance burden on foreign investors. Moreover, the Government needs to work on eliminating multiple levels of taxation, simplifying tax payment and ensuring certainty in tax laws to attract foreign investors to India.”
In the report, EY suggests key recommendations on tax & regulatory front to encourage pooling of funds in India:
Key regulatory recommendations:
- Foreign investment in SEBI registered Alternative Investment Funds (AIFs) should be allowed under the automatic approval route
Foreign investment in SEBI registered AIFs (and in feeder fund vehicles constituted in India to invest in AIFs) should be allowed under the automatic approval route irrespective of the legal constitution of AIF i.e. whether the AIF is constituted as a trust, limited liability partnership (LLP), company or other body corporate. Therefore, investment in and transfer/ redemption of investment in AIFs should not require Government of India/Reserve Bank of India approvals. The following are some of the other recommendations and safeguards which could be put in place to prevent regulatory arbitrage from the aforesaid foreign investment in AIFs:
- The investment activities of AIFs having foreign investment should be subject to the sectoral foreign investment policy issued and updated by the Department of Industrial Policy and Promotion.
- The downstream foreign investment restriction that presently applies to an LLP having foreign investment should be made inapplicable to a SEBI registered AIF constituted as an LLP.
- SEBI-registered foreign venture capital investors should be permitted to invest in Category I AIFs without complying with the sectoral restrictions that are presently being imposed in approval letters at the time of the grant of registration.
- AIFs having foreign investment that propose to make portfolio investments in Indian listed securities (secondary market acquisition) should be mandatorily required to comply with the norms prescribed by SEBI under the SEBI (Foreign Institutional Investors) Regulations and the corresponding Reserve Bank of India regulations.
- The activities of an AIF manager should be specifically included in the defined list of non-fund-based activities that attract the minimum capitalization requirement of USD 0.5 million irrespective of the level of foreign ownership in the AIF management entity.
Key tax recommendations
- Pass-through system of taxation for India-domiciled AIFs
In line with the international practice where the tax pass-through status is automatically available to AIFs in the form of choice of various entities such as limited liability partnerships and limited liability companies, in India the pass-through status should also be granted to SEBI-registered AIFs. A pass-through system would ensure that tax collected on the fund’s income is no more than the tax that would have been payable had the investor injected funds directly in the investee company/asset.
- Income derived by foreign investors in SEBI-registered AIFs should be exempt from tax
The current tax provisions exempts tax on long-term capital gains earned on the transfer of listed securities on which securities transaction tax has been paid. The report recommends that the Government should consider extending the scope of this section to include capital gains earned by AIFs on the transfer of shares of unlisted companies that are held over the long term (with suitable enhancements to the holding period).
Further, the double taxation avoidance agreements entered into by India with some countries such as Mauritius and Singapore have a favourable clause that provides for exemption from tax on capital gains. Where the capital gains earned by the foreign investors in AIF are exempt from tax, it would act as a strong deterrent for fund managers to raise India-dedicated funds from overseas jurisdictions.
- Simplification of the tax compliance mechanism for foreign investors
Reducing tax compliance burden plays a significant role in attracting a large number of investors on account of simplicity of the investment process. In cases where taxes have been discharged or deducted by the trustees of AIF on the distribution of income, foreign investors should be exempt from Indian tax compliances in respect of the income received from the PE fund.
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