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The introduction of the regulatory and tax regime for alternative investment funds (AIF) in International Financial Services Centres (IFSC) undeniably defines a crucial epoch in the journey of the alternative investment asset class in India.
The introduction of the regulatory and tax regime for alternative investment funds (AIF) in International Financial Services Centres (IFSC) undeniably defines a crucial epoch in the journey of the alternative investment asset class in India. Perhaps what renders Gujarat International Finance Tec-City (GIFT City), India’s maiden IFSC regime, as the 'promised land’ for Indian and offshore fund managers is the coordination between policy-makers and industry stakeholders in terms of honing the regime for financial services activities in IFSC.
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It is indeed the result of this partnership that GIFT City offers various conducive avenues to asset managers, as this article elucidates later, to realise its aim of ‘onshoring the offshore’, thereby rapidly garnering interest from major fund players across the globe.
The “pass through” present for Category II AIFs: Category II IFSC AIFs have been accorded the tax pass-through status for Indian income tax purposes (except for business income, in relation to which an AIF can claim a tax holiday). Income of non-resident investors from offshore investments made by Category II IFSCs AIF is not taxable in India. Investors can claim losses (other than business loss) of IFSC AIFs on a pass-through basis, subject to applicable conditions.
Classical private equity funds having a master-feeder unified structure may find it lucrative to position their feeders in GIFT City with their master fund established in non-IFSC India, thereby it being operationally easier and less expensive for managers to manage such IFSC AIFs. This would certainly benefit credit focussed funds since the majority of investors may be from jurisdictions that have tax treaties in place with India and it would be easier for such investors to avail relevant applicable treaty benefits on their interest income.
Another benefit for non-resident investors in IFSC AIFs is that they are not required to obtain a permanent account number or file income tax returns, thereby levelling IFSC with other offshore geographies from an investor administration standpoint.
Supportive Financial Services Framework: The vibrant network of ancillary service providers in GIFT City also makes it conducive for such IFSC and non-IFSC master-feeder structures to flourish, especially for Indian asset managers who were earlier required to establish substance in offshore fund jurisdictions such as Mauritius, Cayman Islands, etc.
Edging hedge funds closer to home: Offshore funds may invest in Indian public markets through the foreign portfolio investor (FPI) route. However, Category III IFSC AIFs set up in IFSC can register with SEBI as FPI and invest in India, in addition to investing in the offshore markets, thereby accessing both the Indian and global markets from the Indian soil out of GIFT City by undertaking limited regulatory approval processes. Further, the tie-up between IFSC NSE and Singapore Stock Exchange is already rendering a wide range of investment products for trade in GIFT City, which is being followed by other stock exchanges proposing to offer platforms for residents to trade in global stocks in GIFT City.
Tax friendly passage towards GIFT shores: Relocation of an offshore fund to IFSC has been made tax neutral from a capital gains standpoint (including carry forward and set-off of losses) wherein the transfer of fund assets should be made on or before 31 March 2023. Further, the requirement of contributing the minimum continuing sponsor commitment amount to an AIF has been made voluntary for such funds relocating to IFSC, which would certainly attract many offshore funds who may wish to relocate to IFSC, being closer to the ground in India.
‘Gifts’ of co-investment, leverage, and investment diversification: A ‘fairly’ free hand to manage funds is what every asset manager yearns for, and with the host of restrictions laid down by SEBI in relation to investment diversification, co-investment and leverage for non-IFSC AIFs, AIF managers had to limit their investment strategies and fund structures to align the same with these regulatory norms. However, with the IFSC AIF regime considerably watering down these restrictions in the favour of promoting more flexibility in fund management and encouraging inventive fund structuring, fund managers are freer to experiment with newer investment styles and strategies for AIFs in IFSC, including the freedom to structure co-investment class units within an IFSC AIF, itself.
Managing offshore funds from India: Outbound investment funds are a varied but prominent category of IFSC AIFs that are emerging in the GIFT City playground, especially in light of no restrictions applicable to overseas investment by IFSC AIFs, permissibility granted to resident individuals to make remittances under the liberalised remittance scheme route in IFSC and facilitation of trading of foreign stocks on recognised stocks exchanges located in IFSC. In light of these incentives, Indian fund managers looking to set up IFSC AIFs to invest in overseas start-ups and venture capital markets is emerging as an upcoming trend in IFSC.
Pocket friendly tax regime for fund managers: In addition to the liberal regulatory and tax framework for structuring and managing IFSC AIFs, GIFT City also helps in deepening fund managers’ pockets by offering a 10-year tax holiday on the business income earned by managers in IFSC, combined with lowered minimum alternate tax/alternate minimum tax rates (as may be applicable) and exemption from goods and services tax on management fee earned by managers in IFSC.
So, which fund managers can explore GIFT City for fund management?
Practically-all. Fund managers managing various asset classes and working with investment strategies such as debt, private equity, credit, distressed, venture capital, hedge funds, etc. may set up AIFs in IFSC and benefit from the relaxed regulatory and tax norms offered by the regime, which may include IFSC AIFs being set up as (a) feeder funds being used in combination with other offshore funds with no India linkage, (b) feeder funds with an India non-IFSC based master AIF, (c) standalone India focussed IFSC AIF with offshore investors, (d) standalone IFSC AIF investing outside India but being managed by Indian managers (on account of being closer to home), (e) multi-layered unified structure with offshore funds, IFSC AIFs and India based non-IFSC AIFs, (f) co-investment fund structures between IFSC AIFs and non-IFSC AIFs, (g) segregated portfolio co-investment structures with offshore feeder funds investing in IFSC AIFs, and such other bespoke platform structures that may be structured in IFSC. Thus, with both Indian and international fund managers already in the midst of their quest to unlock the full potential of GIFT City’s offering to the investment fund industry, it will be interesting to see the range of ingenuity of upcoming fund structures that await to greet the Indian AIF space.
The authors, Divaspati Singh and Ishita Khare, are Partners and Senior Associate respectively at Khaitan & Co. The views expressed are personal
First Published: Aug 18, 2021 4:53 PM IST