Mar 05, 2019

Chambers Global Practice Guide on Investment Funds (India)

A.       Fund Formation

1.       Is your jurisdiction frequently used by advisers and managers for the formation of investment funds?

Economic liberalisation in India was initiated in 1991, with the aim of making the Indian economy global and enhancing its access to global markets. In 1996, the Indian securities regulator, the Securities and Exchange Board of India (SEBI) framed regulations which provided a framework for India based fund managers to raise dedicated pools of capital in the form of investment funds. The regulations did not require fund managers in India to compulsorily register their pooling vehicles as venture capital funds (VCF’s) with the SEBI. However, certain benefits were provided if registration was obtained.

As a result, India based fund managers or foreign fund managers seeking to establish a significant fund management business in India, established India domiciled VCF’s.

The VCF regime was rudimentary and involved several challenges including:

•        raising foreign capital, which required approval from the Government of India;

•        uncertainty with regards to taxability of income in the hands of the investors in the VCF;

•        restrictions on the ability to invest in listed securities and/or debt securities; and

•        restrictions on the ability of a VCF to invest outside of India.

In 2012, the SEBI repealed the VCF regulations and framed a more robust framework for pooling vehicles in India entitled, “Alternative Investment Funds” (AIF’s). AIF’s were categorised into three categories:

•      Category I AIF’s, which include investment funds which focus on venture capital, infrastructure, social venture and small and medium enterprises (SME’s), and angel funds;

•        Category II AIF’s, which are typically sector agnostic funds, seeking to primarily invest in unlisted securities; and

•       Category III AIF’s, focused on employing diverse or complex trading strategies, including employing leverage, such as through investment in listed and unlisted derivatives.

Certain key steps that were taken to alleviate the challenges faced in the VCF regime were:

•      permitting foreign investment in AIF’s under the automatic route, thereby removing the requirement to seek approval from the Government of India;

•        bringing more clarity on taxation of AIF’s and income earned in the hands of the investors; and

•        permitting establishment of AIF’s focusing on investing primarily in listed securities or debt securities.

As per data published by the SEBI on their website, changes in the framework and increased demand has resulted in more than 500 domestic funds being registered with the SEBI as an AIF, with approximately INR1.8 billion raised in commitments and approximately INR750 billion deployed in investments by these AIF’s. However, given that the restrictions on India domiciled AIF’s to invest outside India have not been liberalised, fund managers looking to invest globally still prefer to establish investment vehicles in jurisdictions other than India.

To further India’s objective of establishing itself as a financial services hub and creating a level playing field with financial centres such as Singapore, Mauritius, and Hong Kong, the Indian government has notified its first International Financial Services Centre (IFSC) within a special economic zone, located in the State of Gujarat. Key advantages that funds established in the IFSC will have are:

•        free capital account convertibility;

•        income tax holidays; and

•       exemptions from Goods and Services Tax (GST) leviable on management fees earned by the fund manager in the IFSC, as well as securities transaction tax.

While the regulatory regime for IFSC’s is still at a nascent stage, this might be the platform for a launch of investment funds with a global focus.

2.       Is your jurisdiction generally used for the raising of capital from investors internationally or within your jurisdiction?

AIF’s are used to raise capital from both foreign and India based investors. Foreign investors (other than investors from Bangladesh and Pakistan) are permitted to invest in AIF’s under the automatic route, without the requirement to seek approval from the Government of India. India based investors are also permitted to invest in AIF’s. However, certain categories of investors in India, such as banks, insurance companies and pension funds have limitations on their exposure to AIF’s.

3.       Please describe the common process for setting up investment funds in your jurisdiction.

Pooling vehicles in India are mandatorily required to be registered with the SEBI as an AIF (unless specifically exempt). Key steps for setting up an AIF are as follows:

•        The first step is to ascertain the nature of the entity that will be registered as an AIF, ie whether it should be a private trust, company or limited liability partnership (LLP). In India, the most common form of setting up an AIF is a private trust settled under the Indian Trusts Act, 1882 (Trusts Act) given the ease with which a private trust can be established and operated in India.

•        The second step is to identify the category of the AIF, depending on the investment objective and strategy.

•        The third step is to prepare the documents required for seeking the AIF registration. This includes the constitutive document of the AIF, the placement memorandum/information memorandum (PPM) and an AIF application pack that contains certain information about the proposed AIF and declarations/undertakings to be provided by key parties to the AIF. The documents need to be uploaded on the SEBI’s online portal and also submitted in original form at the SEBI office. Simultaneously, other key documents being the management agreement between the manager and the AIF, and the subscription/contribution agreement by which investors subscribe to the interests in the AIF are also prepared.

Once the SEBI grants the AIF registration certificate, the fund manager can accept binding commitments from investors and start operations as an AIF.

Key points to note in an AIF set up process are that:

•      the fund manager needs to be located in India and therefore any offshore fund manager considering establishing an AIF will need to establish a business presence in India as the first step;

•        fund managers will need to ensure that fundraising is undertaken on a private placement basis; and

•        neither contributions are accepted nor operations are initiated before the SEBI grants the AIF registration certificate.

4.       Regulatory: do fund structures in your jurisdiction have to be managed in your jurisdiction, or are they commonly managed in your jurisdiction?

If the investment fund is set up in India, it is mandatorily required to be registered as an AIF (unless specifically exempt). The SEBI requires an AIF to be managed by a fund manager established in India.

5.       Legal: do investors in funds formed in your jurisdiction benefit from limited liability? Please describe any conditions or restrictions to them enjoying this benefit. Are legal opinions typically given in this respect?

Given that AIF’s in India can be established in the form of a company, private trust or LLP, the legislations governing each of these entities, ie the Companies Act, 2013 (Companies Act), the Trusts Act and the LLP Act, 2008 (LLP Act) respectively are the governing statutes that determine the extent of liability of a shareholder, a beneficiary and a partner in a company, private trust or LLP respectively. A shareholder of a company can be held liable if the corporate veil is lifted, which itself is done in very limited circumstances, such as in cases of fraud or tax evasion by the shareholder. Similarly, in a LLP, a partner may be liable if the partner has defrauded the creditors of the LLP. In a private trust, it is easier to limit the liability of the beneficiary contractually and therefore, private trust has been a favoured form of entity for establishing AIF’s in India.

Structurally, an investor’s liability is limited to its commitment. Typical indemnity provisions may be agreed by investors to indemnify the trustee, manager or other committee member (indemnitees) for claims against the indemnitees, due to activities of the AIF (with usual “bad act” carve-outs, such as for reason of fraud, misconduct or gross negligence). However, this indemnification is also limited to an investor’s commitment. Irrespective of the manner in which the AIF is set up or the indemnification obligations of the investors, contractually the liability of the investors in their capacity as investors are typically restricted to their commitment amount. While the liability of investors is limited in all available structures, if investors participate in the management of the AIF, the liability may extend beyond their contracted capital commitment.

Legal opinions on limitation of liability are provided subject to qualifications and exceptions.

6.       Tax: What is the most common tax regime for investment funds (transparent, exempt, special rate or other regime)?

AIF’s are categorised under the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) into three categories. Only Category I and Category II AIF’s are granted a tax pass through status, whereby any income earned by these AIF’s (other than profits or gains from business) are not taxed at the AIF’s level, but directly taxed as income in the hands of the investors as if these investors had directly received this income from the investments. This principle is applicable to all Category I and II AIF’s irrespective of them being set up as private trusts, companies or LLP’s.

However, there are restrictions on claiming deductions on fee pay-outs and expenses incurred by the AIF while computing its taxable income. For example, the unabsorbed losses of the AIF are not permitted to be allocated to its investors for them to set off against their individual incomes. Further, the distributions from Category I and II AIF’s are subject to a withholding tax of 10% in case of resident investors, and at the rates in force in case of non-resident investors (after giving due consideration to any benefit available to them under any applicable tax treaty).

Having stated the above, business income of Category I and II AIF’s is chargeable at the maximum marginal rate (MMR) of tax (30% plus applicable surcharge and education cess) at the level of the AIF and, once this tax is paid, no further tax on the same income is recoverable from the investors.

Category III AIF’s do not enjoy a statutory tax pass through treatment and hence are typically set up as “determinate trusts”, ie a trust wherein the beneficiaries are identifiable and their respective beneficial interest is determinable at all times. The trustee of a determinate trust may discharge the tax obligation on the income of the trust on behalf of the beneficiaries, ie the investors, in a representative capacity, in the like manner and to the same extent as the investor would have been liable to tax if it would have received the income directly. As an exception to this, trusts having any business income are liable to pay tax at MMR. Given that, under the tax rules, the income tax authorities have the ability to recover tax either from the trustee or from the investors directly, the trustee may prefer to pay the entire tax at the AIF level itself. However, once the entire tax has been paid by the trustee on the AIF’s income, no further tax is recoverable from the investors. The law also grants the trustee (acting as a representative assessee) the right to recover from the investors any taxes paid by it on the investor’s behalf.

Separately, funds set up as revocable trusts should also be eligible for the taxation of their income directly in the hands of their investors, effectively achieving a single level taxation for the income of the fund.

7.       Is your jurisdiction particularly popular with investment sponsors from any particular jurisdictions? If so, is there a specific reason for this?

India has seen a continual upward trend in foreign direct investment (FDI) received with total FDI of more than USD37 billion in the year 2017-18, per the Reserve Bank of India’s (RBI) annual report of 29 August 2018. Mauritius, Singapore and the Netherlands have consistently been the top contributors of FDI in India. These jurisdictions have a robust regulatory regime applicable to investment funds, have a beneficial tax regime with a wide network of tax treaties executed with other countries (including with India) and are well developed financial services centres. India has also executed bilateral investment protection treaties with Singapore and the Netherlands which protects the investors from these jurisdictions from the risk of expropriation.

It is pertinent to note that while certain amendments were introduced to the tax treaties between India-Mauritius and India-Singapore, which resulted in a key benefit with respect to taxation of capital gains in the hands of the Mauritius/Singapore resident investor being taken away, both treaties still offer other benefits. For example, under the India-Mauritius tax treaty, a lower rate of tax of 7.5% on interest income earned by Mauritian resident investors is attractive for yield focused funds. The India-Singapore tax treaty also provides for a lower rate of withholding tax of 15% on interest income arising to a Singaporean resident investor.

8.       Please describe any disclosure requirements to investors with respect to investment funds formed in your jurisdiction. In what circumstances is a PPM required to be issued?

The AIF Regulations require all AIF’s to raise capital by way of private placement only, and exclusively by issuance of a PPM. The AIF Regulations provide guidelines on the disclosures that need to be included in the PPM. These disclosures include all material information about the AIF and its manager, background of the key investment team, targeted investors, fee terms and other relevant expenses chargeable to investors, tenure of the AIF, any restrictions or conditions or limits on redemption, investment strategy, risks and risk management tools and parameters employed, conflict of interest and procedures to identify and address them, and disciplinary history of certain key parties associated with the AIF (such as the manager and sponsor). Any changes made to the PPM are required to be intimated to the investors and the SEBI once every six months, on a consolidated basis.

AIF’s are also required to undertake periodic reporting of their activities to the investors and the SEBI.

9.       Describe the typical legal form(s) of investment funds in your jurisdiction, key differences between the forms and what the different forms tend to be used for.

AIF Regulations permit AIF’s to be set up in the form of companies, LLP’s, or private trusts. Statistically, most AIF’s in India have been set up as private trusts under the provisions of the Trusts Act. Set out below are certain key features of private companies, LLP’s and private trusts:

Sr. No.ItemPrivate Limited CompanyLLPPrivate Trust
1Applicable ActCompanies Act and rules etc, framed thereunderLLP Act and rules etc, framed thereunderTrusts Act and rules etc, framed thereunder
2Legal StatusSeparate legal entity which can sue and be sued and has perpetual successionSame as a private limited companyNo separate legal existence. Trustees are the legal owners of the trust property
3Governing DocumentsCertificate of incorporation, memorandum of

association and articles of association. Shareholders may additionally enter into a shareholders’ agreement

LLP agreement, which sets out all terms between the partnersTrust deed.
4Public Accessibility of RecordsRegistrar of Companies (RoC) records are publically accessibleRoC records (inparticular the LLP agreement) are publically accessibleTrust deed for a trust set up to undertake AIF activity is required to be registered under the Registration Act, 1908. The trust deed is publically accessible
5Management/ GovernanceBy the board of directors.

Can have managing director(s), manager and/or whole time director(s) to look after day to day administration.

Unless agreed otherwise under the LLP Agreement, every partner may take part in the management of the business, and every matter is to be decided by a majority resolution of the partners (each partner having one vote).

DP’s are responsible for statutory compliances under the LLP Act.

Unless agreed otherwise under the LLP Agreement, partners not entitled to remuneration for managing the LLP

Trustee is strictly the manager of the trust. However, trustee can enter into an agreement with the third party (such as professional fund manager) to manage the trust property.
6DissolutionWinding up of companies involves the approval of the National Companies Law Tribunal (NCLT).Winding up of companies involves the approval of the NCLT.By execution of deed of dissolution. In case of AIF’s set up as a private trust, the deed of dissolution would need to be registered under the Registration Act, 1908.


10.      Are there any legal, regulatory or tax legislative changes in process which may impact the current environment?

The SEBI has constituted a standing committee named the Alternative Investment Policy Advisory Committee (AIPAC) under the chairmanship of Mr N R Narayan Murthy (Chairman of Infosys). The AIPAC has submitted three reports to the SEBI with recommendations on legal, regulatory and tax related changes applicable to AIF’s. Some of the key recommendations of the third report of AIPAC are as follows:

•       a reduction in the rate of goods and services tax (GST) leviable on management fees received by a manager from an AIF, in which the majority of the investors are foreign investors, or a consideration of services rendered to an AIF in which the majority of the investors are foreign investors as export of services and thereby a levy of zero rate of GST on management fees;

•        a refinement in the taxation of AIF’s to enable deduction of expenses and pass-through of net losses, while computing income tax liability of investors; and

•        a tax regime for Category III AIF’s which currently do not enjoy any statutory tax pass through status.

Further, the SEBI has notified rules for formation and registration of AIF’s in the IFSC. Please refer to further information provided in the response to Question 1.

B.       Fund Investment

11.     Describe the types of investors located in your jurisdiction you predominantly see investing in investment funds (eg institutional investors, high net worth individuals, family offices, etc.)

Investors who can invest in AIF’s include high net worth individuals, corporates, family offices and institutional investors. Specifically, with respect to institutional investors such as banks, insurance companies and pension funds, their respective regulators being the RBI, the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA) have laid down limitations on their participation in AIF’s.

In so far as foreign domiciled investment funds are concerned, at the outset, it should be noted that investments by Indian investors in offshore funds, which make downline investments in Indian portfolio companies, may be viewed as “round tripping” of funds, and is typically frowned upon by Indian regulators.

The RBI has laid down guidelines with restrictions on the manner in which individuals and corporates may make overseas investments. Under these guidelines, corporates seeking to make investments in joint ventures/wholly owned subsidiaries (which are understood to be strategic investments and exclude portfolio investments) engaged in the financial services sector are required to meet certain regulatory criteria and also obtain prior regulatory approvals both in India and the relevant jurisdiction of the investee entity. Under the extant exchange control guidelines, Indian corporates proposing to make portfolio investments outside India are required to procure prior approval from the RBI. Individuals are permitted to make portfolio investments outside India under the Liberalised Remittance Scheme framed by the RBI, which sets out the type of investments that can be made and the quantum of monies that can be remitted.

12.       Please describe any common legal, regulatory or tax themes or issues to investors in your jurisdiction.

Certain categories of India based investors face the following limitations when investing in AIF’s:

Banks: Banks are permitted to invest not more than 10% of the paid-up capital/unit capital in a Category I/Category II AIF and, if investment exceeds 10% of the paid-up capital/unit capital in a Category I/Category II AIF, the bank would require prior approval from the RBI. The regulatory maximum for investments in AIF’s (Category I and Category II) has been capped at 20% of the bank’s net worth permitted for direct investments in shares, convertible bonds/debentures, units of equity-oriented mutual funds and exposures to AIF’s. Investments by banks in category III AIF’s continues to be not permitted. Further, banks are required to maintain additional capital based on a risk assessment on account of investments in AIF’s, made either directly or through their subsidiaries.

Overall, while a bank’s participation in AIF’s has been restricted, it still has opened up a significant source of capital raise domestically. The need of the hour is to permit banks to invest in category III AIF’s as well (albeit within limits), which will provide a capital source to the AIF’s that are today heavily reliant on foreign capital and Indian retail fund raises.

•         Insurance companies: With respect to insurance companies, the IRDA has permitted both general insurance and life insurance companies to invest in category I AIF’s such as infrastructure funds, SME funds, venture capital funds and social venture funds (as defined under the AIF Regulations) and category II AIF’s (which will invest at least 51% of the funds in infrastructure, SME’s, venture capital and/or social venture entities). The permission to invest in AIF’s from the IRDA however, comes with certain additional restrictions such as iInsurance companies are not permitted to invest in AIF’s which seek to invest in securities of companies incorporated outside India, will take leverage, and/or will be classified as a fund of funds. Further, overall exposure to AIF’s is capped at 3% of respective fund in the case of life insurance companies and 5% of investment assets in the case of general insurance companies. Vis-à-vis a single AIF, insurance companies (both life and general) are permitted to invest the lower of 10% of the AIF fund size or 20% of the overall exposure permitted, provided that in the case of infrastructure funds, the limit is to be read as 20% of the AIF fund size. Further, insurance companies cannot invest in an AIF, where the sponsor of which is a part of the promoter group of the insurer and/or the investment manager is either directly or indirectly controlled or managed by the insurer or its promoters.

•        Pension funds: The PFRDA has recently permitted private sector national pension system scheme (NPS) subscribers to invest in Category I and Category II AIF’s, albeit with the condition that this category of investment has to be in listed instruments or fresh issues that are proposed to be listed. Given the lack of a definitive listing regime for AIF’s, this peculiar condition has created a challenge for pension funds to invest in AIF’s.

Further, the guidelines prescribe that these NPS’s should invest into units of an AIF, which have a minimum AA equivalent rating in the applicable rating scale from one credit rating agency registered with the SEBI, albeit this credit rating would not be required in the case of a government-owned AIF. Other conditions prescribed by the PFRDA are similar to the conditions imposed by the IRDA in respect of investment into AIF’s by insurance companies, for example, the 51% fund utilisation conditions for category II AIF’s, exposure of 10% of the AIF size in a single AIF, restriction in respect of AIF’s who would invest in companies incorporated outside India and the group sponsor and manager restrictions.

In addition, the guidelines prescribe that pension funds should only invest in these AIF’s in which the corpus is equal to or more than INR1 billion. While the guidelines permitting investment by pension funds into AIF’s has been a step in the right direction, much is left to be desired. Restrictions such as minimum corpus of an AIF being an eligibility criterion for a pension fund investment, a credit rating for AIF units and requirement to only invest in listed AIF’s, create a considerable roadblock for investment by NPS’s in AIF’s.

From a tax perspective, the typical issues which are faced by AIF’s and their investors are as follows:

•        the lack of an explicit statutory pass-through status for Category III AIF’s exposes the investors to a higher degree of tax uncertainty since the eventual taxability of the fund and its investors depends on the manner in which the fund is structured and operated;

•        while statutory tax pass through status is available for Category I and Category II AIF’s, investors of these AIF’s are not permitted to offset any unabsorbed losses of the AIF while computing their own tax liability in India; and

•        expenses incurred by investors, such as management fees, are not permitted to be reduced while computing gains arising to investors from an AIF’s investments in capital assets.

Please refer to further information provided in the response to Question 10, along with a summary of key AIPAC recommendations around the tax regime applicable to AIF’s.

13.     Please provide an overview of the marketing restrictions applicable to the marketing of investment funds to investors in your jurisdiction.

AIF’s are permitted to solicit or collect funds on a private placement basis under the AIF Regulations by issuing a placement document that should contain all material information about the AIF. This document is required to be filed with the SEBI. While there is no guidance on the private placement process under the AIF Regulations, an AIF structured as a company should comply with the private placement norms described under Indian company law.

C.       Regulatory Environment

14.   Describe the current regulatory regime in your jurisdiction with respect to advice and management of investment funds. Include details on the authorisation or licensing processes, requirements of the regulator, typical timings and any difficulties that are frequently encountered.

An AIF is required to be managed by a fund manager located in India. The fund manager is typically established in the form of a company or an LLP, depending on legal, regulatory and tax considerations. When acting as a fund manager to an AIF, the entity is not required to obtain any registration over and above the registration of the pooling vehicle it seeks to manage, as an AIF. However, as part of an AIF’s registration process, details of the fund manager including in relation to its key employees, its shareholders, financial statements, details of its infrastructure, and prior experience of managing funds are required to be provided to the SEBI. Given the role that the manager performs vis-à-vis the AIF and the obligations imposed on the manager by the SEBI, the manager is generally understood to be regulated by the SEBI, even though it is not registered with the SEBI.

Further, India based entities also provide investment advisory services to India or offshore fund managers. An entity providing investment advice to any person in India (including AIF’s/managers of AIF’s), or to non-resident Indian investors, is required to be registered with the SEBI as an investment adviser. Registration requires filing an application in a prescribed format with the SEBI, along with other necessary documents. The SEBI typically takes eight to ten weeks to review the application and grant registration. The applicant entity is required to meet the following key requirements:

•        have a minimum net worth of INR2.5 million;

•        showcase sufficient infrastructure to undertake operations; and

•        each of its representatives providing investment advice should procure a certification on financial planning or fund or asset or portfolio management or investment advisory services from the prescribed agency.

Notably, the SEBI regulations place important restrictions on the activities of investment advisers, including a prohibition on charging fees from any person in respect of a transaction of a client, other than the client itself.

Due to tax concerns, typically entities established in India do not directly manage offshore funds, so as to avoid the creation of a place of effective management of the offshore fund in India (which could subject the worldwide income of the offshore funds to tax in India). While the income tax rules provide for safe harbor rules for eligible offshore funds (having a minimum average corpus of INR1 billion) being managed by Indian portfolio managers, the conditions associated with these rules are difficult to comply with in most cases. Entities making non-binding investment related recommendations to offshore funds are more prevalent due to reduced tax risks.

15.      Describe the territorial reach of the regulator in your jurisdiction. How easily can a manager registered in another jurisdiction provide services to a fund in your jurisdiction?

AIF Regulations govern investment funds established in India. Additionally, the SEBI expects the manager of an AIF to be an entity set up in India. Therefore, it is not permissible for entities incorporated outside of India to act as the fund manager to AIF’s.

16.      Are there any investor-protection rules which restrict ownership of fund interests to certain classes of investor?

The AIF Regulations are flexible with respect to the nature of investors who AIF’s are permitted to raise capital from, subject to the minimum subscription amount prescribed as INR10 million per investor (which may be lower for a certain category of investor) and any specific regulations that apply to the investor. However, with respect to angel funds (which are licensed by the SEBI as a sub-category of a Category I AIF, and primarily focus on venture capital undertakings/start-ups), AIF Regulations require that “angel investors” should have net tangible assets of at least INR20 million (excluding the value of principal residence) and should:

•        have early stage investments;

•        have experience as serial entrepreneurs; or

•        be a senior management professional with at least ten years of experience.

Angel funds are permitted to accept lower investments amounts of INR2.5 million from their investors.

Investors who are critical from a systemic risk perspective – and collect deposits or monies from the general public at large, such as banks, insurance companies and pension funds – have a restriction on exposure to alternative assets. For details, please refer to the response to Question 12.

With respect to AIF’s set up in the IFSC, the SEBI has prescribed a minimum net worth of USD1 million for individual investors resident in India who seek to invest in these AIF’s.

17.      Describe the general approach of the regulator in your jurisdiction, for example, whether they are generally co-operative and open to discuss regulatory questions, whether they regularly publish guidance on regulatory matters, whether they tend to be punctual in dealing with matters within expected timeframes, whether they have a history of enforcement or what their approach to enforcement tends to be.

The SEBI and the RBI are approachable and proactive regulators and they frequently interact with industry organisations, service providers and other stakeholders to provide guidance, and develop and improve the regulatory framework applicable to investment funds in India.

Both regulators frequently release guidance, clarifications, FAQ’s and master circulars (which consolidate all relevant circulars and notifications on a given set of regulations) for the ease of reference and understanding. Key changes to regulations are mostly preceded by the release of consultation papers and draft guidelines on which feedback from stakeholders and advisers is sought prior to finalisation.

With particular reference to investment funds, the SEBI has constituted the AIPAC, under the chairmanship of Mr N R Narayan Murthy, to bring further reforms in the AIF industry. The Committee has submitted three reports to the SEBI with recommendations on legal, regulatory and tax related changes applicable to AIF’s.

The SEBI has also laid down a detailed framework for market participants to seek informal guidance from the SEBI pertaining to any aspect of the SEBI regulations. Any such guidance provided by the SEBI is available for public review and available on the SEBI’s website.

D.       Fund Finance

18.      Can funds in your jurisdiction access fund finance for subscription financing and/or leverage?

The AIF Regulations place specific restrictions on the ability of AIF’s to take leverage or borrowing. Category I AIF’s and Category II AIF’s are not allowed to undertake leverage or borrow, whether directly or indirectly, except for temporary funding requirements.

Category III AIF’s are allowed to obtain leverage or borrowing, after procuring the consent of their investors and within the maximum limit prescribed by the SEBI.

19.      Are there any restrictions, issues or requirements in relation to borrowing?

Category I and II AIF’s are not permitted to borrow funds directly or indirectly and shall not engage in leverage, except for meeting temporary funding requirements for not more than 30 days, not more than four occasions in a year and not more than 10% of the investible funds. “Investible funds” has been defined by the SEBI to mean total binding commitments received from investors, net of estimated expenditure for administration and management of the AIF.

While Category III AIF’s may engage in leverage, after procuring necessary investor approval, the extent of leverage employed by a Category III AIF is restricted to two times of its NAV ie, if the AIF’s NAV is INR1 billion, its exposure (Long + shorts) after offsetting positions as permitted shall not exceed INR2 billion, where leverage shall be calculated as under:

Leverage = Total exposure {Longs + Shorts (after offsetting as permitted)} / Net Asset Value (NAV)

Category III AIF’s employing leverage are required to comply with additional compliance and reporting requirements, including filing reports to the SEBI with the details of leverage (in the prescribed format) on a monthly basis.

Category III AIF’s are required to report any breach of the above limit to the investors and the custodian, which in turn are required to report this breach to the SEBI.

E.       Tax Environment

20.    Describe the tax framework that applies to fund structures and allocations and distributions to investors and to carried interest participants. Include a description of the withholding position.

Please refer to the response to Question 6 for a summary of the tax framework that applies to AIF’s and to the investors receiving distributions therefrom, and the description of the relevant withholding tax provisions.

Carried interest is typically subjected to the same tax treatment as applicable to the investors of these AIF’s, when distributed as returns from investments of the AIF. In other cases, where carried interest is paid by AIF’s as performance fees, it would be subject to income tax and GST as levied on fee income.

21.      Provide an overview of the tax treaty network of the jurisdiction and how this impacts the funds industry.

India has an extensive network of tax treaties with comprehensive double tax avoidance agreements executed with 97 countries, in addition to limited tax agreements with eight countries, and tax information exchange agreements with 19 countries. To name a few, India has executed beneficial tax treaties providing key income tax reliefs with Mauritius, Singapore, the US, Canada, the Netherlands, Ireland, Luxembourg etc.

While India has executed treaty protocols with Mauritius and Singapore to withdraw the exemption from Indian taxes on capital gains arising from transfer of equity shares, debt funds focused on investing using debentures continue to benefit from these treaties, both in terms of interest income and gains from transfer of debentures, subject to fulfilment of the treaty conditions and provisions of the General Anti Avoidance Rules (GAAR). Offshore feeder funds and other investors making investments in domestic AIF’s also benefit from any lower rate of withholding tax prescribed under these treaties, while receiving distributions from the AIF’s.

The treaty concluded between India and the Netherlands is particularly advantageous to FPI’s since it provides for a tax exemption on capital gains arising to a Dutch investor from transfer of shares of an Indian company, where these shares represent less than 10% of the total capital stock of the company (which is workable since FPI holdings in shares are subjected to a similar limit under the SEBI regulations), and where the transfer of shares does not occur to a resident of India.

The tax treaties provide greater tax certainty and insulate investors from frequent alterations in the domestic tax framework, thereby boosting LP confidence. Tax treaties facilitate inflow of stable capital to India’s growth hungry corporates. Further, with the Organisation for Economic Co-operation and Development (OECD) issuing its report on the Action Plan on Base Erosion and Profit Sharing (BEPS), inclusion of limitations of benefits clauses in tax treaties and the formal adoption of the GAAR principles into Indian tax laws, the requirement of demonstrating commercial substance has acquired centre-stage in fund structuring discussions.

22.      Describe the FATCA and CRS regimes in your jurisdiction.

With the objective of tackling tax evasion and stashing of unaccounted money abroad, India executed the Inter-Governmental Agreement and Memorandum of Understanding with the government of the US on 9 July 2015 to facilitate exchange of information required by the US, pursuant to FATCA. India also signed a multilateral agreement on 3 June 2015, to automatically exchange information based on Article 6 of the Convention on Mutual Administrative Assistance in Tax Matters under the Common Reporting Standard (CRS). Unless exempted, the term “reporting financial institutions” (RFI) includes both financial institutions resident in India (excluding their offshore branches) and any branches located in India of financial institutions not resident in India. Further, “financial institutions”, as per the Income Tax Act, 1961 (of India), are categorised into: custodial institutions, depository institutions, investment entities, and specified insurance companies.

Pursuant to its international obligations, India has introduced legal obligations for RFI’s to report certain information in respect of “reportable accounts”, by way of amendments to the tax statue. RFI’s are obliged to carry out prescribed due diligence procedures to identify “reportable accounts” (including obtaining necessary documents and a self-certification of status from account holders) and report details of these accounts and the account holders to the Indian income tax department, which may further share it with the governments of other countries in accordance with agreed exchange of information provisions of the applicable treaties and/or international conventions.

Monetary penalties are prescribed for delays in reporting or in cases of incorrect reporting. RFI’s having US reportable accounts are required to obtain Global Intermediary Identification Numbers from the Internal Revenue Service of the US. Notably, domestic AIF’s are required to comply with the aforesaid obligations as financial institutions.

F.       Miscellaneous

23.    Please provide an overview of key asset management industry bodies in your jurisdiction, including who they represent and what their aims are.

While there are several industry bodies in India that represent the interests of various market participants in the asset management space, key industry bodies include:

•        The Indian Private Equity and Venture Capital Association (IVCA): this association seeks to develop and promote India’s private equity sector and actively demonstrates its impact to the government, media, and the public at large, as well as establishes high standards of ethics, business conduct and professional competence. It also serves as a platform for investment funds to interact with each other and develop the private equity/venture capital ecosystem in India. The IVCA represents several fund industry participants, including private equity and venture capital funds, limited partners, corporate and institutional advisers, lawyers and tax advisers.

•        The Indian Association of Alternative Investment Funds (IAAIF): this industry body promotes and protects the interests of the alternative investments industry in India. They are a representative and advocacy body devoted to promote transparency, professional standards and trust in the alternative investments industry with the aim to facilitate interaction and collaboration among its members. Members of this association include fund managers, wealth managers, trustees, brokers, legal and accounting firms, financial research and technology companies, limited partners, credit rating agencies and fund administrators.

24.      Are courts or arbitration generally preferred in relation to fund documents governed by the laws of your jurisdiction?

As per Regulation 25 of the AIF Regulations, an AIF (by itself or through the manager or sponsor) can lay down the procedure for resolution of disputes between the investors, AIF manager or sponsor through arbitration or any such mechanism as mutually decided between the investors and the AIF.

Market participants in the AIF industry tend to prefer arbitration as a mode of dispute resolution. Given most of the AIFs in India are established as trusts, it is important to note that Indian courts have ruled that disputes relating to trusts arising out of the trust deed cannot be decided by arbitration. However, where the contribution agreement (which establishes the relationship between the trustee, manager and each investor) is the principal governing agreement, any disputes arising under the contribution agreement could be decided by arbitration.

25.      What level of litigation/arbitration has there been locally in relation to investment funds management or investment?

The investment funds industry in India is fairly nascent and given fund managers operating in this space raise capital primarily from sophisticated investors who are aware of the risks associated with this investment, this industry has seen a lower level of litigations/arbitrations. This is coupled with the fact that many grievances are efficiently addressed through the SEBI’s online grievance redressal system known as SCORE which allows investors to file complaints directly against the fund managers and gives the fund managers an opportunity to respond to the same.

The litigations/arbitrations that have taken place in this industry have been typically around:

•        disputes by investors against fund managers on allegations of fraud, gross negligence or misrepresentation;

•        alleged penal actions having been taken by fund managers in the case of default to make payment by investors; and/or

•        disputes by team members against fund managers in relation to incentive fee/other compensation payouts.

26.     Are there any periodic reporting requirements for funds in your jurisdiction? If so, is any of the information publicly available?

AIF’s are required to undertake periodic reporting to investors and the SEBI under the AIF Regulations. As per the AIF Regulations, AIF’s are required to submit an annual compliance test report to the trustee (in cases where the AIF is a trust) or sponsor (in the case of any other form of AIF). AIF’s are also required to provide, on an annual basis, reports to investors in relation to the financial information of investee companies and material risks and their management, provided that these reports are not required to be provided by category III AIF’s on a quarterly basis.

The SEBI also requires AIF’s to report in prescribed formats in relation to, inter alia, sector-wise investments, investments in associate entities and number of investors in the AIF itself. This reporting is required to be undertaken by Category I, II and III AIF’s (which do not undertake leverage) on a quarterly basis and Category III AIF’s (which undertake leverage) on a monthly basis. Separately, Category III AIF’s may be subject to additional reporting obligations in cases where they undertake leverage or are investing in commodity derivatives.

In addition, AIF’s are required to provide a description of the valuation procedure and methodology for valuing assets to investors on an ongoing basis and disclose conflicts of interest as and when they arise. Further, in case of an AIF which has a manager/investment manager or sponsor which is not Indian owned and controlled and/or the control of the AIF is not in the hands of the sponsor and manager/investment manager, with the general exclusion to others, additional reporting obligations as prescribed by the RBI and Department of Industrial Policy & Promotion may arise in respect of downstream investments by these AIF’s. Further, the RBI has also set out reporting obligations for an AIF receiving foreign investment.

The information in relation to AIF’s as is reported to investors and the SEBI is not available to the public.

27.      Can investors in your jurisdiction give powers of attorney in favour of fund managers? If so, please describe any limitations.

Considering that monies and assets of AIF’s are held by the fund itself, and the fund manager is typically authorised to undertake decisions in relation to fund investments and execute contracts with investee companies, fund managers typically request for a limited Power of Attorney for execution and/or amendment of fund documents on behalf of the investors, once necessary consents from investors have been obtained.


Ashwath Rau
Pallabi Ghosal
Vivaik Sharma





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