Funds

Debt Investments by FPIs

Published In:Inter Alia - Quarterly Edition - October 2017 [ English Chinese japanese ]

SEBI issued a circular on July 20, 2017, which brought about the following modifications to the existing legal framework governing investments in corporate debt by FPIs:

i. 95% of the combined corporate debt limit (‘CCDL’) will be available for FPI investment on tap, after which an auction mechanism will be initiated for allocating the remaining limits.

ii. Once such limit is exceeded, the National Securities Depository Limited and Central Depository Services Limited will direct custodians to halt further investments in corporate debt securities by FPIs, and inform BSE Limited and National Stock Exchange of India Limited to conduct an auction for allocation of the unutilised FPI corporate debt limit, provided such limit is at least Rs. 100 crores (approx. US$ 15.3 million). If the unutilised FPI corporate debt limit continues to remain lower than the above amount for 15 consecutive trading days, then an auction is to be conducted on the 16th day.

iii. The minimum bid is Rs. 1 crore (approx. US$ 153,000), and the maximum bid is for 10% of the unutilised FPI corporate debt limit. A single FPI/ FPI group cannot bid for more than 10% of the limits being auctioned.

iv. Once the unutilised FPI corporate debt limit has been auctioned, the FPIs have a utilisation period of 10 trading days to make investments, after which the unutilized FPI corporate debt limit allocated to them, reverts to the pool of free limits.

v. Investment in corporate debt by FPIs on tap and issuance of rupee denominated bonds overseas by Indian companies will again be available once the FPI corporate debt limit utilisation levels fall back to less than 92%.

vi. Investments by FPIs in unlisted corporate debt will compulsorily be in dematerialised form, and be subject to a minimum residual maturity period of three years.

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Amendment to SEBI (Alternative Investment Funds) Regulations, 2012

Published In:Inter Alia - Quarterly Edition - January 2017 [ English Chinese japanese ]

Pursuant to the decision taken in the SEBI Board Meeting, the SEBI (Alternative Investment Funds) Regulations, 2012 have been amended with effect from January 4, 2017 as follows:

i. The upper limit of angel investors in a scheme has been increased from 49 to 200;

ii. Angel funds are permitted to invest in start-ups incorporated within five years from incorporation, which has been increased from the earlier limit of three years;

iii. The requirements of minimum investment amount by an angel fund in any venture capital undertaking has been reduced from Rs. 50,00,000 (approximately US$ 75,000) to Rs. 25,00,000 (approximately US$ 37,500), and the lock-in period of these investments has been reduced from three years to one year; and

iv. Angel funds will now be permitted to invest in securities of foreign companies, subject to the guidelines and conditions issued by the RBI and SEBI.

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Amendment to SEBI (Real Estate Investment Trusts) Regulations, 2014 and SEBI (Infrastructure Investment Trusts) Regulations, 2014

Published In:Inter Alia - Quarterly Edition - January 2017 [ English Chinese japanese ]

Pursuant to the meeting of the SEBI board held on September 23, 2016, SEBI has amended the SEBI (Real Estate Investment Trusts) Regulations, 2014 and the SEBI (Infrastructure Investment Trusts) Regulations, 2014. Some of the key amendments include:

i. The minimum holding of the mandatory sponsor in the infrastructure investment trust (‘InvIT’) has been reduced from 25% to 15%;

ii. The existing limit of three sponsors has been removed from both regulations;

iii. The permissible investment limit for investment by real estate investment trusts (‘REIT’) in ‘under construction’ assets has been increased from 10% to 20%; and

iv. InvITs and REITs are allowed to invest in a two-level SPV holding structure, through a holding company.

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Consultation Paper on Amendments/Clarifications to the SEBI (Investment Advisers) Regulations, 2013

Published In:Inter Alia - Quarterly Edition - October 2017 [ English Chinese japanese ]

SEBI, on June 22, 2017, issued a consultation paper on Amendments/ Clarifications to the SEBI (Investment Advisers) Regulations, 2013 (‘IA Regulations’), setting out the following key proposals:

i. Segregation between “investment advisory” services and “distribution/execution services”: To maintain a clear segregation between these two services provided by the same entity and to prevent associated conflicts of interest, SEBI has proposed amending the IA Regulations to prohibit entities offering investment advisory services from offering distribution/execution services, including in cases of banks, non-banking financial companies and body corporates that offer such services through separately identifiable departments or divisions. Such departments will be required to be segregated within a period of six months through a separate subsidiary. Entities which provide advice solely on products which do not qualify as securities have been excluded from the purview of the IA Regulations.

ii. Distribution of mutual fund schemes by distributors: To maintain a clear segregation between “advising” and “selling / distribution” of mutual fund products”, SEBI proposes that mutual fund distributors will only be permitted to explain the features of schemes of which they are distributors and distribute them while ensuring suitability of the scheme to the investors, but will not give any investment advice.

iii. Incidental advice by recognized intermediaries: Under the existing framework, exemptions from IA registration have been granted to inter alia various intermediaries, who give investment advice to their clients incidental to their primary activity. SEBI has now proposed that in order to have a clear segregation between “investment advisory services” and other services provided by such intermediaries, all intermediaries who receive separate identifiable consideration for investment advisory services will need to register with SEBI as an investment adviser. Moreover, persons who provide holistic advice/ financial planning services are compulsorily required to be registered as investment advisers.

iv. Relaxation in registration requirements: SEBI has proposed that the educational qualification requirements for representatives/employees of registered investment advisers be relaxed. It has also been proposed to reduce the net worth requirement for body corporates from Rs. 25 lakhs (approx. US$ 38,000) to Rs. 10 lakhs (approx. US$ 15,000).

v. Regulation of the activity of ranking of mutual fund scheme: SEBI has proposed that the activity of ranking of mutual fund schemes be brought within the ambit of SEBI (Research Analyst) Regulations, 2014, under a separate chapter.

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FAQs in relation to the SEBI (Alternative Investment Funds) Regulations, 2012

Published In:Inter Alia - Quarterly Edition - October 2016 [ English Chinese japanese ]

According to the SEBI (Alternative Investment Funds) Regulations, 2012, a debt fund is permitted to invest in ‘debt or debt securities’. In the past, there was ambiguity on whether a debt fund is permitted to give loans. As per the FAQs issued by SEBI on August 18, 2016 , it was clarified that alternative investment funds are not permitted to give loans and, accordingly, loans cannot be considered under the ambit of “debt or debt securities”.

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Meeting of the SEBI Board

Published In:Inter Alia - Quarterly Edition - October 2016 [ English Chinese japanese ]

The SEBI Board met on September 23, 2016 and took the following decisions:

i.  Currently, FPIs are required to transact in securities through stock brokers registered with SEBI, while domestic institutions such as banks, insurance companies, pension funds etc. are permitted to access the bond market directly (i.e. without brokers). SEBI has decided to extend this privilege to Category I and Category II FPIs.

ii.  In order to facilitate the growth of Investment Trusts (“InvIT”) and Real Estate Investment Trusts (“REIT”), SEBI has decided to amend the SEBI (Infrastructure Investment Trusts) Regulations, 2014 and the SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”). The key amendments will include:

a.  InvITs and REITs will be allowed to invest in the two level SPV structure through the holding company subject to sufficient shareholding in the holding company and other prescribed safeguards. The holding company would have to distribute 100% cash flows realised from the underlying SPVs and at least 90% of the remaining cash flows.

b.  The minimum holding of the mandatory sponsor in the InvIT has been reduced to 15%.

c.  REITs have been permitted to invest upto 20% in under construction assets.

d.  The limit on the number of sponsors has been removed under the REIT Regulations.

iii.  The SEBI Board has approved amendments to the SEBI (Portfolio Managers) Regulations, 1993, to provide a framework for the registration of fund managers for overseas funds, pursuant to the introduction of section 9A in the Income Tax, 1961.

iv.  The SEBI Board has decided to grant permanent registration to the following categories of intermediaries: merchant bankers, bankers to an issue, registrar to an issue & share transfer, underwriters, credit rating agency, debenture trustee, depository participant, KYC registration agency, portfolio managers, investment advisers and research analysts.

v.  The Securities Contracts (Regulation) (Stock Exchanges and Cleaning Corporations) Regulations, 2012 have been amended to increase the upper limit of shareholding of foreign institutional investors mentioned in the Indian stock exchanges from 5% to 15% and to allow an FPI to acquire shares of an unlisted stock exchange through transactions outside of recognised stock exchange including allotment.

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Foreign Investment in Units Issued by REITs, InvITs and AIFs

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

Salient features of foreign investment permitted by RBI, pursuant to its circular dated April 21, 2016, in the units of investment vehicles for real estate and infrastructure registered with the SEBI or any other competent authority are as under:

i. A person resident outside India (including a Registered Foreign Portfolio Investor (‘RFPI’) and NRIs may invest in units of real estate investment trusts (‘REITs’);

ii. A person resident outside India who has acquired or purchased units in accordance with the regulations may sell or transfer in any manner or redeem the units as per regulations framed by SEBI or directions issued by RBI;

iii. An Alternative Investment Fund Category III with foreign investment can make portfolio investment in only those securities or instruments in which a RFPI is allowed to invest; and

iv. Foreign investment in units of REITs registered with SEBI will not be included in ‘real estate business’.

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Guidelines for Public Issue of Units of Infrastructure Investment Trusts

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

SEBI has, on May 11, 2016, issued Guidelines for Public Issue of Units of Infrastructure Investment Trusts (‘Guidelines’), which amend the provisions of the SEBI (Infrastructure Investment Trusts) Regulation, 2014 (‘SEBI InvIT Regulations’).

The Guidelines set out the procedure to be followed by an infrastructure investment trust (‘InvIT’) in relation to a public issue of its units, which includes the appointment of a lead merchant banker and other intermediaries, procedure for filing of offer documents with SEBI and the stock exchanges, the process of bidding and allotment. Further, the allocation in a public issue is required to be in the following proportion: (i) not more than 75% to institutional investors; and (ii) not less than 25% to other investors; provided that the investment manager has the option to allocate 60% of the portion available for allocation to institutional investors and anchor investors (which includes strategic investors), subject to certain conditions. Further, the investment manager, on behalf of the InvIT is required to deposit and keep deposited with the stock exchange(s), an amount equal to 0.5% of the amount of the units offered for subscription to the public or Rs 5 crores (approximately US$ 7,45,000), whichever is lower. The price of units can be determined either: (i) by the investment manager in consultation with the lead merchant banker; or (ii) through the book building process. However, differential prices are not permitted.

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SEBI Board Meetings

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

SEBI, in its board meeting held on May 19, 2016, approved the incorporation of the internal guidance note in the SEBI (Settlement of Administrative and Civil Proceedings) Regulations 2014 (‘Settlement Regulations’), to clarify that only serious and substantial cases are to be taken for enforcement under Regulation 5(2)(b) of the Settlement Regulations. For this purpose, defaults which in the opinion of SEBI have a bearing on the securities market as a whole and not just the listed security and its investors may be considered to have market wide impact.

Thereafter, in its meeting held on June 17, 2016, SEBI approved the two consultation papers in relation to the changes to be made to the SEBI (Portfolio Managers) Regulations and the SEBI InvIT Regulations.

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SEBI Circular on Restriction on Redemption in Mutual Funds

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

SEBI, on May 31, 2016 issued a circular providing details of certain specified circumstances in which mutual funds/ asset management companies/ trustees could impose restrictions on redemption of units of their mutual fund schemes. SEBI has provided that the restriction on redemption cannot exceed ten working days in any 90 day period and would be applicable for redemption requests above Rs 200,000 (approximately US$ 2,975). Further, specific approval of the board and trustees of an asset management company is required before imposing such restrictions and SEBI should be notified of such approval immediately.

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Easing of access norms for investments by Foreign Portfolio Investors

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

SEBI has, by way of circulars dated February 15, 2018 and March 13, 2018 (collectively, the ‘FPI Circulars’), revised the regulatory framework governing foreign portfolio investors (‘FPIs’) under the SEBI (Foreign Portfolio Investors) Regulations, 2014 (‘FPI Regulations’) to ease the access norms for investments by FPIs. Some of the key changes that have come into force are set out below:

i. The current requirement of prior SEBI approval for a change in local custodian/ designated depository participant (‘DDP’) has been replaced with the requirement of obtaining a no-objection certificate from the earlier DDP, followed by a post-facto intimation to SEBI.

ii. The regime has been liberalized concerning FPIs having ‘Multiple Investment Managers’ structure and the same permanent account number, with respect to ‘Free of Cost’ transfer of assets. Approval of SEBI is now not required and DPPs are now entitled to process such requests.

iii. In case of addition of a new share class, where a common portfolio of Indian securities is maintained across all classes of shares/fund/sub-fund and broad based criteria are fulfilled at a portfolio level after adding a new share class, prior approval of the DDP is no longer required.

iv. Private banks and merchant banks are now permitted to undertake investments on behalf of their respective investors, provided that the investment banker/merchant banker submits a prescribed declaration.

v. SEBI also clarified that appropriately regulated Category II FPIs viz. asset management companies, investment managers/ advisers, Portfolio managers, Broker-dealer and Swap-dealer etc. are permitted to invest their proprietary funds.

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Participation by Strategic Investor(s) in InvITs and REITs

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

Pursuant to SEBI’s circular dated January 18, 2018 (‘SEBI Circular’), a Real Estate Investment Trust (‘REIT’) / Infrastructure Investment Trust (‘InvIT’) may invite subscriptions from strategic investors subject to inter alia the following:

i. The strategic investors can, either jointly or severally, invest not less than 5% and not more than 25% of the total offer size.

ii. The investment manager or manager is required to enter into a binding unit subscription agreement with the strategic investors proposing to invest in the public issue, which agreement cannot be terminated except if the issue fails to collect minimum subscription.

iii. The entire subscription price has to be deposited in a special escrow account prior to opening of the public issue.

iv. The price at which the strategic investors have agreed to buy units of the InvIT/ REIT should not be less than the public issue price. In case of a lower price, the strategic investors should bring in the additional amounts within two working days of the determination of the public issue price, and in case of a higher price, the excess amount will not be refunded and the strategic investors will be bound by the price agreed in the unit subscription agreement.

v. The draft offer document or offer document, as applicable, will disclose details of the unit subscription agreement, including the name of each strategic investor, the number of units proposed to be subscribed etc.

vi. Units subscribed by strategic investors, pursuant to the unit subscription agreement, will be locked-in for a period of 180 days from the date of listing in the public issue.

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Outcome of SEBI meeting held on March 28, 2018

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

In its meeting held on March 28, 2018, SEBI accepted the recommendations of the Kotak Committee on Corporate Governance (‘Committee’) along with certain other proposals discussed. Set out below are some of the key proposals:

i. (a) Reduction in the maximum number of listed entity directorships from 10 to (x) eight by April 1, 2019, and (y) seven by April 1, 2020; (b) expanding the eligibility criteria for independent directors; (c) disclosure of utilization of funds from qualified institutional placement or preferential issue; (d) separation of chief executive officer/managing director and chairperson (to be initially made applicable to the top 500 listed entities by market capitalization with effect from April 1, 2020); (e) enhancing the role of the audit committee, nomination and remuneration committee and the risk management committee; (f) strengthening the disclosures pertaining to related party transactions and related parties being permitted to vote against such transactions; (g) enhancing the obligations on listed entities with respect to subsidiaries; and (h) shareholder approval (majority of minority) for royalty/brand payments to related party exceeding 2% of consolidated turnover.

ii. Certain amendments to SEBI (Alternative Investment Funds) Regulations, 2012, with respect to ‘Angel Funds’: (i) Maximum investment amount in venture capital undertakings by an angel fund has been increased from Rs. 5 crores to Rs. 10 crores (approx. US$ 750,000 to US$ 1.5 million); (ii) mandatory minimum corpus of an angel fund has been reduced to Rs. 5 crores (approx. US$ 750,000); and (iii) provisions of the Companies Act have been made applicable to an angel fund, if formed as a company.

iii. Revision of the existing framework for non-compliance of the listing regulations by listed companies, inter alia, empowering the stock exchanges to freeze the shareholding of the promoter and promoter group in a non-compliant entity along with their shareholding in other securities. SEBI is empowered to order suspension if the non-compliance persists.

iv. Undertaking a public consultation process for a review of the SEBI (Buy-back of Securities) Regulations, 1998 and the Takeover Regulations and inviting comments from stakeholders in relation to compliance with various SEBI regulations by listed entities subject to the corporate insolvency resolution process under the IBC.

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Finance Act, 2018

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Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

Some of the key amendments introduced by the Finance Act, 2018 (‘Finance Act’) are summarized below:

i. New long-term capital gains tax regime for listed shares etc.

• Under the unamended provisions of the Indian Income-tax Act, 1961 (‘IT Act’), with respect to transfer/redemption of units of an equity oriented mutual fund or an on-market[1] sale of Indian equity shares (listed or as part of an initial public offer) or units of a business trust, long-term capital gains were exempt from tax in India, subject to payment of securities transaction tax (‘STT’) (which may vary from 0.001% to 0.2% of the transaction value).

• The Finance Act has withdrawn the aforesaid long-term capital gains tax exemption and has proposed a new long-term capital gains tax regime for the above asset class. Under the new regime, the long-term capital gains, in excess of Rs. 0.1 million (approx. US$ 1,500) in a tax year, arising from transfer/redemption of units of an equity oriented mutual fund or an on-market transfer of Indian equity shares (including sale of shares as part of initial public offer) will be taxed at the rate of 10% (plus applicable surcharge and cess) subject to payment of STT, as applicable as before.[2] The computation of such capital gains will be subject to step up of the cost base till January 31, 2018. This amendment will apply on any capital gains arising on or after April 1, 2018.

ii. Scope of ‘Business Connection’ proposed to be widened:

• The scope of ‘business connection’ under the IT Act is similar to the provisions relating to Dependent Agent Permanent Establishment (‘DAPE’) in India’s Double Taxation Avoidance Agreements (‘DTAAs’). However, this scope is proposed to be widened pursuant to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (‘MLI’). In order to align the scope of ‘business connection’ with the expanded definition of DAPE, the Finance Act has introduced an amendment to the definition of ‘business connection’ to also include any business activities carried through a person who, acting on behalf of the non-resident, habitually plays the principal role leading to conclusion of contracts by the non-resident. This has taken effect from the financial year beginning April 1, 2018.

• Until now, the scope of ‘business connection’ under the IT Act provided for physical presence based nexus rule for taxation of business income of the non-resident in India. Therefore, emerging business models such as digitized businesses were not covered within its scope.

In light of the above, Section 9(1)(i) of the IT Act has been amended to provide that ‘significant economic presence’ in India should also constitute ‘business connection’. This amendment in the domestic law will enable India to negotiate for inclusion of the new nexus rule in the form of ‘significant economic presence’ in the DTAAs. Unless corresponding modifications to permanent establishment rules are made in the DTAAs, the cross border business profits will continue to be taxed as per the existing DTAA rules. However, where the foreign enterprise is not entitled to a DTAA protection, the above amendment would become immediately effective. This amendment has taken effect from financial year beginning April 1, 2018.

[1]     Sale on the floor of a recognized stock exchange in India.

[2]     In certain notified listed equity shares, there is a condition that STT should have been paid at the time of acquisition of such shares as well at the time of transfer so as to be eligible for this regime.

 

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Participation of Category III Alternative Investment Funds in the Commodity Derivatives Market

Published In:Inter Alia - Quarterly Edition - July 2017 [ English Chinese japanese ]

SEBI has by way of its circular dated June 21, 2017, permitted Category III Alternative Investment Funds to participate in the commodities derivatives market subject to the following conditions:

i. to participate on the commodity derivatives exchanges as ‘clients’, subject to compliance of all SEBI rules, regulations, position limit norms issued by SEBI / stock exchanges etc., as applicable to clients;

ii. to not invest more than 10% of the investable funds in one underlying commodity;

iii. leveraging or borrowing subject to consent from the investors and maximum limit specified by SEBI (presently capped at 2 times the net asset value of the fund);

iv. disclosures to be made in the private placement memorandum of intent to invest in commodity derivatives, consent of existing investors to be taken and exit opportunities to be provided to the dissenting investors; and

v. to comply with SEBI reporting requirements.

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Proposals approved at SEBI Board Meetings

Published In:Inter Alia - Quarterly Edition - July 2017 [ English Chinese japanese ]

Some of the key proposals approved in the board meetings of the SEBI held on April 26, 2017 and June 21, 2017 are as follows:

i. Amendment to the SEBI (Stock Brokers and Sub-brokers) Regulations, 1992 to permit stock brokers / clearing members currently dealing in commodity derivatives to deal in other securities and vice versa, without setting up a separate entity;

ii. Relaxations from preferential issue requirements under the ICDR Regulations and from open offer obligations under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (‘SAST Regulations’) which are currently available to lenders undertaking strategic debt restructuring of listed companies in distress, and be extended to new investors acquiring shares in such distressed companies pursuant to such restructuring schemes. Such relaxations, however, will be subject to shareholder approval by way of a special resolution and lock-in of shares for a minimum period of 3 years. The relaxations will also be extended to lenders under other restructuring schemes undertaken in accordance with the guidelines of the RBI;

iii. Exemption from open offer obligations under the SAST Regulations, for acquisitions pursuant to resolution plans approved by the NCLT under the IBC;

iv. Extension of relaxations in relation to the lock-in provisions currently available to Category I AIFs in case of an initial public offering to Category II AIFs as well;

v. Proposal for initiation of a public consultation process to make amendments to the FPI Regulations: (a) expansion of the eligible jurisdictions for the grant of FPI registrations to Category I FPIs by including countries having diplomatic tie-ups with India; (b) simplification of broad based requirements; (c) rationalization of fit and proper criteria; and (d) permitting FPIs operating under the multiple investment managers structure and holding FVCI registration to appoint multiple custodians; and

vi. Levy of a regulatory fee of USD 1,000 on each ODI subscriber, once every 3 years, starting from April 1, 2017 and to prohibit ODIs from being issued against derivatives except those which are used for hedging purposes.

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Qualification for Long Term Capital Gains Tax Exemption

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Published In:Inter Alia - Quarterly Edition - July 2017 [ English Chinese japanese ]

Finance Act, 2017 (‘Finance Act’) had amended Section 10(38) of Income Tax Act, 1961 (‘ITA’) to withdraw the long-term capital gains tax exemption available on transfer of listed equity shares acquired on or after October 1, 2004 and which were not chargeable to Securities Transaction Tax (‘STT’). However, the Central Government was authorized to carve out those transactions, which would not lose the capital gains tax exemption, by issuing a notification in that regard.

In pursuance thereof, the Central Board of Direct Taxes (‘CBDT’) has issued a notification dated June 5, 2017 listing both, i.e. the transactions which will lose exemption and also those transactions which will not lose the exemption, as per details below:

i. Acquisition of existing listed equity shares in a company, whose equity shares are not frequently traded in a recognized stock exchange of India, which are made through a preferential issue. However, the following acquisition of listed equity shares (even if made through a preferential issue) are protected and continue to be covered by Section 10(38) exemption:

a. Acquisition of shares which has been approved by the Supreme Court (‘SC’), High Court (‘HC’), NCLT, SEBI or RBI in this behalf;

b. Acquisition of shares by any non-resident in accordance with foreign investment guidelines;

c. Acquisition of shares by an Investment fund or a Venture Capital Fund or a QIB; and

d. Acquisition of shares through a preferential issue to which the provisions of Chapter VII of the ICDR Regulations do not apply.

ii. Transactions for acquisition of existing listed equity shares in a company which are not entered through a recognized stock exchange. However, the following acquisitions of listed equity shares are protected (even if not made through a recognized stock exchange) and continue to be covered by Section 10(38) exemption.

a. Acquisition through an issue of share by a company other than preferential issue, as an example receipt of bonus shares, shares upon conversion of instruments or splitting of shares;

b. Acquisition by scheduled banks, reconstruction or securitization companies or public financial institutions during their ordinary course of business;

c. Acquisition which has been approved by the SC, HCs, NCLT, SEBI or RBI in this behalf;

d. Acquisition under employee stock option scheme or employee stock purchase scheme framed under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999;

e. Acquisition of shares by any non-resident in accordance with foreign investment guidelines;

f.  Acquisition of shares under SAST Regulations;

g. Acquisition from the Government;

h. Acquisition of shares by an Investment fund or a Venture Capital Fund or a QIB; and

i. Acquisition by mode of transfer referred to in Sections 47 or 50B of the ITA if the previous owner of such shares has not acquired them by any mode which is not eligible for exemption as per this notification.

iii. Acquisition of equity shares of a company during the period of its delisting from a recognized stock exchange.

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Changes in the Foreign Investment regime in India

The Reserve Bank of India (‘RBI’) recently issued the Master Directions on Foreign Investment in India (‘Master Directions’) on January 4, 2018, on the heels of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (‘New FEMA 20’) issued by way ofNotification dated November 7, 2017, which replace the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (‘Erstwhile FEMA 20’) and the Foreign Exchange Management (Investments in Firms of Proprietary Concerns in India) Regulations, 2000.

The New FEMA 20 and the Master Directions now contain comprehensive rules on foreign investment in India as issued by the RBI. A summary of some of the key changes to the Erstwhile FEMA 20 introduced by the RBI are set out below:

i. Definition of ‘Capital Instruments’: The New FEMA 20 has introduced a definition of ‘Capital Instruments’[1]. While the base definition remains similar to that of ‘Capital’ under the Erstwhile FEMA 20, two clarifications have been provided as follows:-

(a) Non-convertible/ optionally convertible/ partially convertible preference shares issued up to April 30, 2007, as well as optionally convertible/ partially convertible debentures issued up to June 7, 2007 will be considered to be capital instruments till their original maturity; and

(b) Share warrants can be issued to a person resident outside India only in accordance with the regulations issued by the Securities and Exchange Board of India (i.e. the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009), i.e. share warrants can be issued to a person resident outside India only by a listed Indian company.

ii. Definition of ‘Foreign Investment’: ‘Foreign investment’[2] has been defined under the New FEMA 20 to mean any investment by a person resident outside India in the capital instruments of an Indian company or in the capital of a limited liability partnership (‘LLP’), on a repatriable basis; thereby clarifying that investments made on a non-repatriable basis are to be treated as domestic investments and not included in the foreign investment limits.

iii. Definition of ‘Foreign Direct Investment’: The definition of ‘foreign direct investment’[3] (‘FDI’) under the New FEMA 20 distinguishes between investments in unlisted and listed Indian companies. While any investment by a person resident outside India in the capital instruments issued by an unlisted Indian company is to be treated as FDI, in case of listed Indian companies, only investments of 10% or more of the post issue paid-up equity capital of a listed Indian company, computed on a fully diluted basis, is to be treated as FDI.

iv. New Concept – Foreign Portfolio Investment: Under New FEMA 20, RBI has introduced a new concept of an investment being categorized as ‘Foreign Portfolio Investment’ if the investment made by a person resident outside India in a listed Indian company is less than 10% of the post issue paid-up equity share capital (on a fully diluted basis) of such listed Indian company or less than 10% of the paid up value of each series of capital instruments of such listed Indian company.[4] Please note that there a distinction between foreign portfolio investment and investment by an entity registered with SEBI as a foreign portfolio investor (‘FPI’). All investments by each FPI will necessarily be foreign portfolio investment, whereas investment by entities who are not registered as FPI can also be categorized as ‘foreign portfolio investment’ depending upon the percentage of investment made. Purchase / sale of capital instruments of listed Indian company on a stock exchange by FPIs is set out in Schedule 2 of the New FEMA 20.

Foreign portfolio investment by way of a primary subscription is exempt from the reporting requirements prescribed in respect of FDI transactions. In the event foreign portfolio investment exceeds the 10% limit, such investment will stand re-classified as FDI. However, on the other hand, in the event an existing investment by a non resident in a listed Indian company falls to a level below 10% of such company’s post issue paid up equity capital (on a fully diluted basis), such investment will continue to be treated as FDI.

v. Definition of ‘Indian entity’: The tern Indian entity has been defined to mean an Indian company and an LLP.[5]

vi. Definition of ‘Investment Vehicle’: The Master Directions clarify that venture capital funds established in the form of a trust, company or a body corporate and registered under the SEBI (Venture Capital Funds) Regulations, 1996 will not be considered as investment vehicles for the purposes of the New FEMA 20.[6] Prior Government approval would be required for making foreign investments in venture capital funds established as trusts.

vii. Definition of ‘Listed Indian Company’: Listed Indian Company has been defined to mean an Indian company which has any of its capital instruments listed on a recognized stock exchange in India.[7] Accordingly, an Indian company which has only its non-convertible debentures listed on a stock exchange would not be considered as a Listed Indian Company.

viii. Acquisition through a rights or bonus issue: While the conditions relating to acquisition of capital instruments (other than warrants) by way of rights or bonus issue continue to remain the same, it have been clarified that the conditions would also apply to subscription to capital instruments issued as a rights issue that are renounced by the person(s) to whom they were offered.[8]

Further, a person resident outside India exercising any rights in respect of capital instruments issued when he / she was resident in India, can exercise such rights on a non-repatriation basis (i.e. the original status of the holding will not change even in the event the residential status of the holder changes).[9]

Similarly, an individual resident outside India exercising an option granted pursuant to an employee stock option scheme when he / she was resident in India, can hold the shares so acquired on exercising the option on a non-repatriation basis.[10]

ix. Transfer of capital instruments: Transfer by way of sale of capital instruments by a non-resident Indian (‘NRI’) to non-residents other than NRIs no longer requires prior RBI approval, subject to certain conditions.

x. Reporting Requirements: The onus of filing Form FC-TRS for transfers on a recognized stock exchange will now vest with the non-resident party and not the relevant Indian company.[11] The New FEMA 20 has further clarified that in case of transfer of repatriable capital instruments by a non-resident transferor to another non-resident transferee on non-repatriable basis, the onus of such filing would vest with resident transferor / transferee or the non-resident holding capital instruments on a non-repatriable basis, as the case may be. It is also clarified that a transfer of capital instruments between a non- resident transferor holding such instruments on non-repatriable basis and a resident transferee would not attract such a reporting requirement.[12]

Further, Form FC-TRS is now required to be filed with the authorised dealer bank with 60 days of transfer of capital instruments or receipt / remittance of funds, whichever is earlier.[13]

xi. Downstream investments: While the definition of ‘downstream investments’ under the Erstwhile FEMA 20 only considered indirect foreign investments by one Indian company into another Indian company, the definition has now been revised to include investments by Indian companies, LLPs or investment vehicles (each, an Indian entity), in the capital instruments or the capital (as the case may be), of another Indian company or LLP.[14] Further, downstream investments are now required to be reported by way of a Form DI within 30 days of such investment to the Secretariat for Industrial Assistance, Department of Industrial Promotion. However, the format of this Form DI is yet to be specified by the RBI.[15]

xii. Clarifications regarding reporting and pricing guidelines: In addition to the above, the New FEMA 20 has further clarified that capital instruments of any Indian company held by another Indian company which is not owned and not controlled by resident Indians or is owned and controlled by persons resident outside India (‘FOCC’), can be transferred to:[16]

(a) a person resident outside India without any requirement to adhere to pricing guidelines, provided however such transfer is reported by way of Form FC-TRS;

(b) a person resident in India, subject to adherence with pricing guidelines only; and

(c) another FOCC, without any requirement to adhere to pricing guidelines or to the reporting requirements.

xiii. Rate of dividend on preference shares: Under the New FEMA 20, the ceiling limit of 300 basis points over the prime lending rate of State Bank of India on the rate of dividend on preference shares or convertible preference shares issued under the said regulations has been done away with.

xiv. Alignment with the provisions of Companies Act, 2013: In addition to the above, the New FEMA 20 has attempted to align several provisions with those of the Companies Act, 2013, in order to address ambiguities that existed under the Erstwhile FEMA 20. A few of such alignments include:

(a) the definitions of ‘employees’ stock option’ and ‘sweat equity shares’ have been aligned with the corresponding definitions under the Companies Act, 2013; and

(b) timeframe for allotment of capital instruments has been reduced from 180 days to 60 days.

xv. Late submission fee for delayed filings: The New FEMA 20 states that delay in complying with reporting requirements (including Forms FC-GPR and FC-TRS) will now attract late submission fee (‘LSF’) of such amount as may be determined by the RBI in consultation with the Central Government. Paragraph 12 of Part IV of the Master Direction on Reporting under Foreign Exchange Management Act, 1999 provides for the quantum of LSF for regularizing reporting delays without undergoing the compounding procedure as under:

Amount involved in reporting
LSF as a % of amount involved*

Maximum amount of LSF applicable
Up to 10 million

0.05%
Rs.1 million or 300% of amount involved, whichever is lower.

More than 10 million

0.15%
Rs.10 million or 300% of amount involved, whichever is lower.

* The LSF would be doubled every 12 months.
The LSF shall be applicable for the transactions undertaken on or after November 7, 2017.

xvi. New forms to be filed:

(a) A Indian company issuing employee stock option to, inter-alia, persons resident outside India who are its employees / directors, is required to submit Form –ESOP within 30 days of such issuance.[17]

(b) An LLP receiving amount of consideration for capital consideration and acquisition of profits shall submit Form LLP (I) within 30 days of receipt of amount of consideration.[18]

(c) The divestment of capital contribution between a resident and non-resident in case of an LLP shall be reported in Form LLP (II) to the authorised dealer within 60 days from the date of receipt of funds.[19]

(d) An Indian start-up company issuing Convertible Notes to a person resident outside India shall report such inflows to authorised dealer bank in Form CN within 30 days of such issue.[20]

[1] Regulation 2(v) of New FEMA 20 read with Paragraph 2.2 of the Master Directions.
[2] Regulation 2(xviii) of New FEMA 20 read with Paragraph 2.9 of the Master Directions.
[3] Regulation 2(xvii) of New FEMA 20 read with Paragraph 2.6 of the Master Directions.
[4] Regulation 2(ix) of New FEMA 20 read with Paragraph 2.7 of the Master Directions.
[5] Regulation 2(xxv) of New FEMA 20 read with Paragraph 2.11 of the Master Directions.
[6] Paragraph 2.14 of the Master Directions.
[7] Regulation 2(xxxi) of New FEMA 20 read with Paragraph 2.16 of the Master Directions.
[8] Explanation to Regulation 6 of New FEMA 20 read with Paragraph 6.11.4 of the Master Directions.
[9] Proviso to Regulation 6 of New FEMA 20 read with Paragraph 6.11.2 of the Master Directions.
[10] Proviso to Regulation 7 of New FEMA 20 read with Paragraph 6.12.2 of the Master Directions.
[11] Regulation 13.1(4)(b) of New FEMA 20.
[12] Regulation 13.1(4) of New FEMA 20.
[13] Regulation 13.1(4) of New FEMA 20.
[14] Regulation 4 of New FEMA 20 read with Paragraph 9 of the Master Directions.
[15] Regulation 13.1(11) of New FEMA 20.
[16] Regulation 14(5)(c) of New FEMA 20 read with Paragraph 9.6 of the Master Directions.
[17] Regulation 13.1(5) of New FEMA 20.
[18] Regulation 13.1(7) of New FEMA 20.
[19] Regulation 13.1(8) of New FEMA 20.
[20] Regulation 13.1(12) of New FEMA 20.

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Changes in Investment in Debt Securities by Foreign Portfolio Investors

Published In:Inter Alia - Quarterly Edition - June 2018 [ English Chinese japanese ]

The Reserve Bank of India (‘RBI’) recently issued a notification dated June 15, 2018, in supersession of the RBI notifications dated April 27, 2018 and May 1, 2018, for providing some operational flexibility as well as transition path for investments by Foreign Portfolio Investors (‘FPIs’) in debt (‘Notification’). Below is a summary of the key changes brought about by this notification:

i. Reduced minimum residual maturity for corporate bonds:  The minimum residual maturity requirement for investments by FPIs in corporate bonds has reduced from three years to one year (subject to the condition that short-term investments[1] in corporate bonds by a FPI, calculated on an end-of-day basis, must not exceed 20% of the total investment of that FPI in corporate bonds). Investments: (a) made in security receipts issued by asset reconstruction companies (‘SRs’); or (b) made on or before April 27, 2018, must not be included to calculate such limit.

ii. Single/ Group investor wise concentration limits: This notification imposes the following investor and group wise limits for investments in corporate bonds:

· Per ‘issue’ limit: FPIs can invest in any issue of corporate bonds subject to a cap of 50% of such issue. If such limit is already breached by investments made by an FPI and/or its investor group, such FPIs may not make further investments in such issue until such limit is met. This requirement is not applicable in respect of investments by FPIs in SRs.

· Per ‘corporate’ limit: As on April 27, 2018, FPIs cannot have an exposure of more than 20% of its entire corporate bond portfolio to a single corporate (this includes exposures to related entities of the corporate). If the exposure exceeds 20%, the FPI cannot make further investments in that corporate / group until the above concentration limit is met. Investments in new corporate bonds made by the FPI after April 27, 2018 (in corporates other than those referred to in para a) above) will have to meet the 20% corporate limit from April 1, 2019 onwards. FPIs registering after April 27, 2018 are permitted to comply with this requirement by: (a) March 31, 2019; or (b) six months from the date of registration, whichever is later. The restrictions mentioned above in respect of corporate bonds are not applicable to investments by multilateral financial institutions and to investments by FPIs in SRs.

iii. Relaxation of norms for pipeline investments: Investment transactions by FPIs in corporate bonds that were under process but had not materialised as on April 27, 2018 (pipeline investments), will be exempt from the ‘per issue’ limit and ‘per corporate’ limits described above, subject to the custodian of the FPI reasonably satisfying itself that: (a) the major parameters such as price/rate, tenor and amount of the investment have been agreed upon between the FPI and the issuer on or before April 27, 2018; (b) the actual investment will commence by December 31, 2018; and (c) the investment is in conformity with the extant regulations governing FPI investments in corporate bonds prior to April 27, 2018.

iv. Concentration limits per category of FPI: The following limits for the relevant category, inter alia, have been prescribed by this notification for investments by FPIs in Central Government securities (‘G-secs’), State Department Loans (‘SDLs’) and corporate debt securities: (i) 15% of the prevailing limit; and (ii) 10% of the prevailing limit.

v. Minimum residual maturity for G-secs: The Notification permits FPIs to invest in G-secs (including in treasury bills and SDLs) without any minimum residual maturity requirement, provided that investments by a FPI in securities with residual maturity less than one year, will not exceed 20% of the total investment of that FPI in that category.

vi. The cap on aggregate FPI investments in Central G-secs has been increased from 20% to 30% of the outstanding stock of that security.

vii. FPIs have been prohibited from investing in partly paid instruments.

[1] Investments with residual maturity up to one year.

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Guidelines for Preferential Issue of Units by InvITs

Published In:Inter Alia - Quarterly Edition - June 2018 [ English Chinese japanese ]

SEBI issued a circular dated June 5, 2018 (‘Circular’) setting out guidelines for preferential issue of units by InvITs.As per the Circular, listed InvITs may make a preferential issue of units to an institutional investor subject to the fulfillment of the following conditions:

i. Conditions for preferential issue: (a) Unitholders of the InvIT have to pass a resolution approving the preferential issue; (b) InvIT must be in compliance with the minimum public unitholding requirements, conditions for continuous listing and disclosure obligations; (c) No preferential issue of units by the InvIT should have been made in the six months preceding the relevant date and the issue will be completed within 12 months of the authorizing resolution; (d) The preferential issue of units can be offered to a minimum of two and maximum of 1000 investors in a financial year.

ii. Placement document: The preferential issue of units by an InvIT will be done on the basis of a placement document, which must contain disclosures as specified in the Circular. While seeking in-principle approval from the recognised stock exchange, InvIts to furnish a copy of the placement document, a certificate issued by its merchant banker or statutory auditor confirming compliance with the provisions of this Circular along with any other documents required by the stock exchange

iii. Pricing: The preferential issue is required to be made at a price not less than the average of the weekly high and low of the closing prices of the units quoted on the stock exchange during the two weeks preceding the relevant date. The InvIT cannot allot partly paid-up units. Further, the prices determined for preferential issue will be subject to appropriate adjustments, if the InvIT: (i) makes a right issue of units; and (ii) is involved in such other similar events or circumstances, which in the opinion of the concerned stock exchange, requires adjustments.

iv. Restriction on allotment: No allotment can be made to any party to the InvIT or their related parties except to the sponsor.

v. Restriction on transferability: The units allotted under preferential issue cannot be sold by the allotee for a period of one year from the date of allotment, except on a recognized stock exchange.

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Guidelines for Issuance of Debt Securities by REITs and INVITs

Published In:Inter Alia - Quarterly Edition - June 2018 [ English Chinese japanese ]

SEBI had recently permitted Real Estate Investment Trusts (‘REITs’) and Infrastructure Investment Trusts (‘InvITs’) to issue debt securities by amending the SEBI (REIT) Regulations, 2014 (‘REIT Regulations’) and the SEBI (INVIT) Regulations, 2014 (‘InvIT Regulations’). SEBI has issued guidelines for issuance of such debt securities by REITs and InvITs by its circular dated April 13, 2018 (‘Circular’) which provides that REITs and InvITs issuing debt securities must follow the provisions of SEBI (Issue and Listing of Debt Securities Regulations), 2008 (‘ILDS Regulations’) in the following manner:

i. Restriction in Regulation 4(5) of the ILDS Regulations on issue of debt securities for providing loan to or acquisition of shares of any person, who is party of the same group or under the same management and the requirement for creation of a debenture redemption reserve, will not apply to issue of debt securities by REITs and InvITs;

ii. Compliances to be made under Companies Act in terms of the ILDS Regulations, will not apply to REITs / InvITs for issuance of debt securities, unless specifically provided in the Circular.

For the issuance of debt securities, REITs / InvITs will appoint one or more SEBI registered debenture trustees, other than the trustee to the REIT / InvIT issuing such debt securities. Further, the securities will be secured by the creation of a charge on the assets of the REIT / InvIT or holding company or SPV, having a value which is sufficient for the repayment of the amount of such debt securities and interest thereon. The Circular also provided for certain additional disclosure and compliance requirements.

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Exemption to Interest Income on Specified Offshore Rupee Denominated Bonds

Posted In: ,
Published In:Inter Alia - Quarterly Edition - September 2018 [ English Chinese japanese ]

The ITA currently provides for a tax rate of 5% (plus applicable surcharge and cess) for interest payable with respect to moneys borrowed by an Indian company / REIT / InVT from a source outside India by way of the issuance of Rupee denominated bonds (at any time till June 30, 2020) subject to compliance with prescribed conditions and interest ceiling. These borrowings have now been further incentivized to augment the foreign exchange inflow in the country. Pursuant to a press release dated September 17, 2018, tax exemption has been announced for interest payable by an Indian company / REIT / InVT to a non-resident / foreign company in respect of Rupee denominated bonds issued outside India during September 17, 2018 to March 31, 2019. No tax will be deducted on the payment of interest on such bonds. The press release further states that legislative amendments in this regard will be proposed in due course.

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Fund-raising in India – challenges faced by Indian Fund Managers

Posted In:
Published In:RIPE Magazine (IVCA) December 2018 [ ]

Introduction

An emerging market such as India, with its growing appetite for development, has an ever-increasing requirement for capital and a sound regulatory framework is key in enabling innovative financial instruments through which money can be channelled to India.

With the aid of the Indian regulators, new asset classes, in particular alternative investment funds (AIFs) have grown in the Indian market. Indian Private Equity Report, 2017, issued by Bain and Company highlights that registered AIFs in India have more than doubled over the past 2 years and stood at approximately 270 in 2016. AIFs have also been a significant contributor to overall fund-raising in the Indian market and contributed to 41% of the total India-focussed funds raised in 2016, compared with only 11% in 2014.

The brisk growth of AIFs in India raises an important question – where are Indian fund managers raising this capital from and what is the participation of Indian investors in these pooling vehicles?

The Alternative Investment Policy Advisory Committee (AIPAC) Report, 2016 states that in India, a mere 10-15% of equity capital required by start-ups, medium enterprises and large companies is funded from domestic sources. The remaining 85% – 90% is sourced from overseas. This is in contrast to the U.S. and China where domestic sources fund 90% and 50% respectively, of the venture capital and private equity needs of enterprises. Prequin report of November 2017 on Alternative Assets in India states that a significant proportion (approximately 40%) of India-based institutional investors do not invest in alternatives, reiterating the relative unfamiliarity of the alternatives market for investors in India. However, the report observes that as these institutions develop and mature, the proportion may shrink, as the demand for alternative investments to maximize portfolio diversification increases, as does their familiarity with the alternatives market.

Given the growing awareness amongst Indian institutions to participate in AIFs in particular, this article provides a snapshot of the key legal and regulatory aspects that Indian fund managers need to be cognizant of, while approaching and raising capital from: banks, insurance companies (life and non-life) and pension funds.

Challenges for each institution

The Reserve Bank of India (RBI) has permitted scheduled commercial banks (excluding regional rural banks and urban co-operative banks) in India to invest in category I and category II AIFs, albeit with certain conditions. 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 AIFs (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 AIFs. Investments by banks in category III AIFs continues to be not permitted. Further, the requirement imposed on banks to maintain additional capital basis a risk assessment on account of investments in AIFs made either directly or through their subsidiaries is an added restriction imposed on banks in making investments in AIFs.

Overall, while a banks’ participation in AIFs 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 AIFs as well (albeit within limits) which will provide a capital source to such AIFs which are today heavily reliant on foreign capital and Indian retail fund raise.

With respect to insurance companies, Insurance Regulatory and Development Authority (IRDA) has permitted both general insurance and life insurance companies to invest in category I AIFs such as infrastructure funds, small and medium enterprise (SME) funds, venture capital funds and social venture funds (as defined under the SEBI (AIF) Regulations, 2012) and category II AIFs (which will invest at least 51% of the funds in infrastructure, SME, venture capital and/or social venture entities). The permission to invest in AIFs from IRDA however, comes with certain additional restrictions. For one, insurance companies are not permitted to invest in AIFs which seek to invest in securities of companies incorporated outside India, will take leverage and/or will be classified as fund of funds. In addition, any investment by the insurance company in AIFs is categorised as an ‘unapproved investment’ and requires approval of the board of directors in addition to the approval of the investment committee of the insurance company. Further, overall exposure to AIFs is capped at 3% of respective fund in case of life insurance companies and 5% of investment assets in 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 and 20% of the overall exposure permitted, provided that in 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, 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. In light of the growing awareness and interest of insurance companies to invest in AIFs, further liberalisation of the investment conditions such as permission to invest in category III AIFs (which do not undertake leverage), AIFs which are fund of funds and AIFs which can invest in companies incorporated outside India, subject to compliance with SEBI prescribed conditions, would go a long way in mobilising funds from insurance companies in the AIF industry.

Pension Fund Regulatory and Development Authority (PFRDA) has recently permitted private sector national pension system scheme (NPS) subscribers to invest in category I and category II AIFs albeit with the condition that such 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 AIFs, this peculiar condition has created a challenge for pension funds to invest in AIFs. Further, the guidelines prescribe that such NPS should invest into units of AIF which have minimum AA equivalent rating in the applicable rating scale from one credit rating agency registered with SEBI, albeit such credit rating would not be required in case of a government owned AIF.  Other conditions prescribed by PFRDA are similar to the conditions imposed by IRDA in respect of investment into AIFs by insurance companies, such as the 51% fund utilisation conditions for category II AIFs, exposure of 10% of the AIF size in a single AIF, restriction in respect of AIFs 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 such AIFs whose corpus is equal to or more than INR 100 crores. Whilst the guidelines permitting investment by pension funds into AIFs has been a step in the right direction, much is left to be desired. Restrictions such as minimum corpus of AIF being an eligibility criterion for pension fund investment, credit rating for AIF units and requirement to only invest in listed AIFs, create a considerable road block for investment by NPS in AIFs.

Insurance companies and pension funds have long-term liabilities and given the time gap between the receipt of premium/investment and the payment of claims and returns, they have substantial pool of capital which can be deployed in long-term assets. While this fact has been recognised in foreign jurisdictions where insurance and pension funds are permitted to deploy capital in AIFs in India, the restrictions on insurance and pension companies in India have limited their participation in AIFs. As a first step, pension funds can be brought at par with insurance companies. This will ensure that we see increased participation by them in the AIF industry.

Conclusion

Given the restrictions, often onerous, imposed on fund managers accepting domestic capital from Indian institutions highlighted above, many fund managers first look to raise offshore capital and domestic capital from private institutions, family offices and high net worth individuals. If any meaningful capital raise is to happen from India, the financial institutions mentioned herein with significant capital at their disposal should be allowed more flexibility to invest in alternative assets, albeit with checks and balances. This will go a long way in giving much needed fillip to the ever growing AIF industry.

Authors

1.  Pallabi Ghosal, Partner
2. Ananya Sonthaliya, Senior Associate

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Key Guidance issued by SEBI on AIF Operative Aspects

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Introduction

The Securities and Exchange Board of India (“SEBI”) has issued 3 interpretative letters under the SEBI (Informal Guidance) Scheme, 2003 providing guidance on certain operational aspects of Alternative Investment Funds (“AIFs”). A summary analysis of the same is provided below.

Please note that while the interpretative letters may be considered to be reflecting SEBI’s viewpoint on  the issues raised before it, and that SEBI may generally be expected to act in accordance with it, the interpretative letters are not binding on SEBI.

  • Informal guidelines given to IIFL Asset Management Ltd on November 06, 2018

The query concerned the lock-in period of the pre-issue capital held by a Category II AIF, applicable to  the listed shares held by it. As a background, under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”), the entire pre-issue capital of non-promoter shareholders is locked-in for a period of 1 year from the date of allotment in the IPO process; there is an exemption granted, inter alia, to Category I and II AIFs from the lock-in requirement in respect of their equity holdings, provided that such equity shares are locked-in for a period of at least 1 year from the  date of purchase (“Tenure to Avail Exemption”). The query arose when the National Stock Exchange (“NSE”) and Bombay Stock Exchange (“BSE”) interpreted the ICDR Regulations to mean that the date of the Tenure to Avail Exemption commences from the date of allotment in the IPO process instead of date of purchase, for Category I and II AIFs.

SEBI’s guidance was sought on whether the date of commencement of the Tenure to Avail Exemption would be the date of allotment in the IPO process, or the date of purchase of the concerned shares by the querist AIF.

SEBI clarified that the lock-in period starts from the date of purchase of the equity shares by the querist AIF, and that once equity shares have been held for the Tenure to Avail Exemption the lock-in would not apply.

AZB Analysis: This clarification is in line with the generally accepted interpretation of the exemption condition and it should help Category I and II AIFs to deal with any such queries or questions being raised by the NSE and BSE going forward.

  • Informal guidance given to KellyGamma Advisors LLP on January 10, 2019

The query referred to SEBI was pertaining to the computation of the amounts available to be invested by  a Category III AIF in a single investee company. As per the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), Category III AIFs are permitted to invest up to 10% of their

‘investible funds’1 in a single investee company. However, the querist AIF sought clarifications from SEBI on whether the gains generated by the AIF from sale of existing portfolio investments should be  computed towards their ‘investible funds’. Inclusion of the gains would result in increase of the amounts of ‘investible funds’, which would increase the amount available to the AIF for investments in a single investee company.

SEBI, while referring to the definition of the term ‘investible funds’ under the AIF Regulations, did not consider the gains while computing ‘investible funds.’

AZB Analysis: The interpretation adopted by SEBI in computing ‘investible funds’ of the querist AIF confirms that the profits or losses arising to the AIF from its investments, or a change in the assets under management (“AUM”), should not be factored in while computing ‘investible funds’ of an AIF. While the guidance is issued in context of a Category III AIF, one may understand it to mean that any change in the AUM of an AIF (irrespective of category) would not impact its ‘investible funds’ and consequently its ability to make investments in investee companies remains unaffected from any changes to its AUM.

  • Informal guidance given to JM Financial Limited on October 17, 2018

The query referred to SEBI was pertaining to whether a Category II AIF can invest the distribution proceeds generated upon a Category II AIF’s exit from its portfolio investments in temporary investment,2 pending the distributions of such proceeds to their investors. This clarification was sought in light of the

fact that while the AIF Regulations categorically permit AIFs to make temporary investments from un- invested portions of investible funds, the AIF Regulations do not specifically permit the investments of distribution proceeds generated upon the AIF’s exit from its portfolio investments in any temporary investments.

SEBI noted that the AIF Regulations permit AIFs to make temporary investments from un-invested portions of investible funds, since such deployment of funds is in the interest of the investors. SEBI observed that the same rationale should also be applicable to the deployment of distribution proceeds in temporary investments pending distributions to the investors. Therefore, SEBI observed that such investment of distribution proceeds in temporary investments pending the distribution of such proceeds to their investors by the querist AIF was permitted.

AZB Analysis: While in most cases, funds distribute the returns or proceeds generated from the sale of their investments to the investors since the same is generally in the best interest of both the limited partners and the general partners. However, there may be extenuating circumstances (for example, an expected or contingent liability fructifying, or a tax or statutory claim), in which case the fund managers may be required to retain distributable proceeds in the fund for a temporary period. In such cases, the investments of such distribution proceeds pending distributions to the investors in temporary investments would be in the best interest of the investors.

SEBI’s interpretation keeps in mind the interest of the investors as well as gives operational flexibility to fund managers.

1 Defined in AIF Regulations under section 2 (p) as “corpus of the Alternative Investment Fund net estimated expenditure for administration and management of the fund.”

2  Temporary investments may include liquid mutual funds or bank deposits or other liquid assets of higher quality such as Treasury bills, CBLOs, Commercial Papers, Certificates of Deposits, etc.

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CCI approves acquisition of minority stake in IndiaIdeas.com Limited by Springfield Investments International B.V.

Published In:Inter Alia Special Edition- Competition Law - March 2019 [ English ]

On January 10, 2019, pursuant to the share purchase agreement dated November 16, 2018, CCI approved acquisition of 3.28% in IndiaIdeas.com Limited (‘IndiaIdeas’) by Springfield Investments International B.V. (‘Springfield Investments’) (collectively referred to as ‘Parties’).[1]

Springfield Investments is an investment company forming a part of March Capital Partners (‘March Capital’), a venture capital firm having investments in breakthrough technology companies globally. The services offered by IndiaIdeas have been set out above.

CCI noted that once the transaction is consummated, Springfield Investments will also become a part of the Clearstone Venture Mauritius (‘CVM’). It was further noted that March Capital and CVM group were both existing shareholders of IndiaIdeas. Additionally, based on the individual and combined incremental shareholding in IndiaIdeas of March Capital and CVM group, CCI noted that the proposed combination was not likely to change the competition dynamics in any market in India and accordingly approved the combination.

[1] Combination Registration No. C- 2018/12/621

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CCI approves acquisition of minority stake by True North Fund V LLP, True North Fund VI LLP and Pioneer Investment Fund in Zydus Wellness Limited

Published In:Inter Alia Special Edition- Competition Law - March 2019 [ English ]

On January 23, 2019, CCI approved the acquisition of 12.54% and 1.25% shareholding in Zydus by True North Fund V LLP and True North Fund VI LLP (‘True North Funds’) and Pioneer Investment Fund (‘Pioneer’). Separately, Cadila and Zydus Family Trust (‘ZFT’), existing shareholders in Zydus, proposed to acquire additional equity shares in Zydus. [1]

The parties specifically submitted that the said transaction was undertaken to finance the acquisition by Zydus of Heinz India and both the acquisitions were submitted to be interconnected transactions under Regulation 9(4) of the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011.

As per the transaction, True North Funds would acquire the right to appoint a director/ observer to the board of director. Additionally, following the acquisition of Heinz India, True North Funds would also have a right appoint a director/ observer in Heinz India. CCI observed that True North Funds (directly or indirectly) were neither engaged in the same business nor in any business that may considered to be vertically linked with that of Zydus/ Heinz India. With respect to ZFT and Cadila, it was noted that both were already majority shareholders in Zydus and also, that the acquisition of additional equity shares in Zydus was unlikely to cause any concern.

 In light of the above, CCI concluded that this combination was unlikely to cause AAEC in India.

[1] Combination Registration No. C- 2018/12/622

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CCI Approves SVF Doorbell (Cayman) Limited’s Acquisition of 22.44% of shareholding of Delhivery Private Limited

Published In:Inter Alia Special Edition - Competition Law - April 2019 [ English ]

On February 02, 2019, CCI approved the acquisition by SVF Doorbell (Cayman) Limited (‘SVFD’ or ‘Acquirer’) of approximately up to 22.4% of shareholding of Delhivery Private Limited (‘DPL’) on a fully diluted basis (‘Proposed Combination’). [1] The Proposed Combination was notified to CCI pursuant the Memorandum of Understanding dated October 15, 2018, executed between Softbank Group entity and DPL (‘MoU’), Share Subscription Agreement (‘SSA’) and the Shareholders Agreement (‘SHA’), both dated December 20, 2018, executed between DPL and SVFD. The Proposed Combination also stipulated that a potential subsequent acquisition of additional equity securities by SVFD, from the existing security holders of DPL at such price and on such terms to be agreed between SVFD and such security holder (‘Step 2’), was to take place. However, given that the parties had not executed any binding document in relation to Step 2 (the SSA did not cover Step 2), as is required under Section 6(2) of the Act read with Regulation 5(8) of the CCI (Procedure in regard to the transaction of Business relating to Combinations) Regulations, 2011 (‘Combination Regulations’), CCI did not include Step 2 within its assessment of the Proposed Combination (even though the same was interconnected with the Proposed Combination).

SVFD has been established for the purposes of the Proposed Combination by SoftBank Vision Fund L.P. (‘SVF’). SVF is a venture capital investment fund, focused on making long-term financial investments in companies. Both SVF and SVFD are part of the SoftBank Group (‘SB Group’). DPL is engaged in the provision of third-party logistics (‘3PL’) services in India and provides transportation, warehousing, freight services, etc. to third-party enterprises/persons who operate across different business models and are present across the value chain. Additionally, through its wholly owned subsidiary Delhivery USA LLC, DPL also provides last mile logistics solution/deliveries of cross border shipments from India to the United States of America through the United States Postal Service. As per CCI, DPL has a minimal market share of zero to five percent in the overall logistics market and a share of zero to five percent for provision of 3PL services in India.

Based on the information provided by the parties to the Proposed Combination, CCI observed that there is no horizontal overlap between DPL and SVFD, SVF (neither SVF nor SVFD is engaged the provision of any services or sale of goods), or any of the subsidiaries, affiliates and portfolio companies of the SB Group, including those entities in which the SB Group has non-controlling investments or special rights. Additionally, CCI also observed that although certain portfolio companies of SB Group were involved in the provision of ‘business-2-business’ (‘B2B’), ‘business-2-customers’ (‘B2C’) sales, supply of landline phones, IT peripherals, and provision of vehicles on contractual basis in India and the same may use 3PL services. However, given the minimal shares of DPL, and the presence of several enterprises in the market for logistics services, such as Gati, Xpressbees, etc., CCI held that the Proposed Combination was not likely to have any AAEC in India. Accordingly, CCI approved the acquisition under Section 31(1) of the Act.

The Proposed Combination also stipulated a non-compete clause (‘NCC’). CCI, without disclosing the duration and scope of the NCC observed that it was beyond what was necessary for the implementation of the Proposed Combination and to this extent was not ancillary to the Proposed Combination.

[1] Combination Registration No.C-2019/01/633

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CCI Approves Acquisition by BCP Acquisitions LLC, and CDPQ Fund 780 L.P. and CDP Investissements Inc. (collectively) of the Global Power Solutions Business of Johnson Controls International Plc

Published In:Inter Alia Special Edition - Competition Law - April 2019 [ English ]

On February 14, 2019, CCI approved the acquisition by BCP Acquisitions LLC (‘BCP’), CDPQ Fund 780 L.P. (‘CDPQ Fund’) and CDP Investissements Inc. (‘CDP’) (collectively) of the global power solutions business (‘Target Business’) of Johnson Controls International plc (‘JCI’) (‘Proposed Combination’). BCP is a part of Brookfield Assets Management Inc. (‘Brookfield’) whereas both CDPQ Fund and CDP are wholly owned by Caisse de dépôt et placement du Québec (‘CDPQ’). Pursuant to the Proposed Combination, Brookfield (through BCP) and CDPQ (through CDPQ Fund and CDP) will own 70% and 30% of the Target Business, respectively. The Proposed Combination was notified to CCI pursuant to the share and asset purchase agreement dated November 13, 2018, executed between JCI and BCP (‘SAPA’), and a binding term sheet, entered into between Brookfield and CDPQ pursuant to which both Brookfield and CDPQ had proposed to enter into a shareholders agreement (‘SHA’). (BCP, CDPQ Fund, CDP and JCI are collectively referred to as ‘Parties’). [1]

BCP is a special purpose vehicle (‘SPV’) formed for the purposes of the Proposed Combination, and is not engaged in any business activity in India. Brookfield has various investments across multiple sectors such as real estate, infrastructure etc. in India and elsewhere. CDPQ Fund and CDQ do not have any direct presence in India and CDPQ is a Canadian institutional investor that manages funds primarily for public and para-public pension and insurance plans. The Target Business is engaged in the business of inter alia manufacturing and distribution of low voltage energy storage products using lead-acid and lithium-ion technologies, primarily for use in passenger vehicles, trucks and other motive applications. The Target Business’ products are sold to, or distributed through, original equipment manufacturers and aftermarket retailers and distributors, and the Target Business  is present in India only through its 26% equity shareholding in Amara Raja Batteries Limited (‘ARBL’).

Based on the information provided by the Parties, CCI noted that Brookfield does not have any portfolio investments in India in the same business as that of the Target Business. Further, CDPQ holds certain investments in entities engaged in manufacturing and sale of lead acid-based batteries in India or may have potential vertical linkages with the Target Business. However, given that these investments of CDPQ were of less than five percent of the total equity share capital and in the absence of any special veto/governance rights, CCI approved the Proposed Combination in light of there being no substantial horizontal or vertical overlap between the Parties.

[1] Combination Registration No.C-2019/01/630

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Investment by FPIs in Debt

Published In:Inter Alia - Quarterly Edition - March 2019 [ English ]

The Securities and Exchange Board of India (‘SEBI’) and RBI had, by way of their circulars dated June 15, 2018, inter alia, introduced a ‘per corporate’ limit, disallowing a foreign portfolio investor (‘FPI’) from having an exposure of more than 20% of its entire corporate bond portfolio to a single corporate (including exposures to related entities of such corporate). In order to encourage a wider spectrum of investors to access the Indian corporate debt market, on February 15, 2019, RBI issued a notification withdrawing the above mentioned ‘per corporate’ limit with immediate effect. The ‘per issue’ limit for FPIs (i.e., an FPI and its investor group may invest in any issue of corporate bonds subject to a cap of 50% of such issue) and the 20% short-term investments limit for FPIs continues to remain in place. This withdrawal is in line with the announcement made in paragraph 10 of the Statement on Developmental and Regulatory Policies of the Sixth Bi-monthly Monetary Policy Statement for 2018-19 of RBI, dated February 7, 2019.

To give effect to RBI’s circular dated February 15, 2019, SEBI similarly withdrew this requirement by its circular dated March 12, 2019, with immediate effect.

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Voluntary Retention Route for Investments by FPIs

Published In:Inter Alia - Quarterly Edition - March 2019 [ English ]

RBI has, by way of its circular dated March 1, 2019, announced a separate scheme called the Voluntary Retention Route (‘VRR’). Investments under the VRR scheme have been open for allotment from March 11, 2019. The aggregate investment limit by FPIs under this scheme is Rs 40,000 crores (approx. US$ 5.5 billion) for making investments in Government securities (G-Secs, treasury bills and state development loans) and Rs 35,000 crores (approx. US$ 5 billion) for making investments in corporate debt instruments. The minimum retention period for investment under VRR is three years, and during this period, the FPI must maintain a minimum of 75% of the allocated amount in India. The requisite investment amount is required to be adhered to on an end-of-day basis and can include cash holdings in the Rupee accounts used for VRR. Allocation of investment amount to FPIs under VRR must be made on-tap or through auctions. Subject to certain relaxations, FPIs are required to invest the amount allocated, referred to as the Committed Portfolio Size (‘CPS’), in the relevant debt instruments and remain invested at all times during the voluntary retention period. Successful allottees are required to invest 25% of their CPS within one month and the remaining amount within three months from the date of allotment. FPIs that wish to liquidate their investments through VRR prior to the end of the retention period may do so by selling their investments to another FPI. Investments made through VRR are not subject to any minimum residual maturity requirement, concentration limit or single/group investor-wise limits applicable to FPIs for making investments in corporate bonds under the general investor route. FPIs investing through VRR are eligible to participate in repos for their cash management subject to certain conditions. Additionally, FPIs investing under VRR are eligible to participate in any currency or interest rate derivative instrument, whether over-the-counter or exchange traded, to manage their interest rate risk or currency risk.

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Guidelines for the Public Issue of Units of InvITs and REITs

Published In:Inter Alia - Quarterly Edition - March 2019 [ English ]

SEBI has introduced amendments to the guidelines for public issue of units of Infrastructure Investment Trusts and Real Estate Investment Trusts (together, ‘Investment Vehicles’) in order to further rationalise and ease the process of public issue of units of Investment Vehicles. Key highlights amongst them are:

i.       the definition of ‘institutional investors’ has been updated to refer to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018;

ii.      Mutual funds, alternative investment funds (‘AIFs’), FPIs other than category III FPIs sponsored by associate entities of the merchant bankers, insurance companies promoted by, and pension funds of, associate entities of the merchant bankers have been permitted to invest under the category of anchor investors;

iii.     Bidding period may be extended on account of force majeure, banking strike or similar circumstances, subject to total bidding period not exceeding 30 days;

iv.      Time period for announcement of the floor price or the price band by the investment manager has been reduced from five days to two days prior to the opening of the bid (in case of initial public offer); and

Investment Vehicles are required to accept bids using only the application supported by blocked amount (‘ASBA’) and consequent changes in bidding process have been made.

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SEBI Informal Guidance in the Matter of JM Financial Limited

Published In:Inter Alia - Quarterly Edition - March 2019 [ English ]

SEBI has, in its informal guidance to JM Financial Limited, stated that the objective of Regulation 15(1)(f) of SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) is to further the interests of investors with respect to the un-invested portion of investable funds, till deployment of these funds in accordance with the investment objective of the AIF. Accordingly, applying the same rationale, SEBI has clarified that investment proceeds from sale/transfer of investments or returns earned from the investments can be invested in temporary investment instruments specified in Regulation 15(1)(f) of the AIF Regulations pending distribution of investment proceeds to the investors, provided that details of such transactions are disclosed to the investors and the diversification requirements under Regulation 15(1)(c) of the AIF Regulations would be applicable to such investments as well.

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SEBI Informal Guidance on Investment in Corporate Debt by FPIs

Published In:Inter Alia - Quarterly Edition - March 2019 [ English ]

SEBI has issued an interpretative, non-binding letter dated November 28, 2018, to Genpact India Private Limited (‘Genpact’) under the SEBI (Informal Guidance) Scheme, 2003 providing guidance on SEBI (FPI) Regulations, 2014 (‘FPI Regulations’), RBI circulars dated November 17, 2016 and April 17, 2018 and SEBI circular dated February 28, 2017 on Investment by FPIs in debt (collectively the ‘Circulars’).

Genpact had issued certain rated, unsecured, redeemable and non-convertible debentures (‘NCDs’) on a private placement basis to a FPI registered with SEBI (‘FPI Entity’). The NCDs issued had a maturity period of more than three years and were utilized to meet funding requirements for day-to-day operations, downstream investments and general corporate purposes.

Prior to the Circulars, except for infrastructure companies, FPIs were allowed to invest in listed NCDs only. Pursuant to the Circulars, FPIs had been permitted to invest in unlisted corporate debt, subject to a minimum residual maturity of more than one year, and an end-use restriction on investment in real estate business, capital market and purchase of land.

A clarification was sought on whether Genpact is permitted to delist its existing listed NCDs subscribed to by the FPI Entity prior to the date of the Circulars coming into effect and utilize the proceeds of such listed NCDs in making downstream investments on private arrangement basis. In this regard, SEBI was of the view that:

i.       There was no violation to the end-use restriction rules for the proceeds raised from the issuance of NCDs as Genpact’s nature of business was in accordance with the said rules; and

ii.      On de-listing of NCDs, SEBI was of the view that it depends on the terms of the offer document/private placement memorandum issued by Genpact to the FPI Entity on whether the NCDs are required to be necessarily listed or ‘may be’ listed. If as per the offer document/private placement memorandum, the NCDs have to necessarily be listed, then they should be held till maturity and subsequently de-list in accordance with the procedure set out in Regulation 59 of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015.

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Angel Tax Exemption Notification

Published In:Inter Alia - Quarterly Edition - March 2019 [ English ]

Section 56(2)(viib) of the Income-tax Act, 1961 (‘IT Act’) provides that where a closely held company issues its shares at a price which is more than its fair market value (‘FMV’), the amount received in excess of FMV will be charged to tax in the hands of the company as income from other sources.

The Central Board of Direct Taxes (‘CBDT’) had issued a notification dated June 14, 2016, providing that investments received by ‘start-ups’ (as specified by the Department of Industrial Policy and Promotion (‘DIPP’)) would not be subject to tax under Section 56(2)(viib) of the IT Act. Further, the DIPP issued a notification dated April 11, 2018, as modified by another notification dated January 16, 2019, specifying the procedure and criteria for start-ups to avail tax benefits (‘DIPP Notification’). The CBDT had also issued a notification dated May 24, 2018, specifying that the provisions of Section 56(2)(viib) of the IT Act will not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification as per the DIPP Notification.

In supersession of the DIPP Notification, the Department for Promotion of Industry and Internal Trade (‘DPIIT’) issued a notification dated February 19, 2019 (‘DPIIT Notification’), introducing new measures for taxation of angel investments. Pursuant to the DPIIT Notification, the CBDT issued a notification dated March 5, 2019 stating that provisions governing angel tax will not be applicable to start-ups that have been recognized by DPIIT in the DPIIT Notification. The salient features of DPIIT Notification are as follows:

i.       An entity will be considered a start-up up to a period of 10 years from the date of incorporation if: (i) the turnover of the entity does not exceed Rs 100 crores (approx. US$ 14.4 million) during any year; (ii) the entity is working towards innovation, development and improvement of products, processes or services or employment generation or wealth creation; and (iii) the entity is not formed as a result of reorganization or restructuring.

ii.      A start-up will be eligible for exemption under Section 56(2)(viib) if it is recognized by DPIIT and fulfills the following conditions:

(a)    The aggregate amount of paid-up share capital and share premium or issuance or proposed issuance thereof does not exceed Rs 25 crores (approx. US$ 3.6 million). This limit of Rs 25 crores (approx. US$ 3.6 million) will exclude investments made by (i) non-residents; (ii) venture capital companies or funds; and (iii) listed companies having net worth of Rs 100 crores (approx. US$ 14.5 million) or turnover of at least Rs 250 crores (approx. US$ 36 million).

(b)     The start-up has not invested in certain specified assets (e.g., immovable properties, loans or advances, shares or securities, capital in other entities, jewelry, drawing, painting, etc.) and does not invest in such assets up to a period of 7 (seven) years from the end of the year in which its shares are issued at a premium. An exception has however been carved out to permit investments carried out by the start-up in the ordinary course of its business.

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Chambers Global Practice Guide on Investment Funds (India)

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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.

Authors:

Ashwath Rau
Pallabi Ghosal
Vivaik Sharma

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SEBI Notifies Operating Guidelines for AIFs in IFSC – Key Takeaways

Background

In March, 2015, SEBI had issued guidelines for facilitating and regulating financial services relating to securities market in an International Financial Service Centre (“IFSC”) set up under section 18(1) of Special Economic Zones Act, 2005 at GIFT City, Gujarat. While these guidelines provided a broad framework for setting up of Alternative Investment Funds (“AIFs”) in IFSC, the operating guidelines were yet to be notified. SEBI, on November 26, 2018, has issued a  Circular [1] which sets out the Operating Guidelines for AIFs in IFSC. As a background to the Circular, the SEBI and the RBI had vide various circulars put in place a regulatory regime for setting up of AIFs as ‘financial institutions’ in the IFSC, which would be treated as ‘persons resident outside India’ for the purposes of Indian foreign exchange regulations.

Key Highlights

•        Registration process: a fund set up in IFSC in the form of a trust or a company or a limited liability partnership or a body corporate, can seek registration under the provisions of SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) under the categories mentioned in the AIF Regulations. This would mean that funds set up in IFSC could benefit from the AIF regulatory framework which is conducive to funds having varied philosophies (including VC, PE and hedge funds).

•        Eligibility to invest in the IFSC AIF: following investors are permitted to invest in an AIF in IFSC: (i) a person resident outside India; (ii) a non-resident Indian; (iii) institutional investor resident in India who is eligible under FEMA to invest funds offshore, to the extent of outward investment permitted; (iv) person resident in India having a net worth of at least USD 1 million during the preceding financial year who is eligible under FEMA to invest funds offshore, to the extent allowed in the Liberalized Remittance Scheme of the RBI[2].  Further, an investor is required to make a minimum investment of USD 150,000. If the investor is an employee or director of the AIF/manager, minimum investment amount is USD 40,000.

•       Investment conditions: AIFs in IFSC shall be permitted to invest in the following: (i) securities which are listed in IFSC; (ii) securities issued by companies incorporated in IFSC; (iii) securities issued by companies incorporated in India or companies belonging to foreign jurisdiction. Thus, such AIFs would be eligible to make investments in a wider range of securities, particularly securities of offshore companies for which non-IFSC AIFs registered with SEBI require specific regulatory approval which is granted on a case-by-case basis.

For making investments in India, AIFs in IFSC can make such investments under the Foreign Portfolio Investor or Foreign Venture Capital Investor or Foreign Direct Investment (FDI) route.

•        De minimus requirements:

RequirementAmount (USD)
Corpus of each scheme of the AIF3 million
Minimum continuing interest in the AIF by the manager/sponsor (not through waiver of management fees)

Category I and II AIF

Category III AIF

Lower of 2.5% of corpus or 750,000                                                                  Lower of 5% of corpus or 1,500,000

 

•        Sponsor/Manager of the AIF: Sponsor/Manager of an existing AIF may act as a Sponsor / Manager of an AIF set up in the IFSC by either setting up a branch in the IFSC, or incorporating a company or limited liability partnership in the IFSC. New Sponsor/Manager are required to incorporate a company/LLP in the IFSC.

•       The Operating Guidelines also address the requirement to appoint custodians for AIFs and the manner in which Angel Funds (a category of AIFs) can be established in the IFSC.

Key Takeaways

•        Setting up AIFs in IFSC effectively permits fund managers based in India to manage foreign capital without having to set up presence offshore and incur significant costs. IFSC also offers a regulatory platform for fund managers looking to set up funds seeking to make investments in India as well as other jurisdictions.

•        These guidelines eliminate the tax risks associated with General Anti Avoidance Rules (“GAAR”), permanent establishment, and Place of Effective Management (“POEM”) that surround any offshore structures put into place by Indian fund managers managing/advising on offshore pool of capital. Such tax related considerations have lead to an increase in costs and efforts for demonstrating genuine commercial substance and activity in offshore fund structures. Having said that, an AIF in IFSC would be treated as an Indian resident taxpayer and would not have access to any benefit under any double tax avoidance agreement. However, the beneficial tax regime available to Category I and II Alternative Investment Funds which accords them a tax-pass through status should also be applicable to AIFs set up in the IFSC.

•        Indian fund managers either set up in IFSC or having a branch in IFSC should be able to benefit from the exemption on Goods and Services Tax (which is otherwise applicable at a rate of 18%) on the management fees that the manager charges the AIF for managing the AIF’s pool of capital. Further, such managers should also be eligible for income tax holidays on their fee income i.e. 100% exemption of such income for first 5 years after commencement of business followed by an exemption of 50% of the income for an additional period of 5 years.

•        Funds which are focused on making investments in derivatives, including commodity derivatives, listed on stock exchanges within IFSC could enjoy the benefit of being insulated from any currency risk considering that their investments in the AIF as well as downline investments in derivatives listed on such stock exchanges would be denominated in foreign currencies.

•        Given that the Operating Guidelines indicate that all provisions of the AIF Regulations and the guidelines and circulars issued thereunder, shall apply to AIFs setting up/ operating in IFSC, then the investment conditions/restrictions applicable to different categories of AIFs will also apply to AIFs in the IFSC. For example:

•        An AIF is not permitted to invest more than 25% of its investible funds in a single investee entity. While this condition will apply to AIFs in IFSC, this would not be applicable to an offshore fund investing in India under the extant foreign investment laws.

•        A Category I or II AIF may not 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 4 occasions in a year and not more than 10% of the investable funds. While this is a restriction that the AIF in the IFSC will face, a fund set up in offshore can seek leverage without being subject to these conditions.

•        The Operating Guidelines indicate that an AIF in IFSC can invest in another AIF (in IFSC and outside) subject to AIF Regulations. This will be useful for structuring ‘master-feeder’ structures for the following reasons: (i) fund managers need not incur significant costs of setting up pooling vehicles offshore; (ii) the management fees and carry can be taken in India by the Manager; (iii) the non-IFSC AIF receiving investment from the IFSC AIF will be permitted to invest in debt instruments which a IFSC AIF will not be able to do under the FDI route without taking FVCI registration and/or FPI registration (both of which have restrictions around investment in debt instruments); and (iv) provides operational flexibility. The points to note however are: (i) unlike an offshore vehicle which can invest part of its capital in a non-IFSC AIF and part directly into portfolio companies, an IFSC AIF (Fund of Funds) will be required to invest its entire capital in the non-IFSC AIF; and (ii) all other restrictions that apply to AIFs under the AIF Regulations, will apply to the non-IFSC AIF which would not be the case if the feeder vehicle is established in an offshore jurisdiction which has ease of doing business.

[1] SEBI Circular No. SEBI/HO/IMD/DF1/CIR/P/143/2018
[2] Currently, Indian resident individuals are permitted to remit monies outside India for permissible capital and current account transactions within a limit of US$ 250,000 per financial year per individual

Authors:

Pallabi Ghosal, Partner

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Routes of Foreign Investment in India: Simplifying the Labyrinth for Foreign Investors

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Published In:EMPEA [ ]

Introduction

In the past year, India has seen an influx of foreign investment surpassing its otherwise preferred neighbour China as a recipient of foreign investment.[1] To accommodate this steady inflow, Indian legislators have made significant modifications to the various laws that govern routes of foreign investment that a foreign investor can access when investing in India.

The question that arises is – which route for foreign investment to choose? The intent of this article is to provide a snapshot of the investment routes available to foreign investors desirous of investing in India and the key considerations to bear in mind.

Entry Routes for Foreign Investment in India

There are broadly three entry routes available for foreign investment in India: (a) foreign portfolio investor (“FPI”); (b) foreign venture capital investor (“FVCI”); and (c) foreign direct investment (“FDI”).

FPI

What is the on-boarding process for a FPI?

SEBI registered designated depository participants (“DDPs”) are authorised to on-board foreign investors as FPIs into one of the three categories after ensuring that the proposed FPI meets the eligibility criteria, as well, amongst other things, as applicable know-your-customer, anti-money laundering and combating financing of terrorism guidelines.

The three categories of FPIs and which category a foreign investor will fall under depends on the type of foreign entity making the FPI application. For example, sovereign wealth funds, government agencies, banks, and multilateral organizations would be classified as a Category I FPI. Appropriately regulated broad based funds[2] such as mutual funds, investment trusts, and insurance/reinsurance companies would be classified as Category II FPIs and Category III FPI is the residuary category.

One of the key developments in the on-boarding process for a FPI is the requirement on the FPI to provide details of their ultimate beneficial owner, i.e., natural persons who ultimately own or control an FPI. This disclosure is subject to materiality thresholds prescribed by SEBI. This requirement however does not apply to a Category I FPI.

What investments are permissible for a FPI?

FPIs are permitted to invest in shares, debentures (compulsorily convertible to equity) and warrants of companies,listed or to be listed on a recognized stock exchange in India, through primary and secondary markets. Such investment is subject to the total holding by each FPI or an investor group being less than 10% of the total paid-up equity capital (on a fully diluted basis) or less than 10% of the paid-up value of each series of (compulsorily convertible) debentures or preference shares or warrants issued by an Indian company.In case the total holding of the FPI increases to 10% or more of the paid-up share capital (on a fully diluted basis) or the paid-up value of each series of (compulsorily convertible) debentures or preference shares or warrants issued by an Indian company, the total investments of the FPI are required to be re-classified as FDI subject to conditions as specified by SEBI and RBI.

FPIs are also permitted to invest in listed or proposed to be listed debentures or bonds, subject to conditions, security receipts issued by asset reconstruction companies, securitised debt instruments, units of schemes floated by domestic mutual funds (whether listed on a recognised stock exchange or not), collective investment scheme, listed and unlisted non-convertible debentures/bonds issued by an Indian company in the infrastructure sector, unlisted non-convertible debentures/ bonds issued by an Indian company subject to the guidelines. It should be noted that FPIs are permitted to invest in unlisted non-convertible debentures/ bonds subject to end-use restrictions on investment in real estate business,capital market and purchase of land.

The FPI route is considered attractive for debt investments given debt investments by FPIs are not classified as external commercial borrowings,which is far more regulated. It is however pertinent to note that more recently, concentration norms have been prescribed for FPI investment in debt securities pursuant to which FPIs (including related FPIs[3]) are not permitted to invest in more than 50% of any single issue of corporate bonds (which limit is not applicable to security receipts).

In order to provide a boost to the Indian debt market, RBI has recently introduced the voluntary retention route (“VRR”). VRR exempts FPIs from the restrictions in relation to the minimum residual maturity period (which is one year for the general FPI route), and concentration limits as above. However, VRR imposes a minimum retention period of three years and the requirement to invest 25% of the committed portfolio size within one month and the remaining amount within three months from the date of allotment of the committed portfolio size to the FPI under the VRR.

SEBI has also permitted FPIs to invest in units of real estate investment trusts (“REITs”), infrastructure investment trusts (“InvITs”) and category III alternative investment funds. However, FPIs cannot hold more than 25% stake in units of category III alternative investment funds. While investors prefer to invest in alternative investment funds (“AIFs”) under the FDI route, the FPI route is commonly utilised for making investments in REITs and InvITs given there is no restriction on the percentage stake.

Significant tax benefit for FPIs are that securities held by FPIs are deemed to be capital assets under Indian tax laws and therefore, income would be generally regarded as interest income or capital gains but not business income (which is subject to higher rate of tax). Further, there is no withholding tax on capital gains on securities. Interest income received on debt instruments is subject to withholding tax in the range of 5% to 20%.

FVCI

Investors resident outside India can make investments under the FVCI route pursuant to registration with SEBI under SEBI (Foreign Venture Capital Investors) Regulations, 2000 (“FVCI Regulations”).

What are the permissible investments for a FVCI?

A FVCI is required to invest at least two-third of its investible funds[4] in equity or equity linked instruments (which also includes optionally convertible debentures) of venture capital undertakings[5], provided that the remaining one-third of investible funds can be invested, inter alia, in debt or debt instruments of a venture capital undertaking in which the FVCI already has equity investment.

The RBI has restricted investment by FVCIs to investment in: (a) Indian companies engaged in ten permitted sectors (including infrastructure, biotechnology and IT related to hardware and software); (b) start- ups irrespective of the sectors; and (c) units of a venture capital fund or category I alternative investment funds. Investments by FVCIs in capital instruments are subject to sectoral caps on foreign investment in India and attendant conditions.

Why choose the FVCI route?

The key benefits that the FVCI route provides are exemptions from: (a) the pricing guidelines stipulated under the FEMA Regulations, and (b) pre-issue capital lock-in requirements prescribed under the regulations governing issue of securities. Therefore, foreign investors seeking to make investments in the ten permitted sectors can consider making investment under the FVCI route.

From a tax perspective, it is pertinent to note that there is no clarity on whether income will be characterized as capital gains and such income may be characterised as business income, subject to fact-specific determination.

FDI

What is FDI?

FDI is defined as investments through capital instruments by a non-resident in: (a) an unlisted Indian company; or (b) 10% or more of the paid up equity capital (on a fully diluted basis) of a listed Indian company.

Unlike FPI and FVCI routes, the FDI route does not require registration and any eligible investor is permitted to make investments through this route. There are, however, certain cases where under the FDI route, a specific approval from the Government of India may be required to be taken to make an investment.

What are the permissible investments under the FDI route?

FDI is permitted in equity shares; fully, compulsorily, and mandatorily convertible debentures; fully, compulsorily, and mandatorily convertible preference shares, and share warrants; and in any sector except those sectors that are prohibited. FDI route cannot be utilized to make debt investments.

Investments under the FDI route are subject to entry routes, sectoral caps, pricing guidelines, and attendant conditionalities.

Investments in Alternative Assets

Foreign investments in REITs, InvITs and AIFs (“Investment Vehicles”) have been permitted under the FDI route subject to attendant conditions. It is pertinent to note that RBI has clarified that the extent of foreign investment in the corpus of the Investment Vehicle would not be a factor in determining as to whether downstream investment by the Investment Vehicle is foreign investment or not. However, RBI has further clarified that investments by Investment Vehicles into an Indian investee entity would be reckoned as indirect foreign investment for such entity if the sponsor or the manager to the Investment Vehicle is not owned and controlled by resident Indian citizens, or is owned or controlled by persons resident outside India. Such investments would have to conform to the sectoral caps and attendant conditions including pricing guidelines, if any, as applicable to the investee Indian investee entity in which the downstream investment is proposed to be made.

Conclusion

Given the choice of entry routes available to foreign investors, foreign investors are often faced with the dilemma of electing the most appropriate entry route in order to attain as closely as possible their investment objectives. More often than not, a foreign investor may have to use a combination of routes to access the Indian securities market. A careful analysis of the investment strategy, nature of investment, and commercial reason to use a particular route will need to be undertaken before deciding which entry route should be adopted to make investments in India.

[1]https://economictimes.indiatimes.com/news/economy/indicators/india-pips-china-in-fdi-inflows-for-the-first-time-in-20-years/articleshow/67281263.cms
[2]Broad based fund is defined as a fund established outside India, with at least 20 investors and no single investor holding more than 49% interest in the fund and this criteria can be fulfilled on a look-through basis if an institutional investor is holding more than 49% interest in the fund.
[3]Multiple entities having common ownership, directly or indirectly, of more than 51% or common control would be considered as related FPIs
[4] Funds committed for investments in India net of expenditure for administration and management of the fund.
[5]A domestic company whose shares are not listed on a recognised stock exchange in India, and which is engaged in the business of providing services, production or manufacture of articles or things excluding the negative list (which includes non-banking financial services, gold financing).

Authors:

Pallabi Ghosal, Partner
Ananya Sonthalia, Senior Associate

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KYC and Beneficial Ownership Disclosures by FPIs

Based on the interim recommendations of the Working Group constituted by the Securities and Exchange Board of India (“SEBI”) under the chairmanship of Shri H R Khan with respect to Know Your Client (“KYC”) requirements for Foreign Portfolio Investors (“FPIs”), SEBI had under their circular dated September 21, 2018 clarified that beneficial ownership criteria will only be relevant for the purposes of KYC of the FPI and not for determining eligibility of the FPIs, and had inter alia provided directions for identification and verification of Beneficial Owners (“BO”) for Category II and Category III FPIs.

As per the said circular, BOs are natural persons who ultimately own or control an FPI and should be identified in accordance with Rule 9 of the Prevention of Money- laundering (Maintenance of Records) Rules, 2005 (“PMLA Rules”). The BO of an FPI is required to be identified by way of controlling ownership interest and by way of control. The materiality threshold to be applied for identifying the BO by way of controlling ownership interest would be as provided in Rule 9 of PMLA Rules. The Circular also provides that in respect of FPIs coming from “high risk jurisdictions”, a lower materiality threshold of 10% should be applied for identification of BO and the KYC documentation to be obtained should be as applicable for Category III FPIs. Details of all individuals/ entities above the FPI, holding directly or indirectly more than the materiality threshold in the FPI are required to be disclosed in the BO disclosures. While SEBI has not specified a list of high-risk jurisdictions, the concerned Designated Depository Participant (“DDP”) is required to identify whether the FPI is from a high-risk jurisdiction or not. Interestingly, DDPs have been taking differing views in this regard for certain jurisdictions. Also some custodians have based the 10% threshold solely on the basis of whether the FPI is from a high risk jurisdiction, other custodian banks are applying a lower materiality threshold if the FPI is registered as a Category III FPI whether or not coming from a high risk jurisdiction. In addition to the identification of the BO of the FPI on a controlling ownership interest basis, the FPI is also required to identify the BO on a control basis. The term ‘control’ includes the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.

The materiality threshold to identify the BO is required to be first applied at the level of FPI and next on a look through basis to identify the BO of the intermediate shareholders or owner entity. In the look through basis, the BO and intermediate shareholders or owner entity with holdings equal & above the materiality thresholds in the FPI need to be identified. For intermediate shareholders, or owner entities, the name of such entities and percentage holding is also required to be disclosed in a specified format. In the event the FPI does not identify a natural person as the BO by way of controlling ownership interest or by way of control, then the FPI must identify a senior managing official (“SMO”) as its BO. Further, the exemption provided in Rule 9(3)(f) of PMLA Rules for listed companies is not made available to foreign companies. SEBI has also clarified that, in case of companies or trusts are represented by service providers like lawyers/ accountants, then such FPIs should provide information of the real owners/ effective controllers of the FPI. SEBI has also clarified that these BO disclosure requirements will also have to be followed for Offshore Derivative Instruments.

The Circular further stipulates a periodic KYC review as and when there is any change in material information/disclosure. All FPIs with a Category II or Category III registration from high-risk jurisdiction will be subject to KYC review on a yearly basis. The Circular also reassures that the KYC Registration Agencies (“KRA”) will lock the details provided by the FPI on the BO, including details of the SMO. Such information will only be accessible to intermediaries after authentication and only on a ‘need to know basis’ after the KRA receives confirmation from the FPI, or its Global custodian in this regard.

The Circular is a welcome change from the earlier KYC requirements prescribed by SEBI on April 10, 2018.

Authors:

Rushabh Maniar, Partner
Sonali Ladha, Associate

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