To attract greater foreign inflows into Alternative Investment Funds (AIFs), Infrastructure Investment Trusts and Real Estate Investment Trusts, the government has recently made some changes to the investment regulations.
Investments by non-resident Indians and other foreign investors into such funds or trusts will now be allowed under the automatic route. Earlier, such investments required an approval from the Foreign Investment Promotion Board (FIPB). The Centre has also ensured that investments in turn made by such funds or trusts happen seamlessly.
Recent tweaks AIFs, Infrastructure Investment Trusts and Real Estate Investment Trusts are all investment vehicles regulated by capital markets regulator SEBI. Formed as a trust for the purpose of pooling in capital, any foreign investment into them required an approval from the FIPB. This was time consuming.
With the recent tweaks two things have changed.
One, investments by non-resident Indians and other foreign investors will now happen under the automatic route. Two, the recent changes also do away with a number of ambiguities surrounding the status of the trusts from an FDI point of view. For instance, if a trust was registered in India and managed by an asset manager who was an Indian, but had a substantial foreign holding, it was unclear whether the trust should be treated as an Indian trust and whether investments made by such trust required an FIPB approval.
Now, it has been clarified that if the sponsor or manager of the fund is an Indian, then it will be treated as an Indian trust, even it has a substantial (even majority) foreign holding. The FDI rules hence will not apply to investments made by such trusts.
“This is an extremely important development and follows a series of FDI reforms announced by the Government last week. Importantly, the amendment provides that the downstream investments by such investments vehicles which are sponsored or managed by Indian-owned and controlled entities (other than limited liability partnerships (LLPs)) will be treated as domestic investment and that no FDI related rules will apply to such downstream investments irrespective of the extent of foreign investment into such investment vehicles,” says Kalpesh Maroo, Partner, BMR & Associates LLP.
According to him, these funds will now be able to invest in all sectors without any sectoral caps imposed under the FDI rules. Being an Indian trust, they also need not comply with the norms laid out under the Foreign Exchange Management Act which is regulated by the RBI.
Earlier, while the trusts were regulated by SEBI, there was no provision under the FDI policy for classification of such trusts as Indian-owned and controlled or otherwise.
Gopal Srinivasan, Chairman and MD of TVS Capital Funds, said: “The DIPP Ministry deserves a round of applause for creating an unprecedented breakthrough which will provide abundance of long-term capital. Whatever be the mix in the AIF vehicle — of rupee and dollar funds, the investments made by the AIF will be considered as domestic money. So downstream investments are not affected or limited by FDI restrictions. The ease of doing business for AIF managers becomes simpler and there is no more need for complex structures for taxation arbitrage reasons.”
Tax hiccups
While these are positive developments, the government may still have to resolve certain tax hiccups to ensure large investments into these trusts.
“While the 2015-16 Budget did extend the tax pass-through to AIFs, it also included a 10 per cent withholding tax,” says Maroo.
A ‘pass-through’ status means that the income generated would be taxed in the hands of the investor, and that the fund itself would not have to pay tax on the same. This ensures that the funds are not subjected to double-taxation; paying tax whenever income was generated at the fund level, and then again in the hands of the investor. But the Budget stated that at the time of distribution of such income by the trusts to the investor, a withholding tax of 10 per cent shall apply for which credit can be claimed by the investor.
“Withholding tax issue needs to be resolved through a Budget process and cannot be sorted out through an executive decision as in the case of FDI. If the Centre recognises the issue and chooses to rectify it in the upcoming Budget, then it will go a long way in ensuring large foreign inflows into these trusts,” Maroo says.