Tax and Regulatory update on Foreign Portfolio Investors (FPIs) in India – July to September 2023

Taxation Updates

The Central Board of Direct Taxes (CBDT) grants further benefits to the International Financial Services Centre (IFSC)

CBDT vide notification¹ dated 17 July 2023, amended Rule 21AK of the Income-tax Rules, 1962 (IT Rules) by exempting distribution of income on offshore derivative instruments arising to a non-resident. The scope of section 10(4E) of the Income-tax Act of 1961 (the Act) is widened wherein earlier exemption was only with respect to income on the transfer of non-deliverable forward contracts entered into with an offshore banking unit of IFSC which commenced operations on or before the 31 March 2024.

The notification also amended the definition of ‘Specified Fund’ mentioned in Rule 114AAB of the IT Rules and Form 64D by including the International Financial Services Centres Authority (Fund Management) Regulations, 2022 and Funds under said Regulations respectively within the purview.  Further, consequential changes have also been made in Form 10CCF which is required to be furnished in order to avail exemption under section 80LA of the Act.

CBDT amends Rule 11UAC of the IT Rules providing an exemption to fund relocation to IFSC

Rule 11UAC of the IT Rules prescribes a class of persons to whom provisions of section 56(2)(x) of the Act are not applicable. CBDT through its notification² dated 18 July 2023 provides for a new sub-rule to Rule 11UAC of the IT Rules. The sub-rule provides exemption to any movable property, being shares or units or interest in the resultant fund (Alternative Investment Fund located in IFSC) received by the fund management entity of such resultant fund, in lieu of shares or units or interest held by the investment manager entity (fund manager of the original fund) in the original fund (a fund established or incorporated or registered outside India) pursuant to the relocation, provided:

• not less than 90% of shares or units or interest in the fund management entity of the resultant fund are held by the same entity or person in the same proportion as held by them in the investment manager entity of the original fund; and
• not less than 90% of the aggregate of shares or units or interest in the investment manager entity of the original fund was held by such entity or person.

CBDT widens the list of securities eligible for tax exemption on recognised stock exchanges in IFSC;

Section 47(viiab) of the Act provides an exemption from the capital gain in case of transfer of certain capital assets by non-residents on recognised stock exchanges situated in any IFSC and the consideration for such transaction is paid or payable in foreign currency.

The CBDT vide notification³ dated 12 September 2023, covered the additional securities such as unit of an investment trust; unit of a scheme and unit of an Exchange Traded Fund launched under International Financial Services Centres Authority (Fund Management) Regulations, 2022 within the purview of section 47 of the Act, granting the said securities exemption from gain on transfer.

CBDT notifies valuation rules in respect of angel tax provisions

CBDT through its notification⁴ dated 25 September 2023, notified the valuation mechanism for Compulsory Convertible Preference Shares (CCPS) and unquoted equity shares for determining FMV  by amending Rule 11UA of the IT Rules. The key changes in the amended Rule 11UA from the erstwhile Rule are highlighted below:

• The amended Rule 11UA prescribes additional valuation methods for the issue of unquoted shares or CCPs to non-resident investors apart from the Net asset value (NAV) and Discounted Cash Flow (DCF) methods which are available to a resident investor. The additional methods include: - Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method and Replacement Cost Methods.
• The amended Rule permits venture capital undertaking to consider the issue price of its equity shares as the Fair Market Value (FMV); provided such FMV does not exceed the aggregate consideration and it is received within a period of 90 days before or after the date of issuance of shares.
• The valuation report issued by a merchant banker is not more than 90 days prior to the issuance of shares for computing FMV, such date may be at the discretion of the assessee and be considered as the date of valuation.
• The rule provides a tolerance level for cases where the issue price of shares exceeds the valuation price (for both residents and non-residents). If the excess amount does not exceed 10% of the valuation price, the issue price is deemed to be the FMV.

Regulatory Updates

Mandating a Legal Entity Identifier (LEI) for all non-individual FPIs

On 27 July 2023 Securities and Exchange Board of India (SEBI) vide circular⁵, mandated LEI for all non-individual FPIs. LEI code is a unique global 20-character code which identifies the legal entities engaged in financial transactions. Presently, details of LEI are provided on a voluntary basis by FPIs in the Common Application Form (CAF), KYC and account opening. Accordingly, Designated Depository Participants (DDPs) are being requested to alter the CAF on their portal. Reserve Bank of India has made it mandatory to obtain LEI where the aggregate exposure of FPIs exceeds INR 250 million by non-individual borrowers.

All non-individual FPIs have to mandatorily provide their LEI details with immediate effect. All existing FPIs (including those applying for renewal) need to provide their LEIs to their DDPs within 180 days from the date of issuance of this circular.

Non-compliance with the same would lead to the blocking of their accounts for further purchases until LEI is provided to their DDPs. FPIs are required to ensure that their LEI is always active. In case the LEI code is found inactive or has expired, FPI accounts shall be blocked for further purchases in the securities market till the time the LEI code is renewed by such FPIs.

The validity period of approval granted by the SEBI to Alternative Investment Funds (AIFs) and Venture Capital Funds (VCFs) for overseas investments

VCFs and AIFs currently have a six-month time constraint from the date of prior approval from SEBI to make allocated investments in overseas venture capital undertaking. If the applicant AIF/VCF does not use the granted limitations within six months, SEBI may reallocate them to other applicant AIFs/VCFs.

In order to utilise the allocated limit efficiently, SEBI, in its recent circular⁶, has reduced the validity period for overseas investment approvals taken by AIFs from 6 months to 4 months and, if the limit is unutilised, the same is again available to the AIF industry in a short span of time.

Transactions in Corporate Bonds through Request for Quote (RFQ) platform by FPIs

With a view to improve liquidity and transparency, SEBI on 7 August 2023 through a circular⁷ effective from 1 October 2023, has mandated FPIs to place at least 10% of their secondary market bond trades using the Request for Quote (RFQ) platform on a quarterly basis.

Mandating additional disclosures by FPIs that fulfil certain objective criteria

SEBI vide circular⁸ dated 24 August 2023, mandates additional disclosure- Disclosure of Ultimate Beneficial Owner (UBO) for certain FPIs regarding their ownership, control and economic interest on a full look-through basis up to the level of all natural persons without any threshold.

The said disclosure is required to be provided by FPIs to their respective DDPs if they fulfil any of the below-mentioned criteria:

1. FPIs which hold more than 50% of their Indian equity Assets Under Management (AUM) in a single Indian corporate group;
2. FPIs along with their investor group hold more than INR 25,000 crore of equity AUM in the Indian market.

Exemptions are also being provided to the following FPIs despite exceeding the aforementioned threshold:

• Government and Government related investors registered as FPIs;
• FPIs that are unable to dispose of their excess investments due to statutory constraints;
• Exchange Traded Funds (with less than 50% of exposure to India and India-related equity securities) and entities listed on specified Exchanges of the permissible jurisdictions;
• FPIs winding down their investment shall be required to bring down their holdings to ‘NIL’ within 180 calendar days from m the date of their intimation for surrender.
• Newly registered FPIs for the first 90 calendar days from the date of settlement of first trade in the equity segment in India;
• Pooled investment vehicles: regulated by a Government/ regulatory authority in their home jurisdiction:
• Holding in an Indian corporate group less than 25% of their overall global AUM at a scheme level, or
• Equity AUM in the Indian markets is less than 50% of their overall global AUM at a scheme level
• Public Retail Funds

Further, FPI investor group collectively holding more than INR 25,000 crore of Indian Equity AUM, shall be exempted from providing additional disclosures, if the investor group consists of FPIs which fit/satisfy the exemption criteria and Equity AUM net-off such exempted FPIs fall below INR 25,000. If the Net AUM continues to exceed INR 25,000; then the non-exempted FPIs are required to comply with the additional disclosure requirements.

The circular shall come into effect from 1 November 2023.

Consultation Paper on permitting increased participation of NRIs and Overseas Citizens of India (OCIs) into SEBI registered FPIs based out of IFSC in India and regulated by the International Financial Services Centres Authority (IFSCA)

The current FPI regulation provides for restrictions for NRIs and OCIs. NRIs and OCIs can be a constituent of the FPI after adhering to specified conditions. On 25 August 2023, SEBI released a consultation paper seeking to increase the participation of NRIs and OCIs in FPIs based out of IFSC India.

Framework proposed for channelising NRI/ OCI investments in the Indian securities markets through the FPI route:

• The contribution of a single NRI or OCI should be less than 25% of the total contribution in the corpus of the applicant.
• The aggregate contribution of   NRIs/OCIs may exceed 50% of the corpus provided, the FPI is based out of IFSC.
• Following FPIs are required to provide the granular details of ownership, economic interest, or exercising control:
  • FPIs holding more than 33% of their Indian equity Assets Under Management (AUM) in a single Indian corporate group.
  • FPIs that individually, or along with their investor group (in terms of Regulation 22(3) of the FPI Regulations), hold more than INR 25,000 crore of equity AUM in the Indian markets.
• The identified NRI/OCI beneficial owners of the FPI will be required to provide their passport no. / OCI no., as the case may be, respectively to their DDPs.
• Further, FPI applicants based out of IFSC in India and regulated by IFSCA, desirous of having more than 50% aggregate contribution from NRI/OCIs in a corpus, may do so by submitting declarations to their DDPs with regards to the same.
• The said declaration may be submitted at the time of registration or anytime during their registration validity and shall comply with the relevant conditions, irrespective of the actual aggregate NRI/ OCI contribution in the corpus of the FPI.

Comments on the aforesaid proposal were invited until 10 September 2023.

International Financial Service Centre (IFSC)

International Financial Service Centre Authority (IFSCA)(Banking)(Amendment) Regulations, 2023

The IFSCA through its notification⁹ dated 6 July 2023, has notified IFSCA (Banking) (Amendment) Regulations, 2023. By the way of the said amendment, the IFSCA has permitted the banks to set up in IFSC either as an IFSC Banking Unit (IBU) or a subsidiary known as IFSC Banking Company (IBC).

Prior to the introduction of the said amendment, the IFSCA (Banking) Regulations, 2020 permitted a parent bank to set up only one Banking Unit in an IFSC and only as a branch.

The said amendment to the Banking regulations further also notifies the eligibility criteria in respect of IBU for grant of licence/ permission from IFSCA:

• The Parent Bank is required to provide a minimum capital of USD 20 million to the IBU and such capital shall be maintained by the Parent Bank.
• A No-objection certificate is required to be obtained from the parent bank by its home regulator regarding the setting up of a banking unit as a branch of the parent bank and
• An undertaking shall be submitted by the parent bank that it shall provide liquidity to its banking unit whenever needed for the operations of the IBU.

Similarly, the amendment also notifies the eligibility criteria for an IBC to have a minimum capital of USD 50 million as provided by the parent bank and further similar conditions as prescribed for an IBU.

Authorisation Mandates for Scheme filed under IFSCA (Fund Management) Regulations 2022.

The IFSCA through its circular¹⁰ dated 15 September 2023, has directed all the Fund Management Entities (FME) to seek authorisation from IFSCA for each scheme filed under Fund management Scheme, Exchange Traded Funds (ETFs), and Environmental, Social & Governance (ESG) as provided under Chapter III, IV and V of the IFSCA (Fund Management) Regulations, 2022 in order to facilitate operational efficiency.