GIFT City – New incentives to set up AIF’s in India’s first International Financial-Tec City
GIFT City Snapshot
Over the past few months there has been a flurry of developments involving the Gujarat Internal Finance Tech-City (“GIFT City”). New guidelines are being issued and MOUs executed with financial institutions on a weekly basis, all with the aim of incentivizing overseas financial institutions and overseas branches /subsidiaries of Indian financial institutions to bring to Indian shores those financial services transactions that are currently carried on outside India. The underlying key to this incentivization is the International Finances Services Centre (“IFSC”) which is set up in the special economic zone (“SEZ”) within GIFT City. While the IFSC is technically located on Indian soil, it is considered an offshore jurisdiction for foreign exchange purposes, allowing investors to invest in businesses located within the IFSC without having to comply with India’s foreign exchange regime. Special tax incentives have also been provided to units located within the IFSC to further incentivize offshore investment and bring the IFSC at GIFT City on par with IFSCs globally.
Financial services providers located in the IFSC were originally regulated by various domestic financial regulators, namely RBI, SEBI, PFRDA and IRDAI; however, as of April 27, 2020 the International Financial Services Centres Authority (“IFSCA”) has been established as a unified authority for the development and regulation of financial products, financial services and financial institutions in the IFSC.
The establishment of IFSCA to act as a single-window for regulating activities in an IFSC has already proven an effective tool for rapidly implementing stakeholder asks, and should help build investor confidence through consistency, transparency and clarity in policy measures as GIFT City continues to develop. The ability and desire of the IFSCA to form regulations which are intended to quickly bring the IFSC at GIFT City in line with IFSC’s around the world is an important consideration for both foreign and Indian GPs to take into account when deciding the best jurisdiction for their fund platform.
As further set out below, the IFSC at GIFT City already has in place a robust regulatory and tax framework which affords GPs and their investors an ease of doing business and tax incentives akin to jurisdictions like Singapore and Mauritius, while allowing Indian GPs to manage their funds from within India without the economic burden of Indian taxation.
Legal Framework for AIFs in GIFT City
SEBI (International Financial Services Centre) Guidelines, 2015 (“2015 Guidelines”) provide a broad framework for setting up Alternative Investment Funds (“AIFs”) in an IFSC (“IFSC AIF”). Based on deliberations with the Alternative Investment Policy Advisory Committee and in consultation with stakeholders, SEBI also issued a Circular dated November 26, 2018 (‘2018 Circular”) to further clarify AIF operations within the IFSC. After its establishment as a unified authority governing the IFSC at GIFT City, the IFSCA further addressed stakeholder concerns by issuing Circular dated December 9, 2020 (“2020 Circular) which provides IFSC AIF’s added benefits with respect to leveraging activities, co-investment opportunities and a relaxation of diversification norms.
Accordingly, the 2015 Guidelines read with the 2018 Circular and the 2020 Circular (together, ‘IFSC AIF Regulations’) generally provide the legal framework under which IFSC AIFs operate in GIFT City. Some of the key governing features are as follows:
An IFSC AIF is permitted to accept funds, in foreign currency, from the following types of investors:
Permissible investments by the IFSC AIF
An IFSC AIF is permitted to make investments into the following:
With respect to investments in Indian securities, it has been clarified that an IFSC AIF can invest in India under the foreign venture capital investment (“FVCI”) route, foreign portfolio investor (“FPI”) route, or foreign direct investment (“FDI”) route. Earlier, IFSC AIFs were allowed to invest under the FPI route only. This move by SEBI allows offshore investors flexibility to invest through IFSC AIFs and avail the benefits of the IFSC regime. At the same time, IFSC AIF’s can also invest overseas without adhering to restrictions otherwise provided for domestic AIFs under the AIF Regulations such as the requirement to obtain SEBI approval prior to overseas investment and the inability to invest more that 25% of their investible funds overseas.
Most recently, the IFSCA has responded to demands from stakeholders that the IFSC AIF regime be more in line with international standards, by issuing the 2020 Circular. The key benefits provided under the 2020 Circular are set out in the following table:
The 2020 Circular is indeed a very welcome move for the fund industry, and it illustrates the IFSCA’s commitment to onshoring the fund management industry to India. These relaxations offered to IFSC AIFs should help simplify deal structures which often involved multiple layers and offshore entities in order to accommodate for domestic AIF’s co-investment and diversification restrictions, and complex investment strategies that target both funds and portfolio companies. These changes, along with IFSC AIF’s ability to leverage funds, and the tax incentives (as set out below) provided to IFSC AIF’s brings the IFSC AIF regime one step closer to being on par with international offshore jurisdictions like Singapore, Mauritius, Netherlands, Luxembourg etc.
Sponsor / Manager Entity
Keeping in mind the goal of IFSC to become a financial services hub, it is expected that IFSC AIF managers are also physically located within the IFSC at GIFT City. While an existing sponsor / manager entity of a domestic AIF is permitted to set up a branch or subsidiary in the form of a company or LLP, foreign exchange control provisions, including Foreign Exchange Management (Transfer or issue of any foreign security) Regulations, 2004 (“TIFS Regulations”) and requisite RBI approval for investing in overseas company engaged in financial services should be applicable. These requirements may of course, increase compliance burdens for Indian GPs wanting to manage IFSC AIF from their existing offices outside the IFSC. Having said that, it should be noted that the same foreign exchange control issues would also apply to domestic investors investing in an offshore fund set up in a jurisdiction like Singapore or Mauritius. However, given that the GIFT City IFSC is regulated by Indian regulatory authorities, at the minimum the need for obtaining prior RBI approval for establishment of a manager / sponsor entity in the IFSC and for purposes of complying with the sponsor commitment requirements should be relaxed. This would further incentivize fund managers to choose IFSC AIFs over offshore fund structures, all other commercials being the same.
Tax Framework for AIFs in GIFT City
While any unit in an IFSC including an IFSC AIF and its manager / sponsor entity set up in IFSC is treated as a person resident outside India from a foreign exchange control perspective, for income-tax purposes, such entities are considered to be persons resident in India. That being said, the Income-tax Act, 1961 (“ITA”) provides several incentives to units, including IFSC AIFs and their Investment Managers, located in IFSC, inter-alia including 100 percent tax holiday with respect to business income for any consecutive 10 years out of the unit’s first 15 years in the IFSC under Section 80LA of the ITA. Specifically with respect to income earned by investment managers, the fund industry is currently exposed to the risk of re-characterisation of carry as business income (instead of capital gains). However, this risk is mitigated for manager entities set up within the IFSC as the tax holiday provided under section 80LA should be applicable for performance fees received by the IFSC AIF. This combined with GST exemption makes the GIFT City management structure an attractive model.
The ITA also provides other tax incentives to units located in an IFSC, including reduced minimum alternate tax, concessional withholding tax on interest income, exemption from capital gains tax on transfer of specified securities etc. The Central Board of Direct taxes (“CBDT”) has also clarified that income received by non-resident investors from off-shore investments routed through a Category-I or Category-II AIF, being a deemed direct investment outside India by the non-resident investor, would not be taxable in India. Therefore, income received by non-resident investor from overseas investment made by Category-I or Category-II IFSC AIFs should not be subject to tax in India. Moreover, the CBDT has exempted non-residents having income from investments in an IFSC AIF which is chargeable under the ITA, from filing of income-tax return in India. However, such exemption is available only if tax has been appropriately deducted and deposited to the government by the IFSC AIF as per provisions of the ITA. Along similar lines, the CBDT has also provided an exemption for non-residents with respect to obtaining a Permanent Account Number (“PAN”), provided certain conditions are satisfied.
Relocating offshore funds to the IFSC
Recently, the Finance Act, 2021 has amended various provisions of the ITA to facilitate tax neutrality with respect to the relocation of offshore funds to the IFSC. Such provisions are applicable where the shares and assets of the ‘original fund’ are ‘relocated’ to a ‘resultant fund’ in India. In this context, ‘original fund has specifically been defined under the ITA to mean a fund established or incorporated or registered outside India, which collects funds from its members for investing it for their benefit and fulfills the following conditions, namely:—
Further, ‘relocation’ has been defined to mean the transfer of assets of the original fund, or of its wholly owned special purpose vehicle, to a resultant fund on or before the 31st day of March, 2023, where consideration for such transfer is discharged in the form of share or unit or interest in the resulting fund to,
The ITA also specifies that the ‘resultant fund’ must be a fund established or incorporated in India in the form of a trust, company, or LLP, registered with SEBI has a CAT – I, CAT – II, or CAT – III AIF and is located in an IFSC.
Pursuant to the Finance Act, 2021, the ITA has also been amended to provide the following provisions for ensuring tax neutrally:
While there still exist some challenges in setting up an IFSC AIF, the list is growing shorter at a tremendous pace as the IFSCA focusses on creating a globally competitive environment to incentivize both Indian and foreign GPs to set up AIFs and their investment manager entities within the IFSC. For a more detailed discussion on AIF’s set up in GIFT City, please refer to our collateral titled “Opportunities in GIFT City – Setting up Funds in India’s New Offshore Financial Centre”.
1 IFSCA issued Circular dated February 19, 2021 clarifying that the USD 1 million net value threshold applicable for individual Indian residents to open a freely convertible foreign currency account with a bank set up in the IFSC under the LRS route, shall not be applicable for Indian resident investors remitting funds under LRS to the IFSC for investment in foreign securities.