FPIs rush to rejig structures, hire new managers to escape tax net

Mumbai: Foreign portfolio investors (FPIs) from Mauritius and Cayman Islands are scrambling to protect their investments after the government changed the rules on taxation of indirect transfer of shares. These FPIs are considering to either recategorise themselves to continue under the liberalised regime or appointing a fund manager in Singapore or London so that they don’t fall foul of tax laws.

In Saturday’s budget, the government changed the rules on indirect transfer of shares, saying that only those registered under Sebi’s category-1 scheme will be exempt from tax. The rule comes into effect from April 1.

Category-1 funds comprise FPIs and fund managers that are from countries compliant with the Financial Action Task Force (FATF) rules. Category-2 investors largely comprise funds from Mauritius or Cayman Islands. The exemption was earlier available to both categories of funds.


Funds Considering Options

The change means that category-1FPIs will be exempt from paying the 40 per cent tax on indirect transfer of shares. Those under category 2 will now have to pay tax, but can get upgraded to category 1 if they comply with certain conditions.

The regulations on indirect transfer of shares were brought in after Vodafone won a transfer-pricing tax dispute against the government in 2012. These provide for taxing overseas transactions involving shares of Indian companies if the shares constitute more than 50 per cent of the foreign fund’s total assets (exceeding ?10 crore). Many Asian funds that also invest in other countries have more than 50 per cent weightage for India, and would now face this tax.

According to people in the know, many funds have reached out to their investors and sought to know whether they could disclose the names of shareholders to Indian authorities. This is because a fund can be categorised as category 1 if 75 per cent of the investors are from FATF-compliant countries such as the US, UK or Europe. However, some investors may not be comfortable sharing details with Indian authorities, which could force FPI managements to consider alternatives. “FPIs that have at least 75 per cent direct or indirect investors from FATF countries are looking to submit details to custodians so that they can migrate to category 1,” said Suresh Swamy, partner (financial services), PwC India.

The Alternatives

Other alternatives being explored include changing the fund manager and shifting his or her location to London or Singapore from Mauritius or Cayman Islands.

“To come under the category 1, inter alia, FPIs need to have either the regulated fund or the regulated fund manager from FATF member country. Given the budget proposals, for a fund based in Mauritius that has appointed a fund manager based in Singapore, that fund should get exemption from the indirect transfer tax provisions, where it has got itself re-paperd as category 1. The same may not be how it pans out for Cayman funds with Cayman managers." said Sameer Gupta, tax markets leader, EY India.

Some FPIs are also looking to exit all investments before March end, so that they don’t attract the new provision.

“Investors in funds from Mauritius or Cayman Island that continue to remain in category 2 may hold on to investments made under the FPI 2014 regime as those investments are grandfathered from an offshore transfer provision standpoint. But they will refrain from investing further as fresh investments will be subject to offshore transfer provisions,” said Swamy.