Regulatory Alert - Tax and Regulatory update for Foreign Portfolio Investors (FPI) and International Financial Services Centre (IFSC)- January 2021 to March 2021

Regulatory Updates – FPI

1. Relaxations in investment norms by Foreign Portfolio Investors (FPI) in Defaulted Bonds

Currently, the RBI master circular¹ on ‘Investment by FPI in Debt’ requires FPI investments in corporate bonds to be subjected to a minimum residual maturity of above one year, subject to the condition that short-term investments in corporate bonds by an FPI shall not exceed 30% of the total investment of that FPI in corporate bonds. Also, investment by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond.  

The circular has now been updated² to exempt investments by FPI in non-convertible debentures / corporate bonds which are under default, either fully or partly, in the repayment of principal on maturity or principal instalment in the case of amortising bond from the aforesaid requirements.

2. Guidelines pertaining to Surrender of FPI Registration

The Securities and Exchange Board of India (‘SEBI’) in addition to the circular dated November 05, 2019³ with respect to operational guidelines for Foreign Portfolio Investor (FPI) and Designated Depository Participant (DDP), have also issued additional circular dated March 30, 2021⁴ to be followed by DDP for surrender of FPI registration.

As per these Guidelines, when an application is made by an FPI to SEBI for seeking “No Objection Certificate” (NOC) for surrender of FPI, the DDP shall confirm the following:

• The NRI/ USD accounts held by the applicant with DDP should be NIL and should be blocked for further transactions.
• There should be no outstanding dues with respect to SEBI or any pending proceeding with respect to the FPI.
• The client code/ trading code gets deactivated within 10 days from receipt of NOC from SEBI.

Regulatory Updates –IFSC

1. Framework for Aircraft Leasing Companies announced by IFSCA

The International Financial Service Center Authority (IFSCA) has announced⁵ framework for companies planning to enter into aircraft leasing operations. The aforesaid framework covers mainly:

• Definition of Lessor:

Lessor shall mean an entity engaged in the business of providing aircraft or helicopter and engines of aircraft or helicopter or any other part thereof under an operating lease, which is registered with IFSCA.

• Permissible Activities:

A Lessor in IFSCA shall be permitted to undertake following activities:

• Operating lease for an aircraft lease arrangement including sale and lease back, purchase, novation, transfer, assignment, and such other similar transactions in relation to aircraft lease;
• any other related activity with the prior approval of the IFSCA.

• Eligibility criteria of Applicant:

An applicant shall meet following criteria:

• The entity shall set up operations in IFSC in India by way of Company or Limited Liability Partnership or Trust or in any other form as may be prescribed by IFSCA;
• The person located in control of aforesaid entity shall be located in a Financial Action Task Force compliant jurisdiction;
• The entity shall deploy resources in IFSC commensurate with the business operations;
• The entity shall comply with capital requirement as required under this framework

• Capital Requirement:

• A minimum capital of USD 200,000 or its equivalent in freely convertible foreign currency, is to be maintained at all times by the entity;
• IFSCA may prescribe maintenance of additional capital, based on the nature and scale of business of the entity if required.

• Registration of Lessor:

No applicant shall act as a lessor in an IFSC in India unless it has obtained a certificate of registration from the IFSCA under this framework and registration is to be obtained in the prescribed form as prescribed under this framework;

• Currency for conduct of business:

Lessors shall transact in freely convertible foreign currency only. However, the lessors may defray their administrative expenses in INR by maintaining a separate INR account.

2. Remittances to IFSCs in India under the Liberalised Remittance Scheme (LRS) by Resident Individuals

The Master direction⁶ of RBI on Liberalised Remittance Scheme (LRS) has been amended⁷ to permit resident individuals to make remittances under LRS to IFSCs set up in India, subject to the following conditions:

• The remittance shall be made only for making investments in IFSCs in securities, other than those issued by entities/companies resident (outside IFSC) in India.
• Resident Individuals may also open a non interest bearing Foreign Currency Account (FCA) in IFSCs, for making the above permissible investments under LRS. Any funds lying idle in the account for a period upto 15 days from the date of its receipt into the account shall be immediately repatriated to domestic INR account of the investor in India.
• Resident Individuals shall not settle any domestic transactions with other residents through these FCAs held in IFSC.

3. Procedural Guidelines for Recognition as Custodian of Assets and securities

The IFSCA, through the Circular dated February 24, 2021[8] has announced a mechanism to recognise custodian of assets/securities has been taken to facilitate custodial services in GIFT-IFSC.

The above covers Custodians registered at SEBI, Foreign Regulated Custodians, Capital Market Intermediaries in Foreign Jurisdictions and entities not falling in any of aforementioned categories (‘Other Entities’).

The key aspects of the mechanism are as below:

• Entities registered at SEBI, Foreign Regulated Custodians, Capital Market Intermediaries in Foreign Jurisdictions shall be permitted to provide custodial service at GIFT-IFSC by establishing a branch at GIFT-IFSC subject to prior approval by authorities and compliance with certain conditions:
  • The entity shall adequately ring fence the operational, technological, and financial aspects of the branch in GIFT-IFSC from its domestic operations.
  • The entity shall ensure financial segregation by allocating the prescribed amount of funds towards its IFSC branch and submit a declaration to the Authority in this regard.
  • The foreign regulated custodians, capital market intermediaries in foreign jurisdictions should be from a Financial Action Task Force (FATF) compliant jurisdiction.
  • The entity is registered as a custodian / Capital market intermediary and regulated by a securities market regulator in its home jurisdiction.
  • The entity should have a minimum net worth of:
    • USD 7 million in case of foreign regulated custodians
    • USD 35 million in case of capital market intermediary in foreign jurisdictions.
• Other Entities based in an FATF jurisdiction shall be permitted to provide custodial services by establishing a subsidiary at GIFT-IFSC wherein the subsidiary shall have a net worth of USD 70 million and declaration to the authority has to be submitted in this regard.
• Additional requirements applicable to all entities as well as a template for application before the IFSCA have also been prescribed.

4. Amendment in IFSCA Banking Regulations, 2021

In addition to the International Financial Services Centres Authority (Banking) Regulations, 2020⁹ (‘Banking Regulation’) which lay down key principles applicable to banking operations for an IFSC Banking Unit (‘IBU’), IFSCA has issued a circular with certain amendments in circular dated 25 March, 2021¹⁰. The circular has permitted an IBU to provide Portfolio management services as well as investment Advisory services to persons resident in India and persons resident outside India.

5. Regulations approved for setting up of finance company/unit in IFSC

The IFSCA approved and passed the IFSCA (Finance Company) Regulations, 2021¹¹ (‘Finance Company Regulations’) which lay down major principles for setting up of Finance Company/Unit in the IFSC.

The key aspects of the Finance Company Regulations are listed below:

• A finance company shall commence business only after obtaining a certificate of registration from the IFSC Authority.
• An application for grant of registration as a Finance Company or a Finance Unit, as the case may be, shall be made by the applicant in the form and manner as specified by the IFSC Authority.
• A Finance Company can be set up either as a subsidiary or a joint venture, or as a newly incorporated company under the Companies Act, 2013. Entities set-up as Limited Liability Partnership (‘LLP’) or Trust intending to carry out either one or more non-core activities as mentioned in the Finance Company Regulations are also eligible to apply.
• A Finance Unit can be set up if the investing entity or the ultimate parent of the investing entity is carrying out a regulated financial activity in its home jurisdiction and has obtained the No-Objection Certificate from the home country regulator for setting up a Finance Unit in the IFSCs.
• The applicant seeking registration shall have and maintain prescribed minimum owned fund, depending upon the activity proposed to be undertaken by it.
• The applicant entity and/or its promoters shall be from a FATF compliant jurisdiction and comply with international standards set by the FATF to combat money laundering and terrorist financing.
• A Finance Company or a Finance Unit shall carry out its operations in a freely convertible foreign currency. The IFSCA may specify other business transactions, administrative and statutory expenses that may be carried out in INR.
• Every Finance Company and Finance Unit shall follow KYC norms including reporting requirements as applicable to a Banking Unit in an IFSC. Further, it shall adhere to the guidelines on corporate governance and disclosure requirements to be specified by the IFSC Authority.
• Any mergers, acquisitions, takeovers or change in management of a Finance Company, which results in its change in control of at least 25% of total share capital, or of business decisions under an agreement, shall be subject to prior approval and such other requirements as may be specified by the IFSC Authority.
• Every financial reporting by a Finance Company and a Finance Unit to the Authority shall be in USD. Further, every Finance Company and Finance Unit shall furnish information relating to its operations, in such manner, interval and form, as may be specified by the IFSC Authority.

Apart from the above, the Finance Company Regulations also lay down the rules for general prudential regulatory requirements including maintenance of ratios, exposure ceiling and reserve requirements, permitted activities, and other operational requirements.

Tax Updates

1. Amount of Remuneration to be paid to Fund Managers in respect of fund management activity

Finance Act (No 2) 2019 amended clause (m) of sub-section (3) of section 9A of the Income-tax Act, 1961 (Act) w.e.f. 1-4-2019 to provide for payment of remuneration by an eligible investment fund to an eligible fund manager in respect of fund management activity undertaken by him on its behalf to be not less than the amount calculated in such manner as may be prescribed under Rule 10A of Income-tax Rules, 1962 (Rules). However, the amendment in Rule 10A has been notified after the financial year 2019-2020 got over.

In order to address the hardship caused by the same, CBDT has through a circular¹² clarified that where a remuneration paid to the eligible fund manager for financial year 2019-20 and financial year 2020-21 is lower than the amount prescribed under sub-rule 12 of Rule 10A of the Rules but it is at Arms-Length, it shall be in compliance with the provisions as referred in clause (m) of sub-section (3) of section 9A of the Act.

It has also been clarified that the remuneration to be paid to the fund manager, for the financial year 2021-22, shall be in accordance with sub-rule (12) of rule 10V of the Rules and the application for lower remuneration if any is to be made before 1 February 2021 as notified in the amendment in Rule 10V of Rules¹³.

2. Amendments made by Union Budget, 2021

Please refer BDO India’s Publication on Union Budget, 2021 for relevant amendments.

Please refer to BDO India’s flyer for amendments proposed in BFSI Sector.

Please refer to BDO India’s Tax Alert dated 23 March 2021 for further analysis of supplementary amendment made in Finance Act, 2021.

​3. Clarification on continuation of concessional rate on certain Interest Income

Section 115AD of Act, provides concessional withholding tax rate of 5% for interest income earned by FPIs which is covered in the purview of Section 194LD of the Act. Finance Act, 2021 amended Section 115AD of the Act to allow tax treaty benefits (where available) on the withholding tax rates for FPIs. The press release dated 17 March 2021 has clarified that concessional withholding tax rate of 5% would continue to be applicable for interest income covered in section 194LD of the Act and this benefit does not stand withdrawn due to amendment in Section 115AD of the Act.

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