Tax and Regulatory update on Foreign Portfolio Investors (FPI) in India – October to December 2023

Taxation Updates

Exemption to Non-residents undertaking specified transactions with International Financial Services Centre Banking Units (IBUs) from obtaining Permanent Account Number (PAN)

Central Board of Direct Taxes (CBDT) vide notification¹ dated October 10, 2023 has amended Rule 114B, 114BA and 114BB of the Income tax Rules, 1962 (IT Rules) and has notified a revised Form No. 60.

The key changes from the erstwhile Rule are highlighted below:

• Rule 114B of the IT Rules requires ‘any person’ not having a PAN and has entered into the specified transaction mentioned therein to provide a declaration in Form 60. However, the new amendment narrows the scope by restricting the same to ‘any person not being a company or a firm’. 

Further a newly inserted proviso mandates non-residents who neither have any income chargeable to tax in India nor hold a PAN and has undertaken specified transactions with IBU to make a declaration in Form 60 in order to get exempted from obtaining PAN.

• Rule 114BA and 114BB of the IT Rules shall not apply to non-residents who don’t have any income chargeable to tax in India and makes the deposit or withdrawal of an amount otherwise than by way of cash or opens a current account not being a cash credit and has entered into transaction with an IBU.

CBDT provides relaxation to IFSC Units from furnishing information in Form No.15CA.

As per Rule 37 BB of the IT Rules, any person responsible for making paying to a non-resident which is not chargeable to tax in India is required to file Part D of Form 15CA. CBDT on October 16, 2023 through a notification² effective from January 01, 2024, has exempted units setup in IFSC from furnishing Part D of Form 15CA while remitting any income which is not chargeable to tax in India to the non-resident. Further, the IFSC unit will be required submit a quarterly statement in Form 15CD within fifteen days from the end of each quarter.

India enters into an exchange of information and collection of tax agreements with Saint Vincent and The Grenadines.

Section 90(1)(c) of the Income-tax Act, 1961 (IT Act) gives power to the Central Government (CG) to enter into an agreement with another country for the exchange of information to prevent tax evasion or tax avoidance on income chargeable under the IT Act or corresponding law in force in that country or specified territory.
In this regard, recently, the CG has recently entered into an exchange of information agreement³ with the Government of Saint Vincent and Grenadines to promote the exchange of information relevant to the administration and enforcement of domestic tax laws in both India and Saint Vincent and Grenadines.
This exchange encompasses information necessary for determining, assessing, and collecting taxes, as well as recovering and enforcing tax claims or investigating and prosecuting tax matters.

Recent Jurisprudence

DTAA benefit cannot be denied without invoking GAAR basis unsubstantiated cogent evidence and by disregarding valid Tax Residency Certificate (TRC)

The Delhi Tax Tribunal in its recent ruling⁴, held that TRC issued by the competent authority of a particular country determines the tax residency of a particular person/entity thereby allowing Mauritius based investment holding company to claim benefits under the India-Mauritius Double Taxation Avoidance Agreement (DTAA).
Moreover, though the tax officer did not invoke the provisions of General Anti- Avoidance Regulation(‘GAAR’) or invoked the Limitation of Benefits Clause under Article 27A of India – Mauritius DTAA, the tax officer’s assertions lacked corroborative evidence to prove that the taxpayer has been set up through an arrangement to avoid taxes by adopting a colourable device and should be regarded as an impermissible tax avoidance arrangement. Accordingly, DTAA benefit was granted basis the TRC of the taxpayer.
This is a welcome ruling for the taxpayer. Firstly, because it re-emphasises the importance of TRC and other supporting documents relevant to establishing the economic substance of taxpayers for the purpose of availing DTAA benefits. Secondly, it enunciates that tax authorities cannot merely allege a taxpayer as a conduit company and have been set up under a scheme of impermissible avoidance arrangement without substantiating it through cogent evidence on record. There is a set procedure to invoke GAAR and the same should be followed by tax authorities.

Taxpayer can claim Short Term Capital Gains (STCG) as exempt under DTAA and carry forward Long Term Capital Loss (LTCL) under the IT Act

The Mumbai Tax Tribunal in its recent ruling⁵, held that the taxpayer is entitled to claim beneficial provisions of the DTAA in respect STCG and allowed to carry forward LTCL, as per the provisions of the IT Act.
The heads of income provided under the IT Act for aggregating similar incomes derived from different sources for deduction and taxation purposes.
Under the head of income “Capital Gains”, short-term and long-term assets are different sources of income. Gains / losses arising from different transactions are distinct transactions and a separate source of income.
Accordingly, the provisions of section 90(2) of the IT Act will apply to each stream of income/loss (STCG and LTCL in this case) and not qua each head of income.
The Ruling once again reconfirms the position that that taxpayer can choose to avail benefit of DTAA or the IT Act for each stream of income irrespective of the fact that the said income falls under the same head as provided under the IT Act.

Regulatory Updates

Requirement of Base Minimum Capital Deposit for Category 2 Execution Only Platforms (EOP)

An EOP is a digital or online platform that facilitates transactions in direct plan of mutual funds. Securities and Exchange Board of India (SEBI) vide circular⁶ dated October 06, 2023, requires Category 2 EOP which are registered as a stockbroker to maintain Base Minimum Capital (BMC) deposit of INR 10 Lakhs with the stock exchange.

Whereas category 1 EOP which obtains registration from Association of Mutual Fund of India (AMFI) and act as agent of Asset Management Company do not have such requirement to maintain any deposit.

SEBI releases amendment to the Guidelines on Anti-Money Laundering (AML) Standards and Combating the Financing of Terrorism (CFT)/ Obligations of Securities Market Intermediaries under the Prevention of Money Laundering Act, 2002 and Rules framed there under

With a view to enhance the effectiveness of AML framework, SEBI vide it’s circular⁷, amends AML guidelines. The revised guidelines are as mentioned below:

• The Financial groups must take suitable additional measures to manage the ML/TF risks and notify SEBI if the host country nation forbids the proper implementation of AML/CFT safeguards harmoniously with the requirement of the home country.

• The financial groups are required to establish group-wide ML/TF programs that are appropriate and relevant to all of their branches and majority-owned subsidiaries as under:

1. procedures and standards for sharing data necessary for Customer Due Diligence (CDD) and ML/TF risk management;

2. provision of Information and analysis of transactions or activities that seems unusual (if such analysis was performed) at group level.

3. adequate safety measures for both the confidentiality and use of exchanged data, including precautions to prevent tipping-off.

• In case of a Trust, the reporting entity shall ensure that the trustees disclose their status at the time of commencement of an account-based relationship.

• Beneficial ownership and control will be identified as follows:

1. In case of company: the beneficial owner shall be the natural person along with one or more juridical person if any and has a controlling ownership interest by any means;

2. In case of partnership firm: the beneficial owner is the natural person along with one or more juridical person if any and has a ownership of/ entitlement to more than 10% of capital or profits of the partnership or who exercises control through other means;

3. In case of unincorporated association or body of individuals has a ownership of/ entitlement to more than 15% of capital or profits of the partnership or who exercises control through other means;

4. Where no natural person is identified under any the above cases, the relevant natural person who holds the position of senior managing official will be considered as the beneficial owner;

5. In case of trust: the of beneficial owner shall include identification of the author of the trust, the trustee, the beneficiaries with ten per cent or more interest in the trust and any other natural person exercising ultimate effective control over the trust through a chain of control or ownership;

6. It is not necessary to identify and recognize any beneficial owner in case the owner/ entity having controlling interest is a listed entity in India or is a resident of and is listed on stock exchanges of such jurisdictions as notified by the Central Government or is a subsidiary of such entities.

7. Registered intermediaries dealing with foreign investors may be guided by the prevalent guidelines for the purpose of identification of beneficial ownership of the client;
   The Stock Exchanges and Depositories will be monitoring the abovementioned beneficial ownership provisions through a half-yearly-internal audit.

• No transaction or account-based relationship shall be undertaken without following the CDD procedure.

• The norms of Politically Exposed Persons (PEPs) shall be applicable to the accounts of the family members or close relatives / associates of PEPs.

• Where the registered entity does not have records of the identity of its existing clients, it shall obtain the records forthwith, failing which the registered intermediary shall close the account of the clients after giving due notice to the client.

Access of Sovereign Green Bonds to Non-Residents

Certain specified securities of the CG are open fully to non-resident investors without any restrictions via the Fully Accessible Route (FAR). On November 8, 2023 Reserve Bank of India (RBI) vide notification⁸, has designated Sovereign Green Bonds issued in the fiscal year 2023-24 as ‘specified securities’ which has facilitated access to the non-resident investors via FAR.

Alternative Investment Fund (AIF)

SEBI notifies Revised Framework for computation of Net Distributable Cash Flows (NDCF) by Real Estate Investment Trusts (REIT)

SEBI vide circular⁹ dated December 6, 2023 has issued a revised framework for computation of NDCF for REITs with an attempt to standardize the computation framework. This revised framework supersedes the previous framework outlined in the Master Circular for Real Estate Investment Trusts dated July 06, 2023 and shall be applicable w.e.f. April 1, 2024.

The circular outlines detailed computations for NDCF at both Hold Co/SPV and Trust levels along with illustrations. Further, it is pertinent to note that the trust along with its Hold Co/SPVs are required to ensure that minimum 90% distribution of NDCF be met for a given financial year on a cumulative periodic basis as specified for mandatory distributions in the REIT regulations. The circular further clarifies the inclusion of capital expenditure in NDCF computation and provides guidance on temporarily parked funds to ensure compliance with relevant regulations. Similar circular issued by SEBI vide circular dated December 6, 2023¹⁰ which revised the framework for computation of NDCF for InvITs.  

SEBI prescribes procedure in relation to issuance of dematerialized units of AIF

The SEBI vide circular¹¹ dated December 11, 2023 has outlined the procedure to be followed for dematerializing/ crediting the units issued by AIF wherein the investors are yet to provide the demat account details.

Rules were issued in June wherein the AIFs having a corpus of INR 500 crore or more were required to dematerialise all issued units by October 31, 2023. Further, these AIFs will have to issue units only in dematerialised form from November 1, 2023, onwards. Similarly, AIFs having corpus less than INR 500 crore are required to dematerialise issued units by April 30, 2024, and issue only dematerialised units May 1 onwards.

The said circular outlines that managers of AIFs have to continue to reach out to existing investors and thereby obtain the demat details and credit the units in their respective demat accounts. SEBI has also advised depositories to assist in this process.

Further, the circular also provides in respect of the accounts wherein units have already been issued by the AIFs but the investors have not yet provided the details. In such cases, the units will be credited to separate designated account i.e. ‘Aggregate Escrow Demat Account’. Once, the AIF is in receipt of the pending demat details from the investors, the unit held in the afore-mentioned account shall be transferred to the respective demat account within five working days.

Investments in AIF by Regulated Entities

Regulated entities (REs) are engaged in the acquisition of stakes in units of AIFs as a component of their regular investment activities. However, the RBI has observed certain transactions between REs and AIFs that provoke regulatory apprehensions. These transactions entail substitution of direct loan exposure of REs to borrowers, with indirect exposure through investments in units of AIFs. Such practices necessitate a thorough examination to ensure compliance with the regulatory framework and to address any potential risks associated with these investment strategies.

To mitigate the risk of potential ever greening through this route and maintain financial integrity, RBI has issued notification¹² on 19 December 2023 . The key highlights of the circular are as under:

• REs are prohibited from investing in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the RE.

• If an AIF scheme, in which RE is already an investor, makes a downstream investment in any such debtor company, then the RE is mandated to liquidate its investment in the scheme within 30 days from the date of such investment. In circumstances where the RE’s investment in schemes with downstream investments in their debtor companies is prior to the issuance of this directive, the 30-day liquidation window will be calculated starting from the date this circular is issued. The REs are obligated to promptly communicate with the AIFs to ensure appropriate action is taken in accordance with this mandate.

• Further, REs are directed to allocate 100% provision against the afore-mentioned investments in the event that they are unable to divest their holdings within the prescribed time limits.

In addition, investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from RE’s capital funds.

International Financial Service Centre (IFSC)

Modifications under the International Financial Services Centres Authority (IFSCA) (Anti Money Laundering, Counter-Terrorist Financing and Know Your Customer) Guidelines, 2022

The IFSCA (AML & KYC) Guidelines, 2022, have been modified, as per the IFSCA's circular¹³ dated October 26, 2023. Financial groups must put in place group-wide programmes for exchanging information necessary for CDD and ML/TF risk management, as well as group-wide rules and guidelines, in order to fulfil their obligations under Chapter IV of the Act.

Change in reporting norms for Fund Management Entities under IFSCA (Fund Management) Regulations 2022.

The IFSCA through its circular¹⁴ dated November 03, 2023, has directed all the Fund Management Entities (FME) to provide information in the prescribed formats on a quarterly basis instead of half-yearly basis as specified in Circular dated May 31, 2023 wherein the reporting norms for FMEs were specified.

Procedural Updates

Consultation Paper on Concept of Remote Broker-Dealer

IFSCA in its consistent efforts to enhance foreign participation on Stock Exchange in IFSC has proposed to introduce a framework for a new sub-category of Broker Dealer- Remote Broker Dealer (RBD) via its consultation paper dated November 21, 2023.

Eligibility criteria proposed for RBD is as under:

• The entity is a resident of a country whose securities market regulator is a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding (IOSCO-MMoU) or a signatory to the bilateral Memorandum of Understanding (MoU) with IFSCA;
• The entity is a body corporate, regulated in its home jurisdiction and is a member of the prescribed stock exchanges;
• The entity shall be permitted to trade only on a proprietary basis and shall not be permitted to onboard clients;
• The entities incorporated in India and registered with SEBI as stock brokers shall not be permitted to register as RBD in IFSC and shall be allowed to transact in only cash settled derivatives;
• The entity will have to comply with all other conditions as mandated by IFSCA and relevant regulations from time to time.

IFSCA had requested public comments on the consultation paper by December 13, 2023.

Consultation Paper on Regulatory Framework for Accredited Investors

The IFSCA (Fund Management) Regulations, 2022 provide certain flexibilities to ‘accredited investors’ investing in the Funds set-up in IFSC. However, the current framework do not define the eligibility criteria for an investor to be considered as an ‘accredited investor’.

On November 23, 2023, IFSCA released a consultation paper wherein the eligibility criteria for an investor to be regarded as an ‘accredited investor’ has been defined.

IFSCA has recommended the following eligibility criteria for Accredited Investors:

• Individuals/ Sole Proprietorships/ One Person Company –   

• Joint Investments- 

• Hindu Undivided Families (HUFs) in India or outside India –

HUF should meet the income/ net worth eligibility criteria mentioned above for individuals.

• Body corporate (including LLPs) –

Either minimum net worth of USD 5mn or each of the constituent of body corporate meets the above eligibility criteria.

• Partnership Firm (excluding LLPs) –

Each partner independently meets above eligibility criteria.

• Trusts –

Minimum net worth of USD 5mn, or all beneficiaries independently meets the above eligibility criteria or person(s) responsible for managing the assets of the trust meets above eligibility criteria.

• Deemed Accredited investors –

Government and Government related investors, SWFs, multilateral agency, supranational agency, pension funds and provident funds are deemed to be accredited investors. Further, Venture Capital Schemes, Restricted Schemes, Retail Schemes, Exchange Traded Funds, Investment Trusts, Family investment funds and other specified units in IFSC are also deemed to be accredited investors.

Further Regulated Entities in IFSC intending to accept an investor as accredited investors are required to undertake appropriate due diligence at the time of onboarding and on ongoing basis to ensure that the accredited investor continues to meet the aforesaid eligibility criteria.

IFSCA had requested public comments on the consultation paper by December 07, 2023.

Consultation Paper to ease trading for company insiders

SEBI had constituted a working group to review provisions relating to ‘Trading Plans’ under the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations, 2015. However, in light of the changing landscape of the Indian Capital markets, market feedback suggested review of trading framework. The committee’s key recommendations includes cool-off period, and minimum coverage period, black-out period, price-limits, contra-trade restrictions along with the disclosure timelines and format for reporting the details of the trading plans.

Comments on the aforesaid proposal were invited until December 15, 2023.

Public Comments on IFSCA (Finance Company) Regulations

IFSCA has invited Public comments on IFSCA (Finance Company) Regulations on December 06, 2023 to seek comments from the public on any amendments or additions to the IFSCA (Finance Company) Regulations, 2021.
IFSCA had requested public comments on the consultation paper by December 26, 2023.

Consultation Paper on changes for Special Situation Fund (SSF)

SEBI has introduced a proposal aiming to amend the regulatory framework governing a segment of AIF known as SSFs. This rationale behind the same is to empower SSFs in acquiring stressed loans and fostering the resolution of distressed assets in India.

The key proposed changes to be introduced in the framework have been summarized as under:

• Clarifications are proposed to be introduced in relation to what shall constitute as special situation assets to determine the scope of SSF investments;
• There is a potential issue with the transfer of economic interests to individuals who are disqualified under the provisions of Insolvency and Bankruptcy Code (IBC). Therefore, amendments have been proposed to align the definition of eligible investors as per the IBC as it is considered prudent to extend the due diligence obligations specified in IBC to all SSFs, regardless of the nature of the special situation assets they are investing in.
• Amendment is proposed to be introduced in the definition of the associated entities to ensure that the same is in consistency with the definition of related parties as per the Companies Act, 2013;
• Introduction of amendments in the AIF regulations wherein SSFs may transfer or sell stressed loans on fulfilment of parameters prescribed in RBI Master Directions. This additional amendment has been introduced in addition to the minimum lock in period requirements to ensure the prudential concerns of roundtripping.
• Introductions have been proposed in the framework which contain comprehensive data sharing and monitoring between the RBI and the SEBI. This would cover details about the SSF’s operations, investors, managers, assets, and financing. Additionally, it will allow the RBI to directly obtain information from SSFs when necessary. As per RBI Master Directions, all RBI-regulated entities must report loan transfer transactions to an RBI-notified trade reporting platform, and SSFs must report details of unit issuances, investor information, and other relevant updates to the same platform.
• Dedicated supervisory and monitoring framework has been proposed in addition to the existing AIF framework to encompass the parameters stipulated by the RBI.

SEBI had requested public comments on the consultation paper by December 27, 2023.

Consultation paper on introduction of optional T+0 and instant settlement of trades]

SEBI has issued a consultation paper on December 22, 2023, to invite public comments on the introduction of the facility for clearing and settlement of funds and securities on T+0 and instant settlement cycle on an optional basis in addition to the existing T+1 settlement cycle in secondary markets for the equity cash segment. SEBI, in its endeavour to keep pace with the changing times, development of securities markets and investor protection, has historically shortened the settlement cycles to T+1 settlement.

The key highlights of the consultation paper have been summarized as under:

• In addition to the existing T+1 settlement cycle, a shorter settlement cycle may be introduced as an option for the equity cash segment. This mechanism would enable instant receipt of funds and securities vis-a-vis existing pay-out on T+1.
• The shortening of settlement cycle is expected to provide flexibility in terms of faster pay-out of the funds against the securities to the sellers and faster pay-out of securities against the funds to the buyers thereby allowing better control over the funds and securities.
• The implementation of the proposed mechanism may lead to increase in cost of trading. Further, the same might also lead to divergence in price of same security in T+0 or instant settlement cycle, and T+1 settlement cycle.
• The implementation of the mechanism is proposed in two phases as follows:

The brief recommendations for each Phase are provided at Annexure A of the consultation paper. The recommendation in Phase I is to cover only non-custody clients and therefore FPIs and other offshore investors can opt for T+0 settlement only in Phase 2.

Public comments on the consultation paper were sought by January 12, 2024