Tax and Regulatory update on Foreign Portfolio Investors (FPIs) in India –July 2022 to September 2022

Regulatory Updates – FPI

No external Multiple Investment Managers (‘MIM’) for Foreign Portfolio Investment (‘FPI’)

Securities and Exchange Board of India (‘SEBI’) which is the regulator of Indian Capital Markets has formulated Operational Guidelines (‘OG’) which lays down processes for smooth functioning of FPIs, Designated Depository Participants (‘DDPs’) and Eligible Foreign Investors (‘EFIs’).

These guidelines, among other things, have prescribed that where an FPI has appointed MIMs to oversee their investments, a single FPI can obtain a separate registration for each such manager. Additionally, the MIMs appointed were required to be external managers.

However, SEBI, vide its recent circular dated 26 September 2022¹ modified the OG whereby the requirement of appointing external MIM stands eliminated.

Participation of SEBI registered FPIs in Exchange Traded Commodity Derivatives (‘ETCD’) in India

ETCDs are securities that offer investors a direct access to trade in commodity markets without owning the commodities. The capital market regulator permitted only Alternative Investment Fund (‘AIF’), Mutual Funds, Portfolio Management Services to participate in ETCDs.

In its recent circular dated 29 September 2022², the regulator, with immediate effect, has widened the investor base by permitting FPIs to participate in ETCDs. Thus, foreign investors eyeing to trade in ETCDs shall be allowed to do so via the FPI route.

The said circular has added ETCDs to the investment options available to FPIs like shares, warrants, debentures, units of Mutual funds, collective investment schemes, real estate investment trusts, infrastructure investment trusts, derivatives, debt securities, etc.

However, the said circular inter alia lays down conditions for participation in ETCDs like:

• FPIs will be allowed to participate in cash settled (i.e. no physical delivery of asset) non-agricultural commodity derivative contracts and indices comprising such non-agricultural commodities;
• Risk management measures shall be applicable to FPIs intending to invest in ETCDs;
• The said circular has also prescribed position limits for kinds of FPIs such as individuals, family offices, corporates and others. Moreover, position limit norms laid down by SEBI, stock exchanges shall also be binding.

Relaxations with respect to investments by FPIs in Debt securities

The Reserve Bank of India (‘RBI’), vide Foreign Exchange Management Act, 1999 and regulations made thereunder, monitors investment limits in securities for foreign investors.

Directions are issued on a timely basis for short-term investments. Short-term investments are those investments for which residual maturity³ is not beyond a year. These directions had revised the residual maturity periods and also put a cap on percentage of investment that an FPI will hold in such securities.

The RBI, vide its circular dated 7 July 2022⁴ has brought relaxations for FPIs who have invested in such securities. The same has been summarized as under:

Securities	Minimum residual maturity period	Limit	Relaxation
Central Government Securities, Treasury Bills, State Development Loans	No Minimum residual maturity requirement	Investment in a particular security shall not exceed 30% of total investment of FPI in that security	For investment made between July 08, 2022 and October 31, 2022 (both days inclusive), 30% limit not applicable till maturity or sale
Corporate Bonds (except security receipts, debt instruments issued by Asset Reconstruction Companies, Debt Instrument issued under insolvency resolution process, Non-convertible debentures/corporate bonds under default)	Minimum residual maturity period of above one year	Investment shall not exceed 30% of total investment of FPI in corporate bond	For investment made between July 08, 2022 and October 31, 2022 (both days inclusive), 30% limit not applicable till maturity or sale

In addition to the above, FPIs can now invest in Non-Convertible Debentures and Commercial Papers between July 08, 2022 and October 31, 2022 (both days inclusive) with original maturity of up to one year. Further, the 30% cap, as stated above shall not be applicable for such an investment.

Eligible non-residents can now invest in 2 new Government securities without restrictions

The RBI, with effect from April 01, 2020 had introduced a separate channel for investment for non-residents. The same was named Fully Accessible Route (‘FAR’) wherein certain eligible investors could invest in Government Securities without any restrictions or cap. The eligible non-resident investors could invest via FAR in specific Government Securities (‘G-Secs’) only, which are herein after referred to as ‘specified securities’.

The RBI intermittently amends the list of these specified securities whereby new securities are added for investment by eligible non-residents. Currently, in addition to a list of specified securities, G-Secs with a duration/tenure of 5, 10 and 30 years shall come under the ambit of specified securities.

Vide its recent circular⁵ dated July 07, 2022 the RBI has introduced two additional G-Secs in the list of specified securities. These securities have a tenor of 7 and 14 years. This has further widened the investment options available to eligible non-residents under FAR.

Regulatory Updates –IFSC

Guidelines on Angel Fund to encourage investment in early venture

Considering the beneficial role of Angel funds in boosting startups at early stage by providing financial backing, International Financial Services Centres Authority (‘IFSCA’) has now issued a framework for Angel funds under IFSCA (Fund Management) regulations, 2022 vide its recent circular⁶.

The framework is applicable to Angel Schemes launched by the Fund Management Entities (‘FME’) registered under IFSCA (Fund Management) Regulations, 2022. FMEs shall launch an Angel Fund or Angel Scheme. Peculiarities of the said framework are as under:

• Permissible Investments
  • Angel schemes shall make investments in early-stage venture capital undertakings or
    other regulated angel schemes or angel funds set up in IFSC, India or foreign
    jurisdiction but shall not make any investment in the associates of FMEs or in any early-stage venture capital undertaking which is connected to angel investors who are investing in such undertaking.
• Investment Approval
  • The FME of an angel fund/scheme shall make an investment on obtaining express approval of every angel investor.
  • Further, the angel scheme will be launched by filing a placement memorandum and filing prescribed fees.
  • It is to be noted that placement memorandum shall be under a green channel i.e.  angel schemes shall be open for subscription immediately upon filing a placement memorandum with the IFSCA.
• Restrictions
  • The number of angel investors in each portfolio shall not exceed 200;
  • A minimum commitment of USD 40,000 is required which will be spread across portfolios within a 5-year period;
  • Further, an investment made in early-stage venture capital undertaking by an angel fund/scheme shall not exceed USD 15 million. It is to be noted that the framework permits investments in subsequent fund raising rounds in addition to the cap of USD 15 million;
  • A minimum corpus in an angel fund/scheme of USD 10 million is required. This minimum corpus shall be computed collectively for all portfolios under FME.

Tax updates

Rule inserted for additional conditions to claim exemption from capital gains tax to certain funds

Provisions of the Income-tax Act, 1961 (‘IT Act’) pertaining to capital gains tax apply on transfer of certain assets. However, a provision⁷ of the IT Act carves out certain asset transfer on which there shall be no incidence to capital gains tax (herein after referred to as ‘exempt transfer’).

One such exempt transfer envisaged by the IT Act is when a shareholder, unitholder or interest holder transfer a share, unit or interest in original fund in return for share, unit or interest in resultant fund, respectively. Such a transfer of shares, units or interest must take place when assets of an original fund or its wholly owned special purpose vehicle is made to a resultant fund on or before March 31, 2023.

Original Fund	Resultant Fund
Fund incorporated or registered outside India collecting funds for investors’ benefit. Not an Indian resident.	Fund incorporated or registered in India in form of trust, company or limited liability partnership
Original fund shall be resident of a country with whom India has a Tax Treaty or a specified country	Is registered as an AIF of Category I or II or III
Activities of fund shall be subject to investor protection regulations of its domicile country	Located in IFSC
Certain prescribed conditions (Notified via Rule 21AL of the Income-tax Rules, 1962)

The Central Board of Direct Taxes (‘CBDT’) has recently notified⁸ additional conditions by way of inserting Rule 21AL in Income-tax Rules, 1962. The total investment in a fund, directly or indirectly, by Indian resident shall not exceed 5% of the fund corpus at the time of transfer, in case where a resultant fund is Alternative Investment Fund of Category III.

Thus, in an instance where an investor transfers shares/units/interest of an original fund, where the resultant fund is a Category III AIF, the total investment in such an original fund by Indian resident shall not exceed 5% of the corpus at the time of transfer.

CBDT mandates electronic filing of Form 10F and various Income tax documents

India has entered into Tax Treaties with various countries to avoid double taxation of income. Provisions of the IT Act provide that in order to avoid double taxation and/ or to avail certain beneficial tax treatment under the tax treaty, certain prescribed documents must be furnished such as Tax Residency Certificate (‘TRC’) of the country in which the person/ entity is domiciled and Form 10F as per the IT Act of India.

TRC is issued by the tax authority of a foreign taxpayer and thus, its format would differ. In order to standardize the format as per requirements on the Indian tax authorities, Form 10F was introduced.

Form 10F was furnished physically by a foreign resident/ taxpayer until now. However, the CBDT vide its notification⁹, has mandated electronic filing of Form 10F. The said form will now have to be uploaded on the income tax portal and filed electronically.

Additionally, the CBDT has also notified several other forms, which were filed physically earlier, shall now be filed electronically.

CBDT notifies Form 29D to get refund of tax deducted erroneously under section to a non-resident

There are instances where a payer (or deductor), withholds taxes on payments other than interest and pays taxes to the Indian government before making remittance to a foreign resident/ receiver and later realizes that no tax was required to be withheld. As per provisions of the IT Act, the deductor had to approach the prescribed appellate authority for a refund. This resulted into litigation and longer duration of receiving the actual refund amount.

The Finance Act, 2022 thus, inserted section 239A in the IT Act which provided that a taxpayer may make an application before the tax officer within 30 days of payment of such tax withheld and need not approach the appellate authority to get the said refund.

In a recent notification¹⁰, the CBDT inserted Rule 40G of the Income-tax Rules, 1962 which prescribed the manner for filing of application for seeking refund along with Form 29D in which such an application is to be made.

Rule 40G also states that Form 29D shall be furnished with copies whereby an arrangement/agreement for non-deduction of tax was entered into.

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