Tax and Regulatory update on Foreign Portfolio Investors (FPIs) in India – April 2024 to June 2024

Tax updates

India and Mauritius sign the Protocol amending the India- Mauritius Double Taxation Avoidance Agreement (‘DTAA’ or ‘treaty’).

The Government of India and the Government of Mauritius signed a protocol on March 7, 2024 to amend the India-Mauritius DTAA. The following changes have been proposed-

• The existing preamble to India-Mauritius DTAA is to be replaced to provide that purpose of the treaty is to eliminate double taxation with respect to taxes covered by this treaty without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this treaty for the indirect benefit of residents of third jurisdictions).

• Incorporation of Principle Purpose Test (PPT), wherein a benefit under this treaty shall not be granted in respect of an item of income if it is reasonable to conclude that one of the principal purposes of the arrangement or transaction is to directly or indirectly take benefit of the treaty unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this treaty.

       Currently, the protocol is not effective as the notification is yet to be issued.

Regulatory Updates

Securities and Exchange Board of India (SEBI) issues Standardization for the Private Placement Memorandum (PPM) Audit report

SEBI has issued a circular dated April 18, 2024¹ mandating Alternative investment Funds (‘AIF’) to carry out an annual audit with the PPM and submit the audit report to the Trustee, Board of Directors and the Designated Partners of the AIF and SEBI within six months from the end of the financial year.

To ensure uniform compliance standards and ease of reporting, SEBI has prepared a standard reporting format for PPM audit reports in consultation with Standard Setting Forum (‘SFA’), which shall be available on the websites of AIF Associations, which are a part of SFA.

The PPM audit reports shall be submitted to SEBI by AIFs online on the SEBI Intermediary Portal (‘SI Portal’) as per the aforesaid format and all other provisions with respect to filing of the PPM audit report specified in the Master Circular dated July 31, 2023 shall remain unchanged. However, the audit of sections of PPM relating to 'Risk Factors', 'Legal, Regulatory and Tax Considerations', and 'Track Record of First Time Managers' shall be optional. Additionally, 'Illustration of Fees and Expenses' and 'Glossary and Terms' shall also be optional.

The reporting requirement mentioned in the above-mentioned recent circular shall be applicable for PPM audit reports to be filed for the financial year ending March 31, 2024, onwards.

The RBI Amends regulations for payment and reporting of Non-Debt Instruments

The Reserve Bank of India (‘RBI’) vide notification dated April 23, 2024, issued an amendment to the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.
This amendment introduces Schedule XI to Regulation 3.1, detailing the modes of payment and remittance for equity shares of Indian companies listed on international exchanges. The consideration for purchasing or subscribing to these shares can be paid through banking channels to a foreign currency account of the Indian company or as an inward remittance from abroad. Sale proceeds, net of taxes, can be remitted outside India or credited to the permissible holder's bank account per the Foreign Exchange Management (Deposit) Regulations, 2016.

Regulation 4 mandates that Authorized Dealer Category- I banks report equity instrument transactions by FPIs on Indian stock exchanges to the RBI using Form LEC (FII). Additionally, Indian companies must report purchases or subscriptions of equity shares classified as FPI on international exchanges, excluding transfers between permissible holders. This amendment is effective upon publication in the Official Gazette and applies to all listed companies and Authorized Dealer Category I banks.

SEBI allows AIFs in debt raising by pledging of equity of investee companies:

SEBI vide circular dated April 26, 2024² has amended the AIF Regulations enabling Category I and II AIFs to create encumbrance on equity of its investee companies, subject to the following conditions:

• Investee companies should be in the specified sectors and the purpose of pledging should be only financing of investee companies;

• Existing schemes of AIF which have not onboarded any investors prior to the date of notification of this amendment, can create such encumbrances provided there is explicit disclosure on it in their PPM;

• Any pledge already created by an AIF before April 25, 2024, may continue if PPM have explicit disclosure;

• If such explicit disclosures were not given in the PPM, then the AIFs can retain such encumbrances provided these are for the specified purposes and consent of all its unit holders shall be obtained by October 24, 2024 i.e. within a period of 6 months;

• If consent of all its unitholder could not be obtained or not disclosed by prescribed date, then encumbrances have to be removed latest by prescribed timelines;

• AIFs cannot offer guarantees for investee companies;

• AIFs are still prohibited from creating encumbrances on their investments in foreign investee companies.

Further, SFA has been assigned the task of formulating standards to ensure the adherence to the conditions specified by the SEBI. The move will provide ease of doing business and flexibility to such AIFs

SEBI introduces flexibility to AIFs and their investors to deal with unliquidated investments of their schemes.

SEBI vide circular³ dated April,26,2024 has issued new regulations to provide more flexibility for AIFs and their investors in dealing with unliquidated investments. These occur when an AIF cannot sell all its holdings by the designated liquidation period. Before seeking the requisite investor consent, the AIF / manager shall arrange a bid for a minimum of 25% of the value of its unliquidated investments

During the ‘liquidation period’, an AIF can distribute investments of a scheme which are unsold due to lack of liquidity, in-specie to the investors, or enter the dissolution period, after obtaining approval of at least 75% of the investors by value of their investment in the AIF scheme subject to the satisfaction of conditions prescribed in the Circular. The Circular also prescribes a mandatory in-specie distribution if, during the liquidation period, the requisite investor consent is not obtained for: (a) entering the dissolution period; or (b) in-specie distribution. In case any investor is not willing to take in-specie distribution, such investment is to be written off.

SEBI has provided a one-time option for AIFs whose liquidation period has already expired. These schemes can get a fresh liquidation period until April 24, 2025, provided they have no pending investor complaints
.
RBI revises Limits for investment in debt and sale of credit default swaps by Foreign Portfolio Investors (FPIs).

RBI issued notification⁴ dated April 26, 2024 has revised the limits for the fiscal year 2024-25 for FPI investments in Government Securities (‘G-Secs’), State Government Securities (‘SGSs’) and corporate bonds. The limits will remain unchanged at 6%, 2%, and 15% respectively, of the outstanding stock of securities.
Investments by eligible investors in 'specified securities' will continue under the Fully Accessible Route (FAR) as per A.P. (DIR Series) Circular No. 25 dated March 30, 2020.
Additionally, the aggregate limit for Credit Default Swaps sold by FPIs will be 5% of the outstanding corporate bonds, with an additional limit of INR 2,54,500 crore for 2024-25.

SEBI issued Eligibility criteria for launching Options with Commodity Futures.

SEBI vide Circular⁵ dated May 27, 2024, has revised its regulatory framework for the Commodity Derivatives Segment, as detailed in Chapter 6 of the SEBI Master Circular dated August 4, 2023.

SEBI has revised the eligibility criteria, specifically for Agricultural and Agri-processed commodities. Options would be permitted for trading on a stock exchange only on those commodity futures as underlying that are traded on its platform and satisfy the criteria specified below on the respective exchange: The average daily turnover of underlying futures contracts for the corresponding commodity during the previous twelve months shall be at least: a) INR 100 crore for agricultural and Agri-processed commodities; b) INR 1000 crore for other commodities.

The circular mandates stock exchanges to update their bylaws, rules and regulations accordingly and to notify their members and the public. This change is effective from 1 June 2024, aims to facilitate the introduction of Options on these commodities.

Amendment in Master circular for FPI framework

In addition to the FPI Operational guidelines which lay down major operational principles for FPIs SEBI has issued circular with certain amendments Master Circular⁶ dated May 30,2024

• Streamlining the onboarding process of FPIs.

• Mandating Legal Entity Identifier LEI for all non–individual FPIs.

• Transactions in Corporate Bonds through Request for Quote (RFQ) platform by FPIs.

• Mandating additional disclosures by FPIs that fulfil certain objective criteria.

• Streamlining of Regulatory Reporting by Designated Depository Participants (DDPs) and Custodians.

• Amendment to Circular for mandating additional disclosures by FPIs that fulfil certain objective criteria.

SEBI details framework for providing flexibility to FPIs in dealing with securities post expiry of registration

SEBI vide circular⁷ dated June 05,2024 made modification in SEBI Foreign Portfolio Investors (Amendment) Regulations 2024, focusing mainly on the framework pertaining to dealing with the securities post expiry of the registration of FPIs.

• FPIs are permitted to continue their registration for the subsequent three years and liquidate its holding within 180 days from the expiry of the prescribed 30 days’ time period for reactivation   of registration.

• FPIs need to be reclassified where eligibility criteria are not met under appropriate category/ sub-category. However, fresh purchases are restricted for non-compliant FPIs, but the existing purchases can be sold within the prescribed timelines.

• If a jurisdiction, which was a compliant jurisdiction at the time of grant of registration to FPI, becomes non-compliant, then the custodian shall not allow such FPIs to make fresh purchases until the jurisdiction/FPI becomes compliant.

• Dealing with securities held by FPIs whose registration has expired, Sale of securities within 180 days from the date of the circular will be allowed without any financial disincentive. Further, financial disincentives are levied on the sale done post the 180-day period.

SEBI relaxes timelines for material changes and other obligations for FPIs

SEBI has issued a circular⁸ dated June 5, 2024 wherein the timelines for intimation of the material changes and submission of supporting documents for different types of material changes has been outlined.

• ‘Type I’ material changes refer to those critical changes affecting FPI eligibility or privileges. These must be reported as soon as possible and within seven working days of occurrence. Further, supporting documents should be provided within 30 days of such change.

• ‘Type II’ material changes are significant changes other than Type I. These changes must be reported promptly and within 30 days of occurrence.

• The DDPs are required to assess the material changes informed by the FPIs and evaluate the eligibility of FPIs and determine if FPIs are required to obtain a fresh registration. In case of change of jurisdiction, change in name, change in compliance status of jurisdiction of FPI, change in regulatory status, restructuring and cessation of FPI on account of acquisition/merger/demerger, the DDP shall mandatorily require the FPI to obtain a fresh registration.

SEBI has amended the FPI Regulations 2019.

SEBI Vide notification⁹ dated June 26, 2024 has amended the FPI Regulations 2019, the key changes specify conditions for applicants seeking a certificate of registration as an FPI are as below:
1) A single non-resident Indian (NRI), an overseas citizen of India (OCI), or Resident Indian individual can contribute less than 25% of the total corpus.
2) The combined contribution of NRIs, OCIs, and Resident Indian individuals should be less than 50% of the total corpus.
3) Resident Indian individuals must invest through the Liberalised Remittance Scheme (LRS) of the Reserve Bank of India, specifically in global funds with less than 50% Indian exposure.
4) NRIs, OCIs, and resident Indian individuals shall not be in control of the applicant.
Additionally, the condition mentioned in point no 2 above does not apply to the applicant regulated by the International Financial Services Centres Authority (IFSCA) and based in International Financial Services Centres (IFSCs) in India. This means under this new provision, NRIs, OCIs, and Resident Indian individuals are now permitted to invest up to 100% of the total corpus in an FPI in IFSC.

Procedural Updates

SEBI releases consultation paper on review of certain aspects of the framework for valuation of investment portfolio of AIFs.

SEBI, on May 23, 2024, has sought public consultation regarding the provide relaxation on the following aspects of the framework for valuation of investment portfolio of AIFs. The key highlights have been enunciated as under:

1. Applicability of valuation norms to compute valuation of investment portfolio of AIFs;

• Valuation of securities, other than unlisted securities, for which valuation norms have been prescribed under SEBI (Mutual Funds) Regulations, 1996 (‘MF Regulations’), shall be carried out as per the norms prescribed under MF Regulations.

•  Valuation of unlisted securities shall be carried out as per the valuation guidelines endorsed by eligible AIF Industry Association based on the recommendations of the Alternative Investment Policy Advisory Committee (‘AIPAC’).

2. Change in valuation methodology and approach being considered as ‘material change’;

• Change in valuation methodology/approach to comply with Chapter 22 of Master circular for AIFs on 'Standardised approach to valuation of investment portfolio of AIFs', shall not be construed as 'Material Change'.

•  Change in methodology/approach within the valuation guidelines / valuation norms prescribed for AIFs, shall not be construed as a 'Material Change'. However, in such cases, the valuation of the investment carried out based on valuation methodologies/approaches, both old and new, shall be disclosed to the investors to ensure transparency.

3. Eligibility criteria of independent valuers to be appointed by AIFs;

• It may be clarified that the eligibility criteria for independent valuer for a partnership entity or company shall be as follows –

  •  such entity or company shall be a registered valuer entity registered with IBBI; and

  •  the deputed/authorized person(s) of such registered valuer entity, who undertake(s) the valuation of investment portfolio of AIFs, shall have a membership of ICAI or ICSI or ICMAI or CFA Institute.

4. Timeline for reporting valuation of investment portfolio by AIFs to Performance Benchmarking Agencies.

• AIFs shall provide audited data on cash flows and valuation of their scheme-wise investments, after the audit of books of accounts of the AIF in terms of Regulation 20(14) of AIF Regulations, to Performance Benchmarking Agencies within 7 months from March 31, i.e., by October 31 of each year.

The comments / suggestions were requested to be provided latest by June 13, 2024.

International Financial Service Centre Authority (IFSCA)

IFSCA permits Remote Trading Participants (‘RTP’) on Stock Exchanges in the IFSC

IFSCA has recently issued a circular¹⁰ on April 03,2024 to permit foreign entities, not having a physical presence in IFSC, to trade directly on the Stock Exchanges in the IFSC, on a proprietary basis, without a Broker-Dealer. Such an entity shall be referred to as a ‘Remote Trading Participant’(‘RTP’).In order to be eligible to be onboarded as RTP on stock exchange, the following conditions are required to be fulfilled:

• The entity is a member of specified stock exchanges for at least a period of one year;

• The entity is a body corporate;

• The entity is resident of Financial Action Task Force (‘FATF’) compliant jurisdiction;

• The entity shall not be permitted to onboard clients and shall trade only on proprietary basis;

• The entity shall be permitted to transact only in cash-settled derivative products on the Stock Exchanges;

• Indian Entities are not permitted to be onboarded as RTP.

The RTP shall also be required to enter into an agreement with an IFSCA registered Clearing Member for clearing and settlement of its transactions executed on the Stock Exchanges in the IFSC.

The conditions for onboarding including operational matters such as net-worth criteria, security deposit, application fee, annual fee shall be specified by the Stock Exchange in the IFSC.

SEBI approved alternative routes for increased participation by NRIs and OCIs in Indian securities through IFSC based FPIs.

IFSCA post discussion with SEBI has issued circular¹¹ dated May 02,2024 by allowing 100% participation by NRIs and OCIs based out of IFSC.

Option 1:
FPIs need to disclose PAN (or other KYC documents in the absence of PAN) along with economic interests of all NRI / OCI / RI individual constituents to the DDP.
Option 2:
In absence of PAN / KYC and economic interest the following conditions to be met:

• FPI corpus to be a blind pool i.e. no segregated portfolios and all investors to have pari-passu and pro-rata rights

• FPI to have minimum of 20 investors with each investor contributing not more than 25%

• Maximum of 20% of the corpus of FPI may be invested in the listed equity shares of an Indian entity

• Investors should not influence investment decisions i.e. Investment Manager to FPI must be completely independent

• Investment Manager must be an AMC of a SEBI-registered Mutual Fund sponsored by a RBI regulated bank or its IFSC subsidiary/branch.

Recent Jurisprudence

Delhi Tax Tribunal holds that safe harbour provision for share premium is effective retrospectively.
Delhi Tax Tribunal held¹² that the curative amendment in Rule 11UA of the Income-tax Rules, 1962 (‘IT Rules’) introduced by the CBDT Notification 81/2023 will apply retrospectively and since the difference was less than 10%, deleted the addition made by the Tax Officer.

The taxpayer, a private company had obtained shares at a premium during FY 2014-15. The tax officer had computed the Fair Market Value of the shares at a value lower than the valuation report obtained by the taxpayer. Further, the difference between the value adopted by the taxpayer and the value computed by the tax officer was 2%.

The Delhi Tax Tribunal placed reliance on the afore-mentioned notification wherein it mentioned that where the difference between the issue price and the value adopted by the tax officer is 10% or less, the issue price will be deemed to be the FMV of shares for the purpose of Rule 11UA of the IT Rules. Further, it held that the difference between the value adopted by the taxpayer and the value computed by the tax officer is minuscule and no addition is warranted under section 56(2)(viib) of the Act.

Hence, in view of the above, curative amendment in Rule 11UA of the IT Rules introduced by CBDT Notification 81/2023 will apply retrospectively.

Mumbai Tax Tribunal holds that the premium on redemption of Non-Convertible Debentures (‘NCD’) is taxable as Interest and not Capital Gains.

Mumbai Tax Tribunal held¹³ that profit received by the taxpayer in the form of premium would be construed as interest income and not taxable as capital gains.

An individual taxpayer has acquired certain 0% NCDs of related companies from nationalised banks. Later on, the NCDs were redeemed at a profit. The tax officer contended the entire arrangement appeared to be a make-believe arrangement with an intent to shift profits to the taxpayer. Thereby, the gains were brought within the ambit of capital gains. The First Appellate Authority held the difference between the maturity proceeds and the cost of NCDs is taxable as interest income.

The Mumbai Tax tribunal observed that the companies issuing bonds or debentures usually claim discounts or premiums as interest expenditure and their claim has been allowed. It further held that redemption of debentures is nothing but repayment of debt and not extinguishment. The taxpayer had not sold the NCDs but had redeemed the NCDs. This is nothing but repayment of debt and hence the question of capital gains does not arise. It was held that whatever is received by the taxpayer in the form of a premium is nothing but interest income only.

High court of Punjab and Haryana held that Communication of notices cannot be presumed by only placing it on e-portal.

The High Court held¹⁴ that communication of the notices should be as per provisions of the IT Act.
The income-tax officer had issued show cause notices and reminders to taxpayer. However, the said notice was not sent to the taxpayer’s e-mail and was only reflected on the income-tax e-filing portal. Similarly, the reminders were published on e-portal but also not served upon the taxpayer.

The High Court held that the provisions do not mention of communication to be ‘presumed’ by placing notice on the e-portal. The High Court further held that an individual or company is not expected to keep e-portal open all the times so as to have knowledge of what the income-tax department is doing. The principles of natural justice are inherent in the income tax provisions and the same are required to be necessarily followed.

Hence, the High Court allowed the taxpayer to file his submission and directed the department to examine the same and issue a fresh order.