Pre-Budget recommendations on offshore funds
A recent clarification issued to Foreign Portfolio Investors (FPIs) clarified that fund managers of FPIs who are present in India would not be treated as permanent establishments in India, addressing the concern that the FPIs may be taxable in India to the extent attributable to permanent establishments. An extension of the clarifications to AIFs would encourage foreign funds to set up offices in India and help the growth of the industry in the country. This will create local talent pools, which will help in attracting further PE / VC capital into the economy.
Permanent Establishment Issue
Fund managers of foreign investors (such as FPIs, FVCIs, etc.) remain outside India under the apprehension that their presence in India may have adverse tax consequences i.e. creation of a business connection / permanent establishment in India and offshore funds being regarded as tax resident in India. An amendment was made in Finance Act (No. 2) 2014 to provide that income arising to FPIs from transaction in securities will be treated as capital gains. However, the provisions of the Act have not been adequately amended to address the aforesaid apprehension of the fund managers, resulting in a large number of offshore funds choosing to locate their investment manager outside India.
By providing clarity on issues relating to business connection/ permanent establishment and residential status of offshore funds, India could benefit immensely since it would provide a sense of comfort to fund managers for choosing India as the base for investment managers.
Amend the Act (sections 6 and 9) to provide that management of offshore funds from India should not create a business connection/ permanent establishment of the offshore fund/ manager in India. Also, clarify that management of offshore funds in India would not result in the offshore fund being regarded as tax resident in India
GAAR
GAAR provisions have created significant uncertainty on whether offshore structures set up by PE funds for investing into India would be respected and treaty benefits granted, post 1 April 2015. Investments made before 30 August 2010 have been grandfathered from GAAR, however, structures which may erstwhile have been considered legitimate may get impacted.
Substantive investments have been made into India from Mauritius and Singapore based on the effective assurance that, on exit, no tax would be levied in accordance with relevant DTAA and a valid TRC – no tax exemption on exits after 1 April 2015 results in an unfair treatment on the stakeholders. Many countries do not apply GAAR where SAAR is applicable – it is a settled principle that, where a specific rule is available, a general rule does not apply.
GAAR should not apply to existing structures/arrangements which are legitimate as on 31 March 2015. GAAR should not be invoked in cases where the offshore investment vehicle holds a valid TRC and satisfies the conditions of the relevant DTAA for tax exemption on capital gains. GAAR should not be applied where SAAR is applicable. Objective criteria for invocation of GAAR should be notified for greater certainty.
Safe harbour for advisory entity in India
International transaction pertaining to advisory and support services provided by advisory entity in India to their overseas AEs is subject to transfer pricing. Typically, advisory entity in India charge their AEs for such services on a cost-plus mark-up basis; the mark-up ranges from 15% to 25%. Margin for such transaction assessed by the TPO currently varies from 35% to 106%.
As a rationale for change, upward adjustment to the margins by the TPOs lead to prolonged litigation. Income-tax Tribunals have deleted adjustments made by the TPOs and have restored the margin charged by the advisory entity in India. Certainty is required on the margin to be charged by the advisory entity in India to provide confidence to PE funds on the Indian tax system. It is understood that the APA authority has accepted a margin of 21% for advisory and support services.
Safe harbour margins in the range of 20% to 25% could be prescribed for advisory and support services provided by advisory entity in India, under Rule 10TD of IT Rules.
