Rs 56,261 cr: Huge FPI funds pumped into Indian markets as GAAR kicks in

Foreign investors have pumped in a massive Rs 56,261 crore into the Indian market in March, clocking the highest net inflow by FPIs in a month since 2002, mainly to take advantage of the grandfathering clause ahead of the implementation of the General Anti-Avoidance Rules (GAAR).

FPIs pumped in a total Rs 56,261 crore into Indian market in March – Rs 30,906 crore in equity and Rs 28996 crore in debt – while they bought Rs 9,902 crore in equity and Rs 5,960 crore debt in February 2017. Foreign investors have also rushed to buy initial public offerings (IPOs), as they invested about Rs 8,000 crore in the primary market as per the NSDL data.

The deluge of inflows from overseas funds into the domestic market has surprised both investors and other market participants as it pushed up the benchmark indices like the Sensex and Nifty to their near all-time highs. The domestic market has gained close to 10 per cent so far this year on the back of over Rs 30,906 crore pumped into equity by FPIs in March this year, making it the biggest purchase in a single month in several years.

Foreign funds have stepped up buying in the past two months after being net sellers during October-January when the market saw an outflow of close to Rs 70,000 crore.

Aggressive purchases

“The sharp rise in buying by foreign funds can be attributed to investors making aggressive purchases to take advantage of the grandfathering benefit before GAAR comes into play,” said Rajesh Gandhi, partner, Deloitte Haskins & Sells.

The government has said that all transactions done till April 2017 will be grandfathered, which means that the rule does not apply to investments that are made before the said date and its income cannot come under GAAR.

Many funds have come in as anchor investors in some of the recent IPOs.

GAAR seeks to curb treaty shopping by overseas funds to avoid tax by operating from tax friendly jurisdictions, like Mauritius, without much of commercial substance in that country. It aims to check tax avoidance, empowering the tax department to look into transactions deliberately structured to do this.

The government has taken measures to ensure smooth implementation of GAAR and had held a series of meetings with foreign funds and industrial bodies including Asia Securities Industry & Financial Markets Association (ASIFMA), London-head quartered ICI Global and the European Fund and Asset Management Association (EFAMA) to iron out thorny issues and address their concerns.

According to experts, many overseas investors operating from tax havens have started weighing options to have more genuine operation on the grounds to convince tax authorities.

Many foreign investors operating from tax havens like Mauritius and Cayman Island are said to have set up back offices on the ground in order to prove that they have genuine business operations in these countries while others are looking to let go of tax benefits by operating from their country of origin like the US or UK so that they don’t fall foul of Indian tax authorities.

According experts, many overseas funds that were earlier registered in Mauritius have recently shifted to Singapore as the tax treaty with India has more clarity on limitation of benefit (LoB) clauses.

GAAR was first introduced by then finance minister Pranab Mukherjee in the 2012 budget to stop companies and investors from routing investments through tax havens in order to avoid taxes. However, it was deferred following widespread protest from overseas investors and domestic companies. Last year, the government said that GAAR would be implemented from April 1, 2017.

Exiting tax havens

With treaty benefits for equity investment ending from April 2017, many foreign funds routing their investment to India through Mauritius are considering winding up their operations from the tax haven.

Several large global funds like Fidelity, Morgan Stanley, Goldman Sachs, BNP Paribas and Deutsche group are said to be exploring the option to invest in the Indian equity market from their home countries post April 2017 when the treaty benefit comes to an end.

According to industry experts, foreign investors operating from Mauritius are now doing their cost-benefit analysis and weighing options to shift their operation to home country as treaty benefit on capital gains are no longer there for equity investment from the tax heaven.

These players are trying to play safe as the general anti-avoidance rules (GAAR) are set to kick in from April 2017.

“Many foreign players are investing in the equity market in India from tax havens like Mauritius as they feel that it makes sense to relocate to their home country as there is no tax benefit like earlier and they are also worried about increased scrutiny under the GAAR regime,” Gandhi of Deloitte Haskins & Sells said.

However, debt and F&O focused funds will continue to operate from Mauritius as they get better tax

benefits.

While the amended protocol under the double taxation avoidance agreement (DTAA) with Mauritius had partially taken the sheen out of the tax haven’s attractiveness among foreign funds investing in Indian equity, the island nation continued to be a preferred destination for debt-focused FPIs investing in Indian corporate and government debt markets.

Under the amended DTAA, tax on interest income for investment made from Mauritius has been brought down to 7.5 per cent from the present 40 per cent. The change makes Mauritius more attractive than other tax havens like Luxembourg and Ireland.

Investments routed through Luxembourg and Ireland into the Indian debt market attracted tax on interest earned at 10 per cent, which made them a preferred destination for debt-focused foreign investors to register their funds in order to channelise their investments in Indian corporate and government securities.