Privatisation, FPI investment in REITs, InvITs: How Budget 2021 will impact financial services sector

By Sunil Gidwani

Several major changes and announcements made in the Budget proposals were actually anticipated and in fact widely expected by the financial service sector which has been severely impacted and has been under stress during last few years. Major announcements relate to Banking sector, insurance sector, IFSC and asset monetizing vehicles and investing institutions like REITS, InVITs and Infra funds.

One clear favourite is the IFSC. Several pathbreaking and speedy changes to framework for IFSC in the GIFT city in Gandhinagar in the last two years have already improved IFSC’s rankings among global fund jurisdictions. Several sweeping changes are now proposed by the Finance minister to provide a major thrust to the IFSC.

One significant change relates to foreign funds located in countries like Mauritius and Singapore that are holding existing investments qualifying for capital gains tax exemption on equity shares under the respective tax treaties. The amendment proposes a tax neutral relocation of foreign funds to IFSC on the lines of merger/demerger provisions with continuity of original treaty benefits will encourage funds from countries like to move to IFSC. Currently if offshore funds from other countries were to relocate to IFSC though there may not be any tax on gains earned till the date of moving India shares to IFSC fund, such fund lose exemption provided under the tax treaties for any incremental gains on subsequent sale unless the IFSC Fund is a Cat III fund registered as FPI.

The amendment propose to makes such a relocation from another country to IFSC tax neutral for the Fund as well as the investors in the fund. The relocation is envisaged to be a cashless transfer whereby the Fund would transfer securities to IFSC fund that will issue new units to investors in lieu of original units. Such a relocated fund will continue to get capital gains exemption otherwise available under the respective tax treaty. This change is path breaking and will make such a relocation attractive. One hopes that SEBI makes appropriate changes in FPI regulations to make it seamless from regulatory perspective and the investors are made comfortable with making themselves subject to Indian regulations as compared to a known and tested offshore jurisdiction framework.

Another change relates to safe harbour rules for managing offshore funds from India. Currently the Fund and the Fund manager need to satisfy a host of conditions to get the structure approved by the CBDT. A manager in IFSC managing offshore fund may not need to satisfy these conditions. One will have to wait for the government notifications to see which conditions of these are specifically waived. While the safe harbour for managing funds from India has been in place for a number of years, not many have opted for this regime. One hopes that the change will attract at least the India focused funds to be managed entirely from India thereby doing away with the need to have a dual structure of an offshore manager with an Indian advisory company providing non-binding recommendations and research on Indian stocks.

Tax holiday currently available to other businesses in IFSC has been expanded to aircraft leasing companies. Global aircraft leasing companies currently have operating companies in certain countries like Ireland or Hongkong to lease aircraft because of treaties that provide for exemption from withholding tax on lease payments from India. Offshore lessor, as well as the leasee in the IFSC, are proposed to be exempted from Indian tax (under existing tax holiday scheme). This should add a new dimension to the way aircraft leasing is structured, and new structures will emerge for aircraft leasing.

Currently Indian companies paying dividends to foreign portfolio investors deduct tax @20% even though the respective tax treaty may provide for a lower rate. Proposed amendment allowed Indian companies to withhold tax at the treaty rates (ranging from 5 to 15%) depending on the country of residence of FPI from current rate of 20%. This was strongly demanded by leading industry bodies and will certainly resolve cash flow and compliance issues for FPIs.

Last year significant tax exemptions were introduced for foreign Sovereign Wealth funds and pension funds investing in Indian infrastructure projects. Several conditions attached to such exemptions are proposed to be relaxed. This should provide much needed impetus to the Indian infrastructure sector.

A special asset reconstruction company is proposed to take over NPAs of PSU banks will certainly help improving the health of the affected banks. Currently the foreign investment in the ARC trusts is allowed mainly in the form of FPI investments in the units/SRs issued by the trust. One hopes that in order to mobilize funds for this purpose, apart from government capitalizing the ARCs or relaxing FDI norms in the ARC itself, there should relaxation in foreign investments in the ARC trusts and open it up to various classes of investors other than FPIs. Its time the government also removes ambiguity in respect of tax characterization of income of investors as business income or capital gains.

On the whole the budget appears to be very promising and positive for the financial service sector. Stock markets are clearly thrilled at this stage if one were to go by the indices and the banking stocks.

(Sunil Gidwani is Partner at Nangia Andersen LLP. With inputs from Naitik Doshi, Manager, Nangia Andersen LLP. Views expressed are the author’s own.)