Budget 2019 May Fail To Get Fund Managers Home

The relaxations announced by Finance Minister Nirmala Sitharaman to get fund managers—who manage offshore funds—to shift base to India may prove to be inadequate, experts told BloombergQuint. Onerous conditions on investor diversification, restrictive participation by the Indian manager and investment limits continue to be roadblocks that’ll prevent India from becoming a destination for offshore fund management, they said.

Offshore fund management is a lucrative business activity worldwide with cities like Singapore, London, Hong Kong and tax havens like Bermuda, Bahamas and Mauritius as preferred destinations due to various concessions and incentives provided by them. To encourage this activity out of India, the government had relaxed the tax regime in 2016. It had stated that merely because the fund management activity is being carried out by a fund manager in India, it wouldn’t amount to a taxable presence.

The government has given some relief in Budget 2019 by relaxing two conditions. But some of the more important conditions like requirement to trace resident Indian ownership in the fund and the condition that the fund and fund manager should not be connected persons needs a re-look for this benign yet potentially powerful policy change to be positively impactful for the country, Tejas Desai, partner at EY, told BloombergQuint.

Budget 2019: Relaxations

The finance minister has eased two conditions that have, among others, prevented offshore funds to move fund management to India. These relate to:

• Time limit for achieving the prescribed average corpus value
• Remuneration of fund managers

Time Limit For Achieving Corpus

To avoid a taxable presence in India as a result of onshore management, the offshore fund must achieve an average monthly corpus of Rs 100 crore before the end of the financial year in which it’s incorporated or set up.

Problem arose when such funds were set up towards the end of a financial year in which case, achieving the corpus size became difficult for fund managers. Budget 2019 revises this time limit. Now, an offshore fund being managed from India can claim tax benefits if it achieves the average corpus size before:

• The end of the financial year in which the fund is established.
• Six months from the last day of the month in which the fund is established, whichever is later.

Fund Manager’s Remuneration

Another pain point in qualifying for the tax exemption had to do with conditions around remuneration to the fund manager based in India. Under the existing requirements, the remuneration paid by an offshore fund to the fund manager in India shouldn’t be less than the arms-length price that is paid for such activity—or the price applied when a transaction is between two unrelated persons.

Budget 2019 removes the need for an arms length pricing. Instead, the remuneration must be calculated using a method that will be prescribed by the tax department.

Doing away with the arms length rule for paying remuneration to the fund manager in India would certainly provide much relief as now, the industry will not have to go through the tedious process of determining the acceptable price, Sunil Gidwani, partner at Nangia Advisors said.

Are These Relaxations Enough?

While these relaxations are welcome, some of the remaining requirements for tax exemption are still restrictive and offshore funds may continue to avoid India as a destination for fund management, experts pointed out.

The challenges relate to:

Minimum Number of Investors: Presently, an offshore fund that’s being managed from India must have a minimum of 25 unconnected members in order to claim tax benefits. A relative or a partner, director or a person having substantial interest comes within the purview of a connected person. And so, funds which have lesser members do not qualify for tax benefits.

Investor diversification condition of at least 25 members is onerous, particularly in case of private equity funds and acts as a deterrent, Shefali Goradia, partner at Deloitte India, said.

Restrictive Participation: Currently, any member of the offshore fund, along with connected persons, cannot have a direct or indirect interest exceeding 10 percent. Additionally, the aggregate interest of 10 or less members in the fund cannot be more than 50 percent. This limits participation in such funds to a relatively small number of investors.

On the other hand, aggregate participation in an offshore fund by persons resident in India should not exceed five percent of its corpus value.

The eligible Indian fund manager or the wholly owned offshore subsidiary of the eligible Indian fund manager may be required to put seed capital while setting up the fund in order to demonstrate skin in the game, Goradia said, adding that seed capital may also be required to create a performance track record.

“Given this, the limitation on aggregate participation should be relaxed for fund managers,” she said.

Controlling Stake In An Indian Company: In order to claim tax benefits, an offshore fund that’s being managed from India cannot carry out any business activity in the country, and cannot control or manage any business in or from India.

Experts told BloombergQuint this limitation restricts offshore funds like private equity funds from availing tax benefits. Subsidiaries or associate entities of such private equity funds may acquire stakes in an investee or a target company on behalf of its global parent. In such cases, an offshore fund may end up acquiring a controlling stake in an Indian company, thus making it ineligible to claim the benefits.

This limitation inhibits the investing ability of buyout funds who may want to strategically participate in the business operations of a target company in India, she said.

The changes proposed in the budget will be effective retrospectively from April 1, 2019.