India: Investment Funds – 2016 In Perspective, Budget Expectations 2017

Last Updated: 10 January 2017
Article by Siddharth Shah, Bijal Ajinkya, Divaspati Singh and Abhilasha Mondal

Most Read Contributor in India, December 2017


In an audio-conference specially dedicated to funds and fund managers titled "Investment Funds: 2016 in Perspective, Budget Expectations 2017", we shall discuss several regulatory changes in 2016 and their impact on the business for the fund managers and the fund industry in general leading into what is on the industry wish list for the Budget 2017.

Join us for the audio-conference hosted by us to provide insight into these important developments and their impact on your business in an interactive session.


Siddharth Shah (Partner, Khaitan & Co)

Bijal Ajinkya (Partner, Khaitan & Co)

Local Time:*

Wednesday, 11 January 2017:
19:00 – 20:00 (IST) 08:30 – 09:30 (EST) 13:30  – 14:30 PM (GMT)


Thursday, 12 January 2017:
13:30 – 14:30
16:00 – 17:00
17:00 -18:00
19:00 – 20:00

* Please note that participants (regardless of their jurisdiction) are free to join the audio-conference at any of the above two timeslots, as per their convenience.

You may register for the audio-conference on:

  • Wednesday 11 January at this link; or
  • Thursday 12 January at this link.

Dial In:

USA 13233868721
UK 442034785524
Singapore 6531575746
Hong Kong 85230186877
Japan 81345899421
India (& Rest of World) +91 22 3960 0881

The foreign investment landscape in India has witnessed a bout of regulatory activity under the present administration. While the Indian Government has introduced relaxations in the foreign investment regulations and recognised the need to ensure a non-adversarial tax regime, it has also struggled to strike an appropriate balance between its resolve of popularising the "Make-in-India" campaign on one hand, and protecting its revenue base and preventing tax seepages on the other hand.

Some of the key changes relevant for the funds industry which were announced in 2016, and some of the budget expectations which will form part of the audio-conference are summarised below for ease of reference:

1. Liberalisation of Foreign Investment Regime for Funds and Fund Managers

In February 2016, the Reserve Bank of India (RBI) carried out necessary changes to the Foreign Exchange Management (Transfer and Issue of Securities to Persons Resident Outside India) Regulations 2000 (TISPRO) that in effect permitted foreign investments, under the automatic route, in investment vehicles such as alternative investments funds (AIFs), infrastructure investment trusts, real estate investment trusts and other such regulated entities. The notification also permitted non-resident Indians and registered foreign investors to invest in such investment vehicles under the automatic route.

For a more detailed analysis of the above notification and its impacts, kindly refer to our Ergo – "RBI Permits Foreign Investments in REITs, InvITs and Alternative Investment Funds".

Thereafter, in September 2016, the RBI released another notification (Notification) amending the TISPRO to relax the regime governing foreign investments in the 'non-banking financial services' sector. The Notification sought to: (i) open up the sub-sectors of 'non-banking financial services' for 100% foreign investment participation (under the automatic route provided they are regulated by a financial sector regulator or otherwise under the approval route); and (ii) align the capitalisation norms linked with foreign ownership with those prescribed by the relevant regulators by removing additional capitalisation requirements (if any) under the Foreign Direct Investment Policy (FDI Policy).

The extant framework of FDI Policy posed several challenges for fund managers, such as: (i) high capitalisation norms in case of foreign ownership in asset management company; (ii) regulatory ambiguity regarding approval requirements for asset managers investing their own capital, as a sponsor or otherwise; and (iii) additional capitalisation requirements in case foreign owned asset management entities created downstream joint ventures or subsidiaries. The Notification has eased the above issues faced by entities operating in the 'non-banking financial services' sector.

The Notification provides a much-needed boost to the financial services sector, particularly for domestic fund management and advisory activities which could now access foreign capital under a relaxed regulatory regime, and further the Government's intent to encourage global fund managers to operate out of India.

For a more detailed analysis of the Notification and its impacts, kindly refer to our Ergo – "FDI in Non-Banking Finance Companies: Relaxation and its Impact for Fund Managers".

2. Clarifications to Indirect Transfer Provisions

The indirect transfer provisions were introduced by the Finance Act 2012, with the intention to negate the effect of the judgment of the Hon'ble Supreme Court in the Vodafone case (Vodafone International Holdings BV v. Union of India ([2012] 341 ITR 1)). These provisions state that gains earned by a non-resident on the transfer of shares or interest in a foreign entity that derives substantial value from assets situated in India, will be liable to taxation in India. A share or interest is deemed to derive substantial value from assets situated in India, if on the specified date, the value of such assets:

  1. exceeds INR 100 million; and
  2. represents at least 50% of the value of all assets owned by the foreign entity.

These provisions are not attracted in case:

  1. the transferor is a person who does not have rights of managements or control in the foreign entity or the entity holding the Indian assets, and does not hold more than 5% of the voting power or share capital or interest in the entity holding Indian assets; and
  2. transfer of shares of a foreign company (that derives substantial value from assets situated in India) takes place as a result of amalgamation or demerger of the foreign company, subject to the fulfilment of certain conditions.

In December 2016, the Central Board of Direct Taxes released a circular (Circular) providing clarifications on the scope of applicability of the indirect transfer provisions, to address some of the queries raised by stakeholders. These clarifications primarily pertained to the tax treatment of fund structures such as: (i) funds with FPI registration undertaking investment in Indian securities; (ii) master funds and feeder funds; (iii) nominees or distributors; (iv) India focused sub-funds; (v) offshore listed FPIs, etc.

Khaitan Comment

The quintessential spirit of the Circular was that (except in the case of investments via India focused sub-funds where the indirect transfer provisions had blanket applicability) the indirect transfer provisions will be applicable in most of these scenarios unless the exceptions specified in (i) and (ii) above are met. Most large private equity and hedge fund structures will have a few large investors, and such investors may not qualify for the exemptions. The implications of the Circular gave rise to fears of double taxation; once at the level of the fund, and another at the level of the investor at the point of redemption of his units in the fund; heightening the already prevalent concerns of ambiguity surrounding the regulatory framework around investments in India. In fact, unless quickly rectified by the Government, this adversarial indirect transfer regime is likely to dampen investor appetite for long term capital commitment.

For a more detailed analysis of the Circular and its impacts, kindly refer to our Ergo – "Indirect Transfers in Fund Structures – Government Reiterates Law, does not Alleviate Concerns".

3. Treaty Renegotiations

In May 2016, a watershed moment in India's struggle with tax avoidance, the Government renegotiated the India – Mauritius Double Taxation Avoidance Agreement (Renegotiated India – Mauritius Treaty), and prospectively withdrew the beneficial capital gains tax exemption, in respect of acquisition of shares of an Indian company, that was provided under the extant treaty. The protocol released by the Government (Mauritius Protocol) provides a transition period to cushion the blow, whereby shares of an Indian company, acquired between 1 April 2017 and 31 March 2019 will be taxable in India at 50% of the actual taxable rate, provided the transferor satisfied certain conditions (also known as the 'Limitation of Benefits' clause or LOB). All such acquisitions arising after such transition period, i.e. on or after 1 April 2019, will be taxable in India at the rate provided under the Income Tax Act 1961. Secondly, the Mauritius Protocol also introduced withholding tax on interest income earned in India, whereby interest arising in India to Mauritian resident banks, in respect of debt or loans made after 31 March 2017, will now be subject to withholding tax at the rate of 7.5%. Thirdly, the Mauritius Protocol also provides for the updating of the provisions on information exchange as per international standards.

Subsequently, in November 2016, India and Cyprus signed a protocol (Cyprus Protocol) to amend their existing tax treaty. Unsurprisingly, the tax treatment under the treaty switched from residence based taxation to source base taxation, which in effect, results in the withdrawal of the beneficial capital gains exemptions clauses in respect of income earned in India. Gains from transfers of shares of Indian companies, where such investments are made on or after 1 April 2017 would become taxable in India. The Cyprus Protocol also provides a wider definition to the term 'permanent establishment' and has reduced the rate of tax on royalties from the existing 15% down to 10%. Further, it too provides for the updating of the provisions on information exchange as per international standards.

Interestingly, the Renegotiated India - Mauritius Treaty sealed the fate of the capital gains tax exemption provision under the India – Singapore Tax Treaty as well, as the latter specifically provided that the residence based taxation of capital gains thereunder would remain in force for only as long as the India – Mauritius Double Taxation Avoidance Agreement provided capital gains exemption in the source state. Accordingly, in December 2016, the Government issued a protocol (Singapore Protocol) amending the India – Singapore Tax Treaty, whereby capital gains derived in India from the sale of shares of an Indian company, by a Singapore resident, would become taxable in India. The Protocol provides that all investments made in India on or before 31 March 2017 will be subject to the LOB.  The Singapore Protocol also mirrors the two year transition period as provided under the Renegotiated India - Mauritius Treaty.  Further, the Singapore Protocol also provides for 'Mutual Agreement Procedure' mechanism to facilitate relief from double taxation in transfer pricing cases, and the application of domestic law provisions with respect to tax avoidance and tax evasion. No change is contemplated to the existing tax rates on interest incomes.

Khaitan Comment

With this move of tightening its tax treaties by withdrawing popular tax exemptions, the Indian Government aims to provide a level playing to all jurisdictions and cut down the possibilities of tax arbitrage by setting up investment vehicles in tax friendly jurisdictions for investments into India. Structuring of investments vehicles offshore will now wholly depend on the merits, substance and administrative convenience offered by the offshore regulatory framework of the relevant jurisdictions.

For a more detailed analysis of the treaty renegotiations and its impacts, kindly refer to our Ergos – "A New Year, A New Innings: After Mauritius & Cyprus, Singapore Lose Capital Gains Tax Exemption", "Mauritius No Longer a 'Sweet Spot'?", "India – Mauritius Tax Treaty 2.0 – Equity Investments Out, Debt Investments In", "Cyprus Loses the 'Non-Cooperative Jurisdiction' Tag", and "India makes Post-Facto Christmas Gift to Cyprus".

4. AIPAC Report and Budget Expectations

Wrapping up in December 2016, the Alternative Investment Policy Advisory Committee, set up by SEBI, released its reports listing out recommendations for the immediate improvement and long term development of the alternative investment funds sector in India. The report focused on the recommended regulatory reforms, and the crucial recommendations on the taxation front resonated closely with the stakeholder expectations and the upcoming budget projections, including: (i) removal of withholding tax on exempt incomes and exempt investors; (ii) relaxation of the safe harbour norms for onshore fund managers; (iii) clarification that indirect transfer provisions were not applicable to offshore investment vehicles; (iv) permitting set-off of losses in the hands of the investors; (v) allowing pass through status to Category III AIFs; (vi) exempting foreign investors from the requirements of obtaining PAN and income tax filings; (vii) introducing securities transaction tax to replace existing taxation model of AIFs, etc.

Khaitan Comment

The Government has generally been showing a very positive intent towards liberalisation and rationalisation of the regime for foreign investors. While it has clearly recognised alternative investment funds and investors as strategically important stakeholders for the country, and has introduced some path breaking changes during 2016, what remains to be seen is, having been armed with bolstered revenue courtesy the mainstreaming of the parallel cash economy thanks to the demonetisation drive combined with black money amnesty schemes, how prepared is the Government to be the 'Santa' for the fund industry fulfilling the wishes of the industry.

We intend to discuss in more detail some of the enlisted changes their impact on the fund industry as well as the rationale behind the budget expectations our audio-conference - "Investment Funds: 2016 in Perspective, Budget Expectations 2017", as mentioned above.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at

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Events from this Firm
10 Feb 2018, Video/ Audio, Mumbai, India
Contact Event Organizer: Khaitan & Co Funds Team
This is to remind you that we will be hosting an audio-conference tomorrow, 10 January 2018, titled “SEBI’s Year End Bonanza to Investors and Fund Managers”, which is dedicated to fund managers and investors.
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