In a first of its kind development, the Indian regulators have provided a formal recognition to family offices under the International Financial Services Centres Authority (Fund Management) Regulations, 2022 ("FM Regulations").
In simple words, a family office is a wealth management entity dedicated to the needs of a family with significant wealth and involves a variety of activities such as wealth planning, tax & estate planning, investing, managing corporate and family governance issues, performing administrative, trustee and other concierge services.
Traditionally, a Western and European practice, the concept of family offices has risen in large numbers in recent past amongst Indian ultra-high net worth individuals (UHNIs), family-run conglomerates and high net worth families. As of July 2022, India had approximately 300 family offices with an average asset under management of $100 million each but mostly not in any proper form or structure1. Therefore, it comes as no surprise that with a view to bolster the funding and capital ecosystem at the upcoming International Financial Services Centre, the government provided for family investment funds ("FIFs") under the FM Regulations which are to be governed by the International Financial Services Centres Authority ("IFSC Authority").
A FIF has been defined as a self-managed fund pooling money only from a single family set up as a fund management entity ("FME") in terms of FM Regulations. A few prominent features and investment avenues available to FIFs under the FM Regulations are as follows:
- A FIF maybe setup as a company, trust (contributory trust only) or LLP or any other form as may be permitted by the IFSC Authority from time to time.
- A FIF should have and maintain a minimum corpus of USD 10 million within a period of 3 years from the date of obtaining certificate of registration.
- Subject to the requirements of the family, the FIF could be an open ended or close ended scheme.
- A FIF may invest in the following:
- securities issued by the unlisted entities / securities listed or to be listed or traded on stock exchanges in IFSC, India or foreign jurisdictions;
- money market instruments / debt securities;
- securitised debt instruments, which are either asset backed or mortgage-backed securities;
- derivatives including commodity derivatives / units of mutual funds and alternative investment funds in India and foreign jurisdiction;
- FIFs are permitted to borrow funds and engage in leveraging activities as well in line with their risk management policies.
- All individuals of a single family who contribute to the FIF directly or indirectly, shall prior to the commencement of activities of the FIF give an undertaking to the concerned principal officer, to the effect that they understand the risks, costs and benefits of investing in the FIF and that the usual investor protection measures such as disclosures, regulatory inspection and supervision, etc., may not be available to the same extent to the FIF as they are to other schemes in IFSC.
Till recently, a major issue with the FIFs under the FM Regulations was that 'single family' included only individual family members (who are the lineal descendants of a common ancestor including spouses). This posed a challenge in the establishment and pooling of monies in the FIFs as resident individuals are subject to the annual limit of USD 2,50,000/- under the liberalised remittance scheme ("LRS").
Taking cognizance of the problems faced by potential stakeholders and with a view to encourage more family office organisations to setup at IFSC, the IFSC Authority provided some clarity and additional relaxations recently such as:
- The scope of 'single family' has been widened to include entities such as sole proprietorship firm, partnership firm, company, LLP, trust or a body corporate, in which an individual or a group of individuals of a 'single family' exercises control and directly or indirectly holds substantial economic interest2.
- Setting up of additional investment vehicles (which will be considered as part of FIF for the purposes of meeting the requirements of FM Regulations) has been permitted. These additional vehicles may be in the form of companies, limited liability partnerships, trusts or any other form as may be specified by the IFSC Authority. The main intention seems to increase the options available to FIF to meet the corpus requirement. Since these vehicles can be of any other form (which maybe different than the form of the main FIF, they may tweaked to suit the needs of different family members, to address the independent taxation and sharing of profits of such persons.
- While the FIFs cannot accept monies from outsiders i.e., individuals & entities not belonging to the 'single family', they are now permitted to share economic interest with their employees, directors, FMEs or other persons providing services to them as a rewarding measure. To that extent, FIFs may now accept contributions not exceeding an aggregate of 20% of FIF's profits from the aforementioned persons in this regard.
- Further, to protect the said outsiders holding an economic interest in a FIF, the IFSC Authority has directed the FIFs to ensure that such outsiders are informed of the risks associated with the investment and are also provided with an exit when they do not wish to continue in any particular entity. Such exit may be offered by any person or group of persons from the single family who already holds interest in the entity and the price involved shall not be less than the price determined by an independent third-party service provider3 and have to also compulsorily provide a valuation report to justify the exit price.
These clarifications and relaxations can be a potential game changer in the sphere of family investment vehicles. With the inclusion of entities within the scope of 'single family', now even family-controlled entities (in addition to the individual investments within LRS limits) will be able to invest up to 50% of their net worth as per latest audited balance sheet in the FIFs under the current overseas investment regime4.
Further, the IFSC Authority has also provided comfort of receiving monies from non-family members and setting-up additional investment vehicles (deemed as part of FIF for the purposes of meeting the requirements of FM Regulations) thereby increasing the flexibility in structuring and investment options available to family office players in the IFSC.
While family offices have been around for over a decade in India, it is only now that owing to the recent spate in family offices and the huge potential in this field, a legal framework has been put in place for them. The intention of the government to attract as many investments as possible in the IFSC is clear from its various efforts and regulatory relaxations and it remains to be seen whether the domain of family office gets the necessary impetus as expected by the finance industry and whether the structures would continue to remain feasible in the long run.
2.'substantial economic interest - shall mean at least 90% economic interest, as demonstrated by the Family Investment Funds (FIF) in an appropriate manner to the satisfaction of the Authority which may, inter alia, include: i. percentage of shareholding in case of a company with share capital; or right to exercise control in case of a company without share capital; ii. percentage share of profits in case of partnership firm and limited liability partnership; iii. percentage of beneficial interest specified in trust deed in case of a determinate trust; or pro-rata share in the trust property in case of an indeterminate trust; or iv. any other manner as may be demonstrated to the satisfaction of the IFSC Authority.
3. This independent third-party service provider may be a fund administrator or custodian registered with the Authority, a valuer registered with IBBI or such other person as may be specified by the IFSC Authority and shall take into account the following factors: a) the highest price paid by any person for acquiring any interest in the entity during the last twelve months; b) the fair price of the entity, to be determined after taking into account valuation parameters including return on net worth, book value, earning per share, price earning multiple vis-à-vis the industry average, and such other parameters as are customary for valuation of such entities
4. Foreign Exchange Management (Overseas Investment) Rules, 2022 read with Foreign Exchange Management (Overseas Investment) Regulations, 2022 and Foreign Exchange Management (Overseas Investment) Directions, 2022.
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