Budget 2016: Impact on alternative fund industry.

In the backdrop of slow global growth, turbulent financial markets and volatile exchange rates,one may say that expectations from the Union Budget 2016 were overall low. Amid a need to maintain fiscal discipline and with limited avenues to mobilise additional resources (except by increasing taxes), aspects like no substantial increase in service tax, no change in the structure of taxation for listed securities and no change in extension in holding period for an asset to qualify as longterm capital asset, all are signs of relief and indicators of a stable regime.

Having said that, the alternative fund industry, being the source of risk capital for Indian
entrepreneurs, had significant expectations from the Budget. They were hoping that the
government will significantly accept the recommendations of the Alternative Investment Policy Advisory Committee (AIPAC) formed by the Securities and Exchange Board of India (SEBI) under the chairmanship of NR Narayana Murthy. In fact, the report had a chapter dedicated to tax reforms required for the alternative funds industry.

While many of those recommendations could have been accepted, the Budget proposals fell
short of expectations in this regard. However, some proposals relevant to the alternative fund industry made their way and are summarized below: Withholding tax on distributions by Alternative Investment Funds (AIF): It is proposed that distribution of income by AIFs to nonresident investors shall not be subject to 10 per cent withholding tax provided such nonresident investor is eligible for tax treaty benefits.

This proposal will be warmly welcomed by the AIFs, specifically, the fund managers based in India, who were looking to raise capital from offshore investors, to capitalise on the recent FDI liberalisation allowing 100 per cent FDI in AIFs under the automatic route. However, it would have helped if the government had taken distributions to exempt resident investors or distributions of exempt income to residents out of 10 per cent tax withholding.

Applicable longterm capital gains tax rate to foreign funds: The issue of applicability of
reduced rate of 10 per cent tax on longterm capital gains arising on transfer of unlisted
securities for nonresidents is proposed to be resolved. It is proposed that such rate shall be
available on longterm capital gains derived on transfer of unlisted securities or shares of
company in which public is not substantially interested. While taxation of gains arising to most of the foreign funds would be protected under the applicable tax treaty, this amendment should help foreign funds in tax indemnity related discussions on exits.

Reduction in holding period: In another welcome move, the finance minister said that the
holding period of securities of unlisted companies to be treated as longterm capital asset is
proposed to be reduced from three to two years. However, enabling provisions to enact such amendment in the law seems to have been missed out.

Safe harbor rules largely unchanged: Allowing onshore asset management of offshore pool of capital has been a key demand of the alternative fund industry for more than three years. If enacted, the amendment will help the government not only in restricting export of intellectual capital but also raise additional revenues by way of income tax on fund management fees.

While two small amendments have been made (explained below), a lot was expected about
investment diversification, investor diversification and provisions relating to arm’s length
management fees. One hopes that these will be dealt through a separate notification for which the law provides for – though this needs some sense of urgency.

(i) Safe harbor rules were applicable to an eligible investment fund resident of a country /
specified association, with which India has entered into a double taxation avoidance agreement.

This section is proposed to be amended to also include a country which may be notified by the government. Here also instead of a country to be notified, what the industry expects is that the fund could be set up or established or incorporated in the countries with which India has a tax treaty.

(ii) Currently, an eligible investment fund is not permitted to carry on or control and manage,
directly or indirectly, any business in India or from India. This condition is now proposed to be restricted to controlling any business in India and not from India.
Place of Effective Management (POEM) effective from April 1, 2016: In order to provide clarity for implementation of the POEMbased residency test and also to address concerns of the stakeholders, it is proposed to defer the applicability of such rule by a year. However, it is expected that the government will soon finalise the detailed guidelines relating to determination of POEM for effective implementation.

MAT on foreign companies: With a view to provide certainty in taxation of foreign companies, it is proposed that MAT provisions shall not apply to foreign companies if it is from a treaty country and does not have a permanent establishment in India or it is not from a treaty country and is not required to register under the Companies Act.

New asset classes: Probably the last hurdle from tax standpoint for REIT/ InvIT, is proposed to be cleared in this Budget. Once enacted, dividend received by an REIT / InvIT from wholly owned special purpose vehicles (SPV) shall not be taxable in the hands of the trust nor will it be subject to dividend distribution tax (DDT) in the hands of the SPV.

Similarly, a new taxation regime for securitisation trusts and its investors has been provided.
Amongst others, tax passthrough status has been provided to income of securitisation trust
and income from securitisation trust would be taxable in the hands of investors. Further, 100
per cent FDI is proposed to be allowed under the automatic route in asset reconstruction
companies. For foreign portfolio investors regulated by SEBI, it is proposed that they shall also be allowed to invest 100 per cent of security receipts issued by the securitisation trust. Both provisions should help fund managers focusing on these asset classes in short to medium term.

Other important amendments include introduction of the Organization for Economic
Cooperation and Development's (OECD) recommendation on certain action plan of Base Erosion and Profit Shifting (BEPS) project, tax incentives for units located in International Financial Services Center, systematic phase out of tax incentives currently available under the tax laws and replacing it with tax incentive for startups and entities generating employment.

The industry still craves for clarity around characterisation of gains of an AIF to be treated as ‘capital gain’, extension of tax passthrough to all categories of AIFs and allowing retirement and pension funds invest in AIFs – though the circular issued yesterday should address one of the concerns in this regard (regarding characterization).

One would hope the government issues the necessary guidance to provide certainty on the
above issues, as these are a must for better development of the alternative fund industry.
Vikram Bohra is partner and Devang Ambavi is associate director manager, Financial Services Tax and Regulatory Services, PwC India.

RBI releases draft norms for account aggregators

Such NBFCs should have minimum net-owned funds of Rs2 crore and cannot provide any services other than account aggregation

The Reserve Bank of India (RBI) on Thursday released draft guidelines for setting up of non-banking finance companies (NBFC) that would act as account aggregators and provide customers with a single platform view of all their financial holdings across banking, insurance, mutual funds, provident funds and shares.

“At present, persons holding financial assets such as, savings bank deposits, fixed deposits, mutual funds and insurance policies do not get a consolidated view of their financial asset holdings, especially when the entities fall under the purview of different financial sector regulators. Account aggregators would fill this gap by collecting and providing information of customers’ financial assets in a consolidated, organized and retrievable manner to the customer or any other person as per the instructions of the customer,” RBI said in its release.

Such NBFCs should have minimum net-owned funds of Rs.2 crore and cannot provide any services other than account aggregation, the central bank said, adding that the account aggregator cannot support transactions in financial assets. Only NBFCs that have registered with the RBI will be allowed to undertake account aggregation. However, companies that aggregate accounts of only a particular financial sector governed by other regulators can be exempt from seeking RBI approval, the central bank said.

Initially, only financial assets whose records are stored electronically and are under the regulation of the financial sector regulators, namely RBI, Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority (IRDA) and Pension Fund Regulatory and Development Authority (PFRDA) shall be considered for aggregation, the draft norms said.

The NBFCs would provide account aggregation services in response to a specific application by the customer for availing such services and would be backed by appropriate agreements and authorisations, the draft norms said.

“No financial asset-related customer information pulled out by the account aggregator from the financial service providers should reside with the account aggregator,” the central bank said.

Pricing of services would be as per the account aggregator’s board-approved policy, RBI added.

In July 2015, RBI governor Raghuram Rajan had announced the intention of setting up such NBFCs for account aggregation.

The central bank has sought comment and feedback on the draft norms by 18 March.

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Sebi set to get tougher with wilful defaulters

Regulator will make it hard for wilful defaulters to raise funds from public; they can opt for rights issues or share sales to institutional investors

Mumbai: The Securities and Exchange Board of India (Sebi) will make it difficult for so-called wilful defaulters from raising fresh equity or debt from the public, according to two people familiar with the agenda of the regulator’s next board meeting.

The move will mark yet another effort by the Indian government, the Reserve Bank of India (RBI) and now Sebi to crack down on the problem of bad loans.

A wilful defaulter is a company or individual who borrowed money and has no intention of paying it back, has diverted the money to some other purpose than the one for which it was borrowed, or has sold the asset acquired or developed with the money without the lender’s knowledge.

Sebi will, however, allow such entities to raise funds through rights issues or share sales to institutional investors, said one of the two persons, asking not to be identified.

The entity will need to disclose itself as a wilful defaulter in the offer document if it chooses to go in for a rights issue (sale of shares to existing shareholders), or a qualified institutional placement, added this person

Sebi’s board meeting is scheduled for 12 March. A Sebi spokesperson did not respond to an email seeking comment.

In January 2015, Sebi issued a draft paper proposing that wilful defaulters would not be allowed to sell shares, debt securities and non-convertible preference redeemable shares to the public.

The paper suggested that wilful defaulters be barred from taking control of another listed entity, but that they be allowed to participate in counter offers to deal with hostile takeover bids.

Each of these restrictions would be applicable if the issuer, its promoter, group company or director of the issuer of such securities were in the list of wilful defaulters published by RBI, the stock market regulator said.

“The final regulations will be based on the discussion paper that dealt with the wilful defaulters,” said the second person, who too asked not to be identified.

In addition to restrictions to fund raising, such entities and persons will be ineligible to serve as market intermediaries or run mutual funds or alternative investment funds, added the second person.

Bankers said such restrictions would help.

RBI has been asking banks to get tough on wilful defaulters and has a tough set of rules in place which say that anyone tagged a wilful defaulter cannot raise fresh funds from the banking system.

The banking regulator, however, has been of the view that such defaulters also need to have their access to capital markets restricted. “If someone has knowingly stopped repaying banks, then why should he be allowed to access the capital markets? Any such limitation on the borrower would definitely be a power for the banks since they can squeeze these wilful defaulters better,” said Ashwani Kumar, chairman and managing director of Dena Bank and chairman of the Indian Banks’ Association.

While RBI has not disclosed the quantum of loans that fall under the wilful default category, data has emerged from some large public sector banks.

Loans worth Rs.11,700 crore given by State Bank of India have been locked up as non-performing assets as nearly 1,160 defaulters have wilfully decided not to repay, PTI reported on 24 February.

Another state-owned lender, Punjab National Bank (PNB), declared 904 borrowers who owed it a combined Rs.10,869.71 crore as of December-end as wilful defaulters. PNB added 140 companies to the list of wilful defaulters in the December quarter alone.

While banks believe that banning wilful defaulters helps their cause, corporate lawyers caution against a sledgehammer approach.

“Wilful defaulters should be restricted from raising funds from public because there is no accountability to return funds to shareholders. However, Sebi should steer clear of a blanket restriction on fund-raising by defaulters as this would potentially limit the chances of a revival of the company and the existing shareholders would end up paying the price,” said Tejesh Chitlangi, a partner at IC Legal.

Parag Bhide, senior associate at Advaya Legal, said Sebi should approach the issue on a case-by-case basis.

“A complete ban on wilful defaulters may not be good for existing shareholders, including retail investors. Further, such a lifetime exile from financial markets may not be constitutional. Ideally, there should be some time limit (three-five years) for such a ban.”

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Jewellery sector contributes to black money: CBEC chief

Despite the ongoing jewellers' strike to protest against reimposition of 1 percent excise duty on gold and diamond jewellery, CBEC today said the sector contributes to generation of black money and needs to be brought under the tax ambit.

"We have brought jewellery (sector) into the tax net. This is the levy which we had attempted two years ago and withdrawn... This is the sector which you will agree with me needs to be brought into tax needs," Chairman of the Central Board of Excise and Customs (CBEC), Najib Shah today said at an event organised by industry body Assocham.

"This is a sector which lends itself to generation of unaccounted wealth." Finance Minister Arun Jaitley in the Budget for 2016-17 had proposed 1 percent excise duty on jewellery without input credit or 12.5 percent with input tax credit on jewellery excluding silver other than studded with diamonds and some other precious stones.

Jewellers are on a three-day pan-India strike to protest against the proposed re-introduction of 1 percent excise duty on gold and diamond jewellery and mandatory quoting of PAN by consumers for transaction of Rs 2 lakh and above.

Shah noted: "... manufacturing sector contributes 17 percent of GDP. We have a huge chunk of industry which is out of the tax net." The CBEC chairman said the revenue department will take a hit of Rs 1,000 crore due to the change in CENVAT credit rules.

"But we thought it is essential because the cost of litigation for you and me are much more than revenue which otherwise we have got," he said.

Noting that the government has increased some duties, Shah said it's done so to create a level-playing field for Indian industries as was the case in defence.

He urged industries to stop demanding exemptions to avail of goods and services tax (GST).

"If you want GST, you should not demand exemptions because two don't go together," Shah said.

 

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