India: Tax issues for offshore asset managers in an ever changing landscape
Gautam Mehra, Nehal Sampat and Neha Shah of PwC discuss the key Indian income tax issues relevant for foreign investors and asset managers investing into India.
"The trouble with our times is that the future is not what it used to be", as suggested by Paul Valery, may reflect the ever changing landscape of the asset management industry in India, especially the taxation regime for foreign investors.
General anti-avoidance rule (GAAR)
The first topical issue in any discussion with an offshore asset manager on Indian taxation is, invariably, the GAAR.
Over the past couple of years, GAAR has been the subject matter of so many debates, articles, representations, and so on, that a search on "India GAAR" on a popular search engine suggests more than 400,000 results.
Hence, without delving into the chronology of GAAR, the key takeaways for offshore asset managers have been summarised below:
There are no specific provisions for the asset management industry in the GAAR provisions, though specific representations have been filed by industry associations and by PwC to consider and review the impact on the asset management industry differently, given its unique characteristics.
Based on the provisions, offshore funds making use of treaty benefits, especially under the India-Mauritius tax treaty, which do not have either pooling vehicles in Mauritius or substance in the form of an asset manager with operations in Mauritius, may face a significant challenge in the form of GAAR after April 1 2015.
Singapore is fast emerging as an alternative to Mauritius, given that it is an asset management hub. Asset management groups, which have existing operations in Singapore, may be in a position to leverage off that for establishing India structures. The capital gains protection under the India-Singapore tax treaty, which is contingent upon continuation of a similar protection under the India-Mauritius tax treaty. Additionally, the India-Singapore tax treaty has the specific anti-avoidance rule (SAAR) in the form of the limitation of benefits clause, which requires demonstration that the Singapore structure is not set up primarily to take advantage of the treaty provisions.
An important aspect to be considered in evaluating Singapore as a jurisdiction is the form of an entity and the ease of repatriation of exit proceeds from a local regulatory perspective. Where the entity is set up as a company, there are conditions relating to solvency and procedural aspects that need to be factored in, especially if proceeds are required to be repatriated regularly.
New funds are actively considering the potential impact of GAAR, including evaluating more appropriate jurisdictions to domicile the fund/fund manager in light of the commercial considerations.
From a potential impact perspective, the following merits attention:
An impact analysis for a hedge fund may generally not be critical for a long-term only fund investing in Indian listed securities with a holding period of more than a year, unless the fund wants flexibility to exit from Indian investments with a shorter holding period or there is an aspersion on the continuation of the exemption for long-term capital gains on sale of listed equities on the stock exchange.
For an existing PE/VC fund, an impact analysis is not required for (i) investments that were made before August 30 2010 or (ii) investments where exit is probable before April 1 2015 or (iii) investments where the likely mode of exit is an IPO or (iv) investments in listed securities where the exit is on the stock exchange and within the price band usually allowed for trading on the exchange. All other investments could potentially be affected by GAAR. If treaty benefits were to be denied, an exit tax of 20% could be applicable, unless the investments were in "securities" as defined under the relevant securities law, in which case, the concessional exit tax rate of 10% could apply. There is ambiguity on whether shares in a private company qualify as "securities", and a relatively simple solution to the debate, subject to other considerations, could be to convert a private company into a public company.
Where a fund, especially a hedge fund, for commercial considerations, decides to migrate from one jurisdiction to another, for example from Mauritius to Singapore, there would be regulatory considerations such as approvals from the local securities regulator and transaction taxes that need to be considered. Furthermore, if the migration were to reset the holding period, and thus risk long-term capital gains being regarded as short-term, it may not be an optimal solution and so evaluation of alternative strategies may be required.
Like GAAR, the provisions relating to taxation of "offshore transfers" have been the subject matter of extensive debate and deliberations. The key takeaways for offshore asset managers have been summarised below:
The provisions are primarily relevant for India-focussed funds or global funds that invest into India through SPV structures.
There is significant ambiguity with respect to:-
Threshold for the provisions to be triggered, in the context of value of shares or interest in an offshore entity, and the meaning of the phrase "substantially derived from Indian assets". A threshold of 50% may be reasonable though there are strong grounds to support an even lower threshold.
The mode of valuation of Indian assets to which the threshold of "substantially derived" has to be applied (book value, fair market value, whether it includes intangible assets, and so on).
Manner of computation of gains including both the sale consideration and the cost.
Recently, the Andhra Pradesh High Court in the case of Sanofi Pasteur Holding SA  354 ITR 316 (AP) held that the retrospective amendment on offshore transfers should not have an impact on any benefit otherwise available under the applicable tax treaty. Therefore, tax arising on account of offshore transfers should continue to be eligible for exemption, if any, under the applicable tax treaty. However, the case is now pending before the Apex court for final adjudication.
These provisions may be particularly relevant in the context of cross-border restructurings such as merger of Funds, etcetera because there are no carve-outs for any such exercise.
Additionally, while it may not have been the legislative intent, these changes require careful consideration at the time when funds are repatriating proceeds above the SPV or fund levels.
Continuing with the momentum on tax controversies, transfer pricing is fast emerging as the biggest tax issue on the Indian tax landscape.
A significant tax controversy that has been raging for the past few months is the applicability of transfer pricing principles in the context of a transaction involving the issue of shares by an Indian company to its non-resident parent, at an alleged discount to the fair market value. The transfer pricing officers are of the view that such an alleged discount constitutes income (strangely, in the hands of the issuing company).
Also, there is a contention of a deemed loan by the Indian company to its parent when shares are issued at a discount that merits attribution of notional interest in the hands of the Indian company. It appears that the transfer pricing officers are now also looping the foreign parent into the debate. Particularly relevant in the context of follow-on investments by non-resident parents, a question arises as to whether the non-resident parent is required to report the subscription of shares and the valuation basis to the Indian tax authorities. In addition to a litigation risk with respect to valuation, there is a significant risk of imposition of penalties (that extends up to 2% of transaction value) for failure to report.
Also, Indian subsidiaries of asset managers that operate on a cost plus basis have been visited with litigation by the transfer pricing officers, enhancing the mark-up from 20% to significantly higher levels in some cases. Advance pricing agreements (APAs) are fast emerging as a solution, especially where the Indian operations are sizeable.
Exit by PE/VC funds – other considerations
Many PE/VC funds with an early vintage that have invested into India are in exit mode with respect to some of their initial investments. Some of the tax issues that get featured in exit discussions include:
Obligation to withhold tax
Extensive tax litigation in India has generally made investors wary when it comes to acquiring shares from non-residents who are entitled to treaty benefits. While a buyer may prefer the non-resident seller to seek a confirmation from the Indian tax authorities for the amount of tax to be deducted, or a ruling from the Authority for Advance Rulings, it may be a challenge given the time involved and other constraints. To achieve the twin objectives of concluding transactions and mitigating tax risks, the parties may agree on other modes of obtaining tax protection from any tax litigation, including furnishing of tax indemnities to be provided by the non-resident seller to the buyer. Indemnity caps, period and credit risk on the entity providing the indemnity are subject to negotiations.
This could be a challenge, where the life of the selling Fund is coming to an end, when tax insurance may be another option to explore.
Pending tax proceedings/demands
Buyers also tend to seek appropriate representations from the seller to the effect that there are no pending tax proceedings as, in certain situations, the sale could become void where there are pending tax proceedings against the seller.
For a seller, it is imperative to maintain up-to-date documentation in the form of a tax residency certificate and declaration in the Form 10F to make use of tax treaty relief.
The silver lining
While the above may paint a grim picture, there is a silver lining. India has witnessed historic results in the recently concluded general elections. A new government has been elected which is perceived by investors to be more business and investor friendly. Although tax uncertainties may have acted as a deterrent for foreign investors and fund managers, it is anticipated that the new government may change the tax narrative in India. India tax, hopefully then, will not be a matter of concern for asset managers.
Gautam is sector leader in asset management for PwC in India and leads the PwC financial services tax and regulatory team.
He has a varied experience of more than 28 years. Before joining PwC in September 2003, he had stints with two leading accounting and tax consultancy firms, which was followed by a long association with an independent practice founded by him. In the past few years, he has been focused on working with players in the financial services space with a particular emphasis on the asset management sector, and also in providing strategic tax inputs to large multinational as well as domestic Indian players.
Gautam is a regular speaker at seminars, both in India and overseas and a contributor to the media. He has been a member of the National Direct Tax Committee of The Confederation of Indian Industry (CII) and the American Chamber of Commerce and a member of the Expert Advisory Committee of the Institute of Chartered Accountants of India.
Gautam is a Chartered Accountant, has post-graduated in law and holds a degree in financial management.