Global interest in the LP (Limited Partner) ecosystem, for investments in India focused businesses, is at an all-time high. According to recent surveys, about 108 India focused private equity firms are in the market looking to raise funds. The first half of the year 2018 has been characterized by large value deals as pension funds, sovereign funds and global buyout funds have increased their India exposure (Source: Economic Times).
The positive regulatory changes have influenced the investor preference for pooling of funds both on-shore and off-shore for investing in India focused businesses. Some of the significant statutory/legislative revisions/clarifications, brought in over the last couple of years, are as follows:-
- Liberalization of foreign direct investment (FDI) in the home-grown alternative investment funds (AIFs) sector in 2015, which now allows 100% investment in AIFs through the automatic route, as opposed to the prior FIPB approval requirement.
- Down-stream investments by AIFs with FDI is now deemed as foreign investment, only if neither the sponsor nor the manager nor the investment manager is Indian ‘owned and controlled’. This has led to an opening up of choices for many FDI taking AIFs and have also taken away the mandatory obligation of complying with the pricing guidelines for any downstream investment.
- Clarification issued by the Central Board of Direct Taxes (CBDT) that dividend distribution by off-shore companies with respect to underlying Indian assets would not result in a tax liability since it does not result in indirect transfer of shares.
- Clarification brought in through the Finance Act, 2017, that indirect transfer tax provisions would not be applicable for capital assets held directly or indirectly by way of investment in Category I or Category II FPIs.
- Opening up of FDI in limited liability partnerships LLPs and taking away minimum capitalization requirements for investment advisory businesses in March 2017.
[Source: RBI Notifications, CBDT Circular No. 4/2015 and the Paragraph 4 of the Finance Act, 2017]
These changes have led us to consider and advise on various unified as well as co-investment fund structures. Each such structure requires evaluation from compliance and taxation perspective. A very high level overview of some of these structures are given below:-
Direct Investment by an Off-Shore Fund. Also known as a pure off-shore structure, this where an off-shore investment pooling vehicle can pool and directly invest into India portfolio companies, as FDI, FPI or FVCI investment. Few things to be kept in mind for this structure would be:-
- Spread of LP appetite for India/non-India focused investment;
- Permanent establishment connotation if the off-shore investment manager is being advised by an Indian investment advisor;
- Advantage of not having to mirror every investment decision of Indian investment manager.
Indirect Investment through a Unified or Master-Feeder Structure. The on-shore fund pools investments from Indian investors and the off-shore fund pools investments from global investors and the off-shore fund becomes one of the investors of the on-shore fund, by executing a contribution agreement. Advantages could be as follows:-
- Indian investors can overcome liberalized remittance scheme (LRS) or overseas direct investment (ODI) or round tripping related restrictions;
- For global investors, it is easy to invest through an off-shore structure as that helps in operational ease of not having to obtain PAN registration for each investor, not having to report each individual investment with RBI;
- Global investors still get to benefit from the various Direct Tax Avoidance Agreements (DTAA). For example, continued tax benefits for sale of debentures, lower withholding tax rate of 7.5% for interest income, as available to Mauritius investors under the India-Mauritius DTAA.
- The investment manager gets to pay on the management fee and carry allocation on the entire fund at the on-shore level.
Co-Investment Structure. This is where, typically, the investment management of the on-shore and the off-shore funds are handled by different entities, in the respective jurisdictions. Advantages would be as follows:-
- The off-shore fund need not necessarily participate in every investment made by the on-shore AIF.
- The investment spread between the 2 entities could be decided on a case to case basis, depending on availability of funds.
Taxation from an ‘Association of Persons’ perspective, in India, needs to be carefully thought through while adopting this structure and it is suggested to have completely separated investment committees and managements from this aspect.
Disclaimer: Fund structuring is complex matter that requires a case to case evaluation of investor-base, investor jurisdiction spread, taxation at each investor level, demonstration of level of substance and permanent establishment. The purpose of this article is to disseminate information only and readers are requested to seek profession advice shall for any individual requirement.