India has experienced a significant outflow of funds in recent times coupled with a weakening currency. However, given its strong fundamentals and growth forecasts, the country continues to remain an attractive destination for foreign investors in the medium to long term. Indian regulations currently allow global investors to invest in India via a number of different routes namely Foreign Direct Investment, Foreign Portfolio Investment, Foreign Venture Capital Investment, and Alternative Investment Fund, etc. Depending upon the modalities of investment and other factors, one of the most preferred routes is Foreign Portfolio Investment (FPI).
Q1. What is Foreign Portfolio Investment?
Ans: FPI is an investment by non-residents in Indian securities including shares, government bonds, corporate bonds, convertible securities, units of business trusts, etc. The class of investors who make an investment in these securities is known as Foreign Portfolio Investors.
Q2. What are the major laws/regulations applicable to an FPI in India?
Ans: FPIs are primarily governed by The Securities and Exchange Board of India (SEBI). SEBI has recently introduced the SEBI (Foreign Portfolio Investors) Regulations, 2019, repealing the erstwhile 2014 Regulations. Further, FPIs are also required to comply with the Foreign Exchange Management Act, 1999 and the Income-tax Act, 1961.
Q3. What are the types/categories of FPI?
Ans: An applicant can obtain FPI license under SEBI regulations, in one of the two categories mentioned below:
(a) “Category I FPI” which mainly include:
- Government and Government related investors;
- Pension funds and university funds;
- Appropriately regulated entities such as asset management companies, banks, investment managers, investment advisors, portfolio managers;
- Eligible entities from the Financial Action Task Force (FATF) member countries;
(b) “Category II FPI” which include all investors not eligible under Category I such as:
- appropriately regulated funds not eligible as Category-I foreign portfolio investor;
- endowments and foundations;
- charitable organizations;
- corporate bodies;
- family offices;
- Unregulated funds in the form of limited partnership and trusts.
Q4. What are the advantages of being registered as a Category I FPI as opposed to Category II?
Ans: The main advantages of category I am as under:
(a) eligibility to issue Offshore Derivative Instruments (ODIs);
(b) ease of compliance of certain know your client (KYC) norms as compared to Category II FPIs; and
(c) enhanced position limits in case of stock and currency derivatives.
Apart from the above, Category I FPIs are exempted from the applicability of “Indirect Transfer” provisions under the Indian Income-tax Act, which are otherwise applicable to an overseas investor upon transfer of shares/interest in an overseas entity with assets in India.
Q5. What are the relevant operational aspects of an FPI?
Ans: The following are the relevant operational aspects:
1. Appoint a legal representative:
Appoint a legal representative in India to assist in obtaining an FPI license under SEBI regulations which includes making an application in the prescribed format and complete necessary documentation. The role of legal representative can be played by any financial institution authorized by the Reserve Bank of India. Even reputed law firms can assist in the process.
2. Appoint a Tax advisor:
A tax advisor will help comply with all tax obligations that will arise from the activities of an FPI in India. This will include maintaining records, issuance of certificates for repatriation of funds out of India, annual tax compliances, and representation before tax authorities.
3. Appoint a Domestic Custodian
Appoint a domestic custodian (before making any investments in India) for custodial services (including banking & Demat operations) in respect of securities. Domestic Custodian means any entity registered with SEBI to carry on the activity of providing custodial services in respect of securities.
Q6. What are the compliances applicable to an FPI under the Income Tax Act, 1961?
Ans: Since FPIs invest in securities such as shares, bonds, debentures, units of business trust, etc., they earn income in the nature of dividend, interest, and capital gains. FPIs would also need to remit such incomes (along with capital investment) out of India at regular intervals.
As a pre-condition to remittance of funds, the applicable income tax on such income needs to be deposited with the government treasury. The taxes are deposited either in the form of withholding taxes or payment of taxes in a self-assess mode or a combination of both depending upon the nature of income. The custodian/banker would also require a certificate from a professional tax advisor prior to remitting the funds.
Moreover, after the end of the financial year (April 1st to March 31st in India), the FPI is required to file an annual tax return (in electronic mode). If the tax authorities wish to scrutinize the tax return in detail, it would require representation before them.
Burning Issues faced by FPIs under the present tax regime
- FPIs structured as non-corporates are subject to a higher rate of a surcharge prescribed on income from capital gains. This has led to many FPIs considering a conversion from a non-corporate to a corporate structure. This conversion could potentially attract General Anti Avoidance Rules (GAAR) under the Indian tax laws.
- FPIs having fund managers located in India having potential exposure to establishing a business connection in India, upon not satisfying certain prescribed conditions.
Areas where InCorp can assist FPIs in meeting taxation and other obligations:
Incorp has a dedicated team of professionals with expertise in catering to FPIs. Incorp can assist by providing the following services:
- Assistance in advising and structuring under the FPI route.
- Assistance in Setting up the structure under the FPI route.
- Coordination with the custodian for obtaining information on periodic transactions and maintaining necessary records of the same.
- Computation of tax liability in respect of income earned on securities considering provisions of the Indian Income Tax Act and the Treaty (i.e. Double Taxation Avoidance Agreement) along with the applicability of Multi-Lateral Instrument.
- Issuance of certificate for repatriation of funds out of India as per the requirements of the Income-tax Act and RBI guidelines.
- Preparing and filing of Annual Income Tax Return.
- Replying and attending to notices/letters issued by the tax authorities and advising thereon.
- Appearing before the tax authorities in the course of any proceedings and reviewing assessment orders passed by them.
- General correspondence with the tax authorities.