Section 9A of the Income-tax Act, 1961 (“IT Act”) carves out a special taxation regime to exempt eligible offshore funds from being regarded as having a business presence in India and hence subject to taxation in India, despite their fund managers being located in India. If the offshore funds as well as the Indian fund managers satisfy the requirements set out in Section 9A of the IT Act, the fund management activity carried out through such fund managers shall not constitute the offshore fund’s ‘business connection’ in India. Further, section 9A excludes an eligible investment fund from being treated as resident in India for tax purposes, merely because the eligible fund manager undertakes fund management activities for the offshore funds while situated in India. Thus, section 9A helps mitigate adverse Indian tax consequences for offshore funds having their fund managers in India.
Section 9A prescribes several conditions for an offshore fund and its Indian fund managers to be eligible for exemption from taxable presence or residence in India. One of the conditions for an eligible fund manager to avail the above exemption is prescribed under section 9A(3)(m) of the IT Act, in relation to the remuneration of the fund manager. Earlier, Section 9A merely stipulated a subjective criterion, stating that the remuneration paid to the fund manager should be on an arms’ length basis. The Finance (No. 2) Act, 2019 had made this provision more objective and definite. It now stipulates that the remuneration paid by the fund to an eligible fund manager for undertaking fund management activity should meet a minimum threshold as calculated under section 9A. Pursuant to this change, the manner of calculating the minimum threshold has now been prescribed under Rule 10V of the Income-tax Rules, 1962 (“IT Rules”).
The Central Board of Direct Taxes (“CBDT”) has notified on May 27, 2020 (“the Notification”), the rules for computation of minimum management fees that eligible fund managers must receive from eligible offshore funds in order to avail the beneficial regime under section 9A of the IT Act. The CBDT had earlier published draft rules in this regard, in December 2019, which through a public consultation process, have been adopted into the IT Rules and made applicable with effect from May 27, 2020. In addition, the Notification also amends the reporting requirements applicable to eligible fund managers. We have discussed below the details of the Notification.
Minimum manager remuneration
The minimum management fees payable to eligible fund managers shall be computed as follows:
- Where the offshore fund is registered as a Category I Foreign Portfolio Investor (“FPI”) under Regulations 5(a)(i) to 5(a)(iv) of the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019 (“FPI Regulations”), the minimum management fee payable shall be 0.1% of the ‘assets under management’ (“AUM”). Category I FPIs under Regulations 5(a)(i) to 5(a)(iv) of the FPI Regulations include central banks, sovereign wealth funds, other Government related funds with at least 75% direct or indirect Government ownership, pension funds, university funds, banks, appropriately regulated entities such as investment advisors, portfolio managers, broker/ swap dealers, etc. In addition, entities from Financial Action Task Force (FATF) member countries, which are themselves appropriately regulated or whose investment managers are appropriately regulated Category I FPIs, or from other countries notified by the Central Government for this purpose, are also eligible to avail registration as Category I FPI.
- In case of all other types of eligible funds, the minimum management fee shall be:
- 3% of the AUM; or
- In case of profit-linked manager remuneration, 10% of profits derived by the fund in excess of the specified hurdle rate from the fund management activity undertaken by the fund manager; or
- In case of funds with multiple investment managers, 50% of the management fee, whether in the nature of fixed charge or linked to the income or profits derived by the fund from the management activity undertaken by the fund manager, paid by such fund in respect of the fund management activity undertaken by the fund manager as reduced by the amount incurred towards operational expenses, including distribution expenses.
For this purpose, AUM has been defined as the annual average of the monthly average of the opening and closing balances of the value of such part of the fund, which is managed by the fund manager.
The Notification also provides for a mechanism for approval from the CBDT where the management fee paid to the eligible fund manager is lower than the thresholds stipulated above. In such a scenario, the offshore fund may seek approval for a lower amount of remuneration from the relevant authority of the CBDT.
Replacement of the subjective criterion of remuneration from an arms’ length basis to specific thresholds is a welcome move and will go a long way in reducing litigation and uncertainty.
With the change in the language in respect of minimum remuneration in section 9A Rules 10V(5) to 10V(10) of the IT Rules, which applied to the determination of arm’s length remuneration under the erstwhile provisions will not apply with effect from April 1, 2019 (i.e., with effect from assessment year 2020-2021). The Notification now prescribes a single report in Form 3CEJA, to be duly verified by an accountant, in relation to information and record-keeping by the eligible fund manager. Alongside Form 3CEJA, the annexure requires the eligible fund manager to submit documents, including details of eligible investment funds for whom the eligible fund manager has undertaken fund management activity, particulars of remuneration received in respect of each eligible investment fund and each activity undertaken, and particulars of any other transaction undertaken by the fund manager with/on behalf of the eligible investment fund. The amended rules no longer deem the eligible fund manager and the eligible offshore fund to be related parties for the purposes of the Indian transfer pricing regulations. Accordingly, the reduced compliance requirements will have a positive effect on the administrative burden and costs of the eligible fund manager, where these entities are not related parties. However, such report will have to be filed in addition to other transfer pricing compliances, where the eligible fund manager and the eligible fund are related parties under the transfer pricing regulations.
The above changes are a welcome move and are intended to provide an impetus to the Indian fund management activities. The minimum manager remuneration prescribed seems to be consistent with customary market practices, and it should be feasible for funds to meet the threshold management fee. Thus, the earlier lack of clarity and uncertainty on minimum manager remuneration have been eliminated and the compliance burden for eligible fund managers in terms of transfer pricing audits and record maintenance has been reduced to a significant extent, through these changes in the Rules. The safe harbour regime has been made more accessible to global fund groups looking to structure their operations through Indian managers.