A special taxation regime, provided under Section 9A of the Income-tax Act, 1961 (“IT Act”), exempts eligible offshore funds, with their fund managers located in India, from treating them as having taxable business presence in India. On satisfaction of the requirements set out in Section 9A of the IT Act, management of the funds through such Indian fund managers would not constitute the offshore fund’s ‘business connection’ in India. It is important to note that when an offshore fund, satisfying these conditions is not taxable in India on its business income under the domestic law, then the question of it not having permanent establishment under the applicable double taxation avoidance agreement (“DTAA”) becomes moot. Additionally, Section 9A also excludes an eligible investment fund from being treated as resident in India for tax purposes under the provision of ‘Place of Effective Management’ when the eligible fund manager undertakes fund management activities while situated in India.
Several conditions are prescribed under Section 9A for an offshore fund and its Indian fund managers to be eligible for exemptions stated above. An investment fund will qualify for the benefits provided under this Section if it meets the following criteria:
a. the fund is not a person resident in India;
b. the fund is a resident of a country or a specified territory with which India has entered into a Double Taxation Avoidance Agreement or if such country is notified by the Government in this context;
c. the aggregate participation or investment in the fund, directly or indirectly, by persons resident in India does not exceed 5% of the corpus of the fund (subject to some relaxations):
d. the fund and its activities are subject to applicable investor protection regulations in the country or specified territory where it is established or incorporated or is a resident;
e. the fund has a minimum of 25 members who are, directly or indirectly, not connected persons;
f. any member of the fund along with connected persons shall not have any participation interest, directly or indirectly, in the fund exceeding 10%;
g. the aggregate participation interest, directly or indirectly, of 10 or less members along with their connected persons in the fund, shall be less than 50%;
h. the fund shall not invest more than 20% of its corpus in any entity;
i. the fund shall not make any investment in its associate entity;
g. the monthly average of the corpus of the fund shall not be less than INR 100 crore (subject to some relaxations):
h. the fund shall not carry on or control and manage, directly or indirectly, any business in India;
i. the fund is neither engaged in any activity which constitutes a business connection in India nor has any person acting on its behalf whose activities constitute a business connection in India other than the activities undertaken by the eligible fund manager on its behalf; and
j. the remuneration paid by the fund to an eligible fund manager in respect of fund management activity undertaken by him on its behalf is not less than the amount calculated in such manner as may be prescribed.
As per the proviso to Section 9A, the specific conditions contained in clauses (e) to (g) above would not be applicable to an investment fund set up by the Government or the Central Bank of a country other than India, a sovereign fund, or any fund which the Indian Government may notify in this regard. It is pertinent to note that this exemption was also available to Foreign Portfolio Investors (“FPIs”) which were registered as Category I FPIs or Category II FPIs under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 (“2014 Regulations”). However, the 2014 Regulations were amended and replaced by the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019 (“2019 Regulations”) in September 2019. In view of this, there was lack of clarity on the applicability of the above exemption to FPIs falling in Category I under the 2019 Regulations and those FPIs which did not fall within Category I under the 2019 Regulations. The recent notification of the Central Board of Direct Taxes (“CBDT”) clarifies this.
Recently, the CBDT issued a notification which clarified that funds which are set up by Category I Foreign Portfolio Investor (“FPI”) registered under the 2019 Regulations are eligible to be exempt from the above conditions (e) to (g) under Section 9A and that this exemption is deemed to be in force from September 23, 2019, i.e. the date when the 2019 Regulations were notified.
This notification puts to rest the uncertainty faced by Category I FPIs under the 2019 Regulations. However, FPIs which were registered as Category II FPIs under the 2014 Regulations and do not satisfy the conditions for Category I registration under the 2019 Regulations will not be exempt from these conditions under Section 9A.