India: Tax incentives set to attract global investors

The Government of India introduced various amendments earlier this year vide Finance Act, 2021 in the domestic tax laws in order to further incentivize the financial services sector. The amendments include making the International Financial Services Centre (IFSC) located in Gujarat (GIFT City) more attractive for the fund industry and aircraft leasing business. Also, there are relaxations of certain conditions for sovereign wealth funds (SWFs) and pension funds (PFs) to ensure long-term stable capital participation.

Setting up a Category-III Alternative Investment Fund (‘AIF’) in IFSC

With a vision to make India a hub for international financial activities, the Government of India had established GIFT City, a global financial and IT services hub, as India’s first IFSC in 2015. GIFT City caters to India’s large financial services potential by offering global firms world-class infrastructure and facilities and aims to bring back those financial services that are currently carried on outside India.

Category III AIFs are not granted pass-through status under the Indian domestic tax law, consequently, taxability could arise in the hands of the AIF. Recently, the tax laws were amended to provide tax exemption from inter-alia the following incomes in the hands of Category-III AIF which are set-up in IFSC, subject to the condition that all units of Category III AIF are held by non-residents (other than units held by its sponsor or manager):

• any income accrued or arisen to, or received by a Category III AIF in IFSC from transfer of specified securities (other than shares in a company resident in India)
• Income from securities issued by a non-resident (not being a permanent establishment of a non-resident in India) and where such income otherwise does not accrue or arise in India
• Income from a securitization trust, which is chargeable to tax business income

The domestic tax laws also provide other tax incentives to units located in an IFSC, including reduced minimum alternate tax, concessional WHT on interest income, tax holidays etc.

Relocation of offshore funds to IFSC

Prior to the amendment, any relocation by an offshore fund to IFSC was subject to tax in India. Also, if offshore funds relocate to India, such offshore funds would lose the tax exemption (i.e. grandfathering provisions) provided under the tax treaties for any incremental gains on subsequent sale.

The Government of India has introduced a tax neutral relocation of foreign funds to IFSC. The amendment makes relocation from another country to IFSC tax neutral, i.e. the transfer of capital asset by an “original fund” (from a tax treaty jurisdiction) to a “resultant fund” in IFSC in “relocation” will be exempt from tax, subject to certain conditions.

A tax exemption has also been provided from capital gains tax on transfer by a shareholder/ unit holder, in a relocation, of capital asset being share/unit held by him in the original fund in consideration for shares/units in the resultant fund.

Further, and more importantly, it has been proposed that the resultant fund in IFSC will continue to get capital gains exemption, otherwise available under the respective tax treaty for the original fund in respect of subsequent transfer of shares of an Indian company.

Aircraft leasing in IFSC

With a view to develop a self-reliant aviation industry and to enter into aircraft financing and leasing activities from Indian shores, the Government of India has provided tax exemption to offshore aircraft lessors.

Currently, aircraft leasing is being undertaken by original equipment manufacturers (OEM)/ aircraft lessors from jurisdictions such as Ireland. Income earned by such OEM / aircraft lessors from Indian lessees are not being subject to tax by placing reliance on tax treaties.

The amendment exempts royalty and interest income from aircraft¹ leasing earned by a non-resident from unit in IFSC (subject to certain conditions). Additionally, a deduction is provided in respect of gains arising on the transfer of an aircraft by an IFSC unit, engaged in aircraft leasing, to a person. This amendment should motivate non-resident lessors to lease aircrafts in India through IFSC units, thereby reducing reliance on tax treaties and reducing tax litigation.

ADIA, sovereign wealth and pension funds

Prior to the amendment vide Finance Act, 2021, income earned by Abu Dhabi Investment Authority (ADIA) or SWFs or PFs on investment made by them, were subject to tax exemption on fulfilment of certain conditions.

One of the conditions was that investment should be made in a company or enterprise carrying on the business of developing, or operating and maintaining, or developing, operating and maintaining any infrastructure facility. The benefit of the exemption is also allowed if ADIA/SWFs/PFs made investment through Infrastructure Investment Trust (InvITs), Real Estate Investment Trust (REITs) and AIFs. In the case of AIFs, the exemption is allowed to ADIA/SWFs/PFs, if their investment has been made through Category I/II AIFs that have 100% investment into entities engaged in “infrastructure facility” as defined under the Indian domestic laws.

Additionally, in order to claim the tax exemption, SWFs and PFs were not allowed to undertake any commercial activity whether within or outside India.

The Government of India has earlier this year rationalized certain conditions for such funds to make further investments in India. The proposed key amendments are as follows:

• Tax exemption for ADIA/SWFs/PFs extended to:
  • Investments made into a domestic holding company set up and registered after 1 April 2021 which in turn will have a minimum 75% investment in infrastructure entities;
  • Investments in NBFC-Infrastructure Debt Fund/infrastructure finance company (NBFC IDF / IFC) provided it should have minimum 90% lending to infrastructure entities; and
  • Investment in Category I/II AIF with minimum 50% (earlier 100%) investment in aforementioned domestic holding company or NBFC-IDF/IFC or in specified infrastructure entities or InvIT;
• Condition for not undertaking commercial activity is replaced by non-participation in day-to-day operations of investee entities;
• Exemption is not available, if investments in India are made out of direct or indirect loans and borrowings. Loans and borrowings are specifically defined; and
• Earlier, a PF could take benefit of the tax exemption, inter alia, if it is not liable to tax in its home jurisdiction. It has now been clarified that PFs who may be “liable to tax” but entitled to exemption in their home country are also eligible for tax exemption on qualifying investments.

The relaxations introduced by the Government of India will provide the desired impetus to SWFs / PFs to invest in India.

¹ Aircraft is defined to mean aircraft, helicopter or an engine or part thereof.

If you wish to discuss these topics, please contact: Dhruva Advisors, India.

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