Insight 9 April 2020

Sebi tweaks rules to stem outflow of foreign funds

With foreign funds liquidating their investments in India and taking flight due to the covid-19-related uncertainties, the Securities and Exchange Board of India (Sebi) has initiated measures to stem the outflow.

On Tuesday night, the regulator allowed countries or jurisdictions to approach it for Category-I registrations. The move comes as a big boost for the ₹4.37 trillion worth of portfolio investments that were made by Mauritius last year.

On Tuesday night, the regulator allowed countries or jurisdictions to approach it for Category-I registrations. Lack of this registration had saddled many Mauritius-based funds with higher tax liability, and forced many managers to restructure their funds. In some cases, they even considered shifting of jurisdictions.

Sebi amended the foreign portfolio investment (FPI) regulations, which said that funds “coming from any country specified by the central government by an order or by way of an agreement or treaty with other sovereign government" will also be eligible for Category-I registration.

This means that countries such as Mauritius and others, which are currently not part of the Financial Action Task Force (FATF) jurisdiction, or not compliant with FATF, can still obtain Category-I FPI licence.

The move comes as a big boost for the ₹4.37 trillion worth of portfolio investments that were made by Mauritius last year. Mauritius was the second-largest source of foreign portfolio investments in India after the US in 2019.

There was a fear that the bulk of this flow would dry up and, under the current market conditions, may even move to more tax-neutral jurisdictions.

In the current environment, addressing such ambiguities and challenges faced by offshore investors is a step in the right direction.”

Bhavin Shah Partner, PwC India

Around $15 billion of foreign money flowed out of Indian equity and debt in March—the highest ever outflow in a single month. The outflow was primarily from quant funds, hedge funds and risk parity funds.

The problem for these funds had started due to a budgetary provision, which levied indirect transfer provisions on Category-II FPIs. These include hedge funds, those routing their investments through Mauritius and other non-FATF-compliant countries.

Indirect transfers are those involving transfer of shares or interest in a foreign entity, and apply to funds that have deployed more than 50% of their portfolio investment in India. These can be taxed in India as they derive substantial value from Indian assets. Gains from such transactions attract capital gains tax of 10-40% depending on whether gains are short- or long-term.

While a majority of foreign funds were exempted from indirect transfer provisions in 2017, the Finance Bill of 2020 had removed exemptions for Category-II funds.

FATF norms, which have been set up to combat money laundering and terror financing, had also put Mauritius in the grey list in February.

Such steps will make it easier for funds to invest in India through Mauritius.”

Khushboo Chopra Head of Business Development - India

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FATF commends the tremendous progress made by Mauritius and advises to keep this momentum