It is an unprecedented move that is likely to open the flood gates for infusion of fresh funds by foreigners into India’s stock market. One of India’s leading asset management companies (AMCs)—HDFC AMC has secured approval to start six feeder funds in GIFT City (IFSC) that will in turn invest in its domestic mutual fund (MF) schemes. The feeder funds will be structured as Category III AIFs, or alternative investment funds.
Zero tax in India
Funds located in GIFT City that buy and sell MF units in India are not subject to capital gains taxation in India. This, though, does not hold true for stocks: the same feeder funds will be subjected to short-term capital gains of 15% or long term capital gains of 10% depending on their holding period for the stocks they have sold. Since category III AIFs are taxed at the scheme level, unlike category I and II AIFs which are pass-through vehicles for tax purposes, the investors in GIFT City will also not pay any tax at the time of redemption. The six AIFs will have a daily net asset value denominated in US dollars and will be available for purchase and redemption on a daily basis.
Currently, foreign citizens wishing to invest in India must register as foreign portfolio investors, or FPIs, in India which is a cumbersome process. By contrast, GIFT City funds will have a simple KYC (know your customer) format. The investors in these funds will not be mandated to open bank accounts in GIFT City. After KYC and registering with the fund administrator, they can directly remit money from their foreign bank accounts. The move could also be beneficial to non-resident Indians (NRIs). As of now, NRIs wishing to invest in the country must open either an NRO or NRE account. They must then invest money through either the Portfolio Investment Scheme (PIS) or non-PIS route for direct stocks, both of which have different types of restrictions. In case of mutual fund investment, only a few funds in India are open to NRIs based in the USA and Canada. NRIs are also subject to tax deduction at source, or TDS, on their capital gains in Indian mutual funds. However if NRIs invest through these GIFT city funds, there will be no TDS on capital gains. Since the AIFs will invest only in growth plans of mutual fund schemes, their only income will be capital gains and hence free of tax. There is also no requirement of the Permanent Account Number (PAN) for investors in feeder funds, but investors who do have a PAN will have to disclose the same.
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What’s the catch?
GIFT City AIFs have a minimum ticket size of $150,000 and hence this means that only wealthy foreigners or NRIs will be able to invest through them. Also, the funds cannot be marketed in foreign jurisdictions without registering with foreign regulators. According to a person with knowledge of the matter who did not wish to be identified, HDFC AMC has applied for registration with the US SEC in order to make these funds available to qualified investors in that country. However, investors who come into the funds on their own (without marketing from the AMC) are free to do so. Note also that end-investors in these feeders funds may be liable to tax in their home jurisdiction.