Investing in India Foreign Institutional Investors

Investing in India Foreign Institutional Investors

Overview The Securities and Exchange Board of India (SEBI), established as a statutory body in 1992, regulates the Indian securities market. The board issues regulations pertaining to disclosure requirements for public companies and investor protection, as well as formulates regulations to govern various intermediaries such as brokers, portfolio managers, asset managers and merchant bankers. Further, it governs investments made by Foreign Institutional Investors (FIIs) in India. FIIs are also required to comply with the Indian exchange control regulations stipulated by the Reserve Bank of India (RBI), the central bank in India. FIIs are permitted to invest in the primary and secondary securities markets in India in accordance with the SEBI (Foreign Institutional Investors) Regulations, 1995 as amended from time to time the FII Regulation ). The term FII is defined as an institution/ fund/ company, etc., established or incorporated outside India for making investments in Indian securities. All non-resident entities (excluding Non-Resident Indians) looking to make portfolio investments as FIIs are required to register with SEBI and to comply with the provisions of the FII Regulations as prescribed by SEBI. FIIs may function either in their capacity as investors or in their capacity as, inter alia, fund managers (i.e., investing the funds of their clients to be registered as their sub-accounts ). FIIs/sub-accounts can invest in debt or equity without any restriction on investment allocations between debt and equity. SEBI occasionally prescribes overall monetary limits for aggregated FII investments in Indian debt securities. Accordingly, an FII proposing to invest in debt securities is required to check allocation limit through the established procedure. While there are no prescribed monetary limits for equity investments, FII investments in Indian equities are subject to a single investment limit of 10% and an aggregate limit (across all FIIs/subaccounts) of 24% in an Indian company. This aggregate limit may be increased to sectoral/statutory ceiling set by the Government of India for that industry if the concerned Indian company has passed a special General Body resolution to that effect. FIIs must designate a bank in India to route all their investment transactions in the country, as well as appoint a local custodian for their securities. They can open Rupee and foreign currency-denominated accounts with the designated banks and can, thus, invest in Indian securities. FIIs are also permitted to freely repatriate their capital after ensuring that appropriate Indian income tax is paid on income/ gains. As on 30 June 2012, more than 1,700 FIIs registered with SEBI.

Registration of FIIs/ sub-accounts FII regulations prescribe that foreign pension funds, mutual funds, investment trusts, insurance companies or reinsurance companies can invest in Indian securities as FIIs. In addition, asset management companies, investment managers or advisors, nominee companies, sovereign wealth funds, banks, institutional portfolio managers, university funds, charitable trusts or their power of attorney holders can invest in Indian securities as FIIs on behalf of clients who are eligible for sub account registration. Criteria for registration as an FII Application for registration must be made to SEBI in Form A, along with all the supporting documents. SEBI examines the following while registering an FII: Whether the FII is established/ incorporated outside India Whether the FII proposes to make investments on behalf of clients or proprietary funds Professional competence, financial soundness, experience, general reputation of fairness and integrity Track record based on one year s audited financial statements of the applicant; in case of new entities, SEBI may, at its discretion, consider promoters / managers track record Whether the FII is registered with an appropriate foreign regulatory authority Pending legal proceedings initiated by any statutory authority Whether the FII is a fit and proper person 1 What can be registered as a sub-account A broad-based fund 2 A proprietary sub-account A foreign corporate or a foreign individual 3 University fund, endowment, charitable trust or society eligible to be registered as an FII Criteria for registration of a sub-account SEBI would examine the following while registering a sub-account: Whether the FII through whom the application for registration is made holds a certificate of registration as an FII is authorized to invest on behalf of the sub-account has submitted the required undertakings on behalf of the subaccount Whether the sub-account is a fit and proper person 1 Criteria for determining a fit and proper person are laid down under the Schedule II of SEBI (Intermediaries) Regulations, 2004. For the purpose of determining as to whether an applicant is a fit and proper person, criteria such as financial integrity, competence, good reputation and character may be taken into consideration. 2 A broad-based fund means a fund that has at least 20 investors with no single investor holding more than 49%. If the broad-based fund has institutional investors, it shall not be necessary for the sub-account to have 20 investors. Further, if any institutional investor holds more than 49% of the shares/units of the broad-based sub-account, the above condition would be satisfied, if the institutional investor is itself broad based. 3 A Foreign Corporate is defined as a body corporate incorporated outside India whose securities are listed on a stock exchange outside India, has an asset base of not less than USD 2 billion and an average net profit of not less than USD 50 million during the three financial years preceding the date of the application. A Foreign Individual is defined as a foreigner who has a net worth of not less than USD 50 million, holds the passport of a foreign country for a period of at least five years preceding the date of application, holds a certificate of good standing from a bank and is the client of the FII or any other entity that belongs to the same group as the FII for at least three years preceding the date of the application

Taxation of FIIs Securities Transaction Tax ( STT ) STT is levied on transactions undertaken on recognized stock exchanges in specified securities 4. As per the Finance (No 2) Act, 2004, STT is collected by the stock exchange/mutual fund from the buyer/seller based on the value of securities transactions as follows: Taxable securities transaction STT rate (%) Purchase of equity shares of a company or units of an equity-oriented fund on a stock exchange (delivery based) Sale of equity shares of a company or units of an equityoriented fund on a stock exchange (delivery based) Sale of equity shares of a company or units of an equityoriented fund on a stock exchange (non-delivery based) Sale of option on a stock exchange Sale of option on a stock exchange, where option is exercised Sale of futures on a stock exchange Sale of units of an equity-oriented fund to the mutual fund Sale of unlisted equity shares under an offer for sale Income tax 0.1 Payable by the purchaser 0.1 Payable by the seller 0.025 Payable by the seller 0.017 0.125 0.017 On option premium payable by the seller On settlement amount payable by the purchaser On settlement price payable by seller 0.25 Payable by the seller 0.2 Payable by the seller FIIs are subject to income tax in India only on their India-sourced income. Income earned by FIIs can be broadly categorized into the following: Gains from the transfer of securities 5 Dividend income Interest income As per the Income-tax Act, 1961 (Act), in the case of transactions in specified securities 4 effected on a stock exchange in India and subject to levying of STT, FIIs/sub-accounts are to be taxed on their income at the following rates: Nature of income Rate of tax (%) Foreign companies 6 Non-corporate entities 7 Long-term capital gains Nil Nil Short-term capital gains (other than gains on derivative transaction) 15.759 15.45 Gains on exchange-traded derivatives 31.518 30.9 Dividends Nil Nil Interest 21.012 20.6 Other income 42.024 30.9 Gains, if any, in respect of off-market transactions (e.g. buyback, etc.) and securities such as bonds and debentures that are not subject to STT will be subject to tax at 30% 8 (for short-term gains) or 10% 8 (for long-term gains). The first-in-first-out method is adopted for calculating gains from the transfer of securities. The above tax rates are subject to tax treaty relief, as applicable. Interest paid to FIIs by domestic companies is subject to withholding tax. Tax, if any, on realized capital gains/other income earned by FIIs must be discharged by way of advance tax prior to repatriation of sale proceeds or before specified due dates, whichever is earlier. FIIs are required to file annual tax returns with the Indian Revenue authorities, reporting their Indian-sourced income to tax. Any excess tax paid is refunded by the Indian Revenue authorities. 4 Specified securities include equity shares, units of equity oriented mutual funds and certain exchange-traded derivatives. 5 See also Some tax issues for consideration 6 Including surcharge of 2% (for corporates having income in excess of Rs 10 million) plus an education cess of 3% on income tax and surcharge 7 Including education cess of 3% on income tax 8 Plus applicable surcharge and education cess

Requirement to obtain a Permanent Account Number (PAN) PAN is a unique tax identification number to be obtained by a legal entity. An FII/sub-account requires a PAN for opening its bank and securities account in India to invest in the domestic capital markets. To obtain a PAN, an FII/sub-account is required to fill an application with relevant authorities (i.e., PAN intermediaries), along with documents evidencing proof of identity and proof of address. The formation documents of a company/ trust indicating the name of the entity, the date of creation/ establishment and the registered address should be filed along with the PAN application. Some tax issues for consideration Indian tax laws have been drafted principally in the context of transactions typically undertaken by Indian companies or foreign companies having Indian operations. At times, therefore, they do not contain specific provisions to address certain types of transactions undertaken by foreign investors. We have listed below, for your information, a few tax issues that may need to be considered by FIIs in the absence of specific provisions in the Indian tax laws: Historically, FIIs have been offering their gains from the transfer of Indian securities to tax as capital gains. However, the characterization of such gains as capital gains/business profits has not been free from doubt. In this context, the Advance Ruling Authority has given contradictory rulings on the characterization of income earned by an FII from investment in India. A circular issued by the Central Board of Direct Taxes has clarified that the following three principles will, inter alia, determine whether the income earned by an investor is capital gains or business income: Whether the assets are held as stock-in-trade or capital assets The magnitude of transactions Whether the motive of the investor is to earn dividend or gains It would be pertinent to note that the circular is binding only on the Revenue Authorities and not on the taxpayer. The issue of characterization becomes more vexed in the context of certain short-term securities such as exchangetraded derivatives. FIIs undertake overseas reorganizations to avail certain advantages. Such reorganizations may be tax neutral in the home jurisdiction. However, in cases where such transactions involve the transfer of Indian securities, they could trigger Indian tax implications. Umbrella/Series funds constituted as corporate entities are required to file a consolidated tax return in India, reporting the income earned by all their sub-funds (i.e., after offsetting capital losses incurred by one sub-fund against capital gains earned by another sub-fund). This may not be in accordance with the practice followed by umbrella funds/ series funds in their home jurisdiction. In addition, positions taken on the manner in which capital gains earned by FIIs/sub-accounts are required to be computed and the rates of tax applicable to such gains could also result in some litigation with the Revenue Authorities. Proposed tax law changes As part of its tax reform initiatives, the Government of India has introduced the Direct Taxes Code (DTC) for revising, consolidating and simplifying the language and structure of direct tax laws. The Standing Committee formed included certain members of Parliament and has provided its comments on the DTC. A final draft of the bill is expected to be presented before the Parliament. The Government has also proposed anti-avoidance regulations and introduced taxation on indirect transfer of Indian shares. On being finalized, the impact of the above on FII investments would need to be reviewed.

How we can assist A proactive and structural industry specialization is the foundation of Ernst & Young s professional services. Our professionals have extensive experience in the industry and are capable of providing practical and innovative tax solutions. Ernst & Young has a one-to-one relationship with every client. We address queries and issues keeping in mind the unique needs of each client. We believe in adding value to work. Obtaining registration with SEBI An entity seeking registration as an FII is required to file an application in the prescribed form with SEBI. We assist our clients in evaluating whether they fulfill the eligibility criteria laid down by SEBI for registration as FIIs and steps to be undertaken for this. We also assist our clients in obtaining registration as FIIs/ sub-accounts with SEBI on a best efforts basis. Inbound investment advisory Tax implications are an important factor affecting investment decisions. Double taxation avoidance agreements between India and other countries have provided opportunities for tax planning through effective blending of tax treaties and domestic law. Depending on facts and circumstances, tax planning opportunities may be available to reduce/mitigate Indian tax on FII investments into Indian securities. We assist our clients in reviewing the tax implications of their investments in India. Where applicable, we assist our clients in identifying suitable jurisdictions for setting up funds for investment in India and also provide assistance in implementing the identified investment structure. We review the prospectuses to be issued by overseas funds to prospective investors for ensuring that the disclosures made therein are in conformity with the Indian income tax and regulatory provisions. In cases of fund reorganizations undertaken outside India (e.g., mergers, conversions, liquidations), we advise our clients of the Indian income tax implications. Constant changes in domestic and international tax laws create a need for updating and innovating tax strategies. Our experienced team can help you do that. Assistance with ongoing tax compliance FIIs are governed by special taxation provisions in India and are, ordinarily, required to discharge tax on gains from their Indian investments (please refer our discussions on page 4). Our experienced team can help you with the following: No FII/sub-account can open a dematerialized security account with its Indian custodian (and consequentially commence transacting in Indian securities) unless it has obtained a PAN from the Revenue Authorities. We can assist you with obtaining a PAN. Another important procedural aspect is the requirement for FIIs to discharge their tax liability prior to the repatriation of funds from India. Consequentially, the computation of FII capital gains tax liability is required on a periodic basis, the frequency of which is contingent on the frequency of sales affected by the FII and the remittances of monies outside India made by the FII. We have a specialized dedicated team working to accurately and expeditiously perform such computation and subsequently liaise with the custodian for depositing this tax liability into the government treasury to enable the repatriation of funds on a timely basis. As your tax advisor, our team undertakes all compliance work concerning Indian taxation such as assisting in filing of annual returns, computing and assisting in timely payment of advance tax and final taxes to avoid/reduce interest liability. In cases where the annual return of the FII is selected by the Indian Revenue Authorities for a scrutiny audit, we have the capability to assist you in making representations during such assessments.

01 Ernst & Young India is a dynamic professional services firm with a distinctive blend of skill sets, experience and expertise. We are one of the largest professional services firm in India with close to 7,500+ people working from our offices in New Delhi, Mumbai, Kolkata, Bangalore, Chennai, Hyderabad, Pune, Kochi and Ahmedabad. 02 Our professionals combine strong capabilities with industry-specific expertise, knowledge of fiscal laws and regulations, and in-depth understanding of technical issues. 03 Ernst & Young maintains a very high ethical code of conduct and has invested in a dedicated team of highranking professionals who constantly provide guidance on risk matters, which is critical to protect the interest of our clients. 04 Our focus on quality is impeccable, and we believe in setting new standards and benchmarks. The Asia-Pacific Independent Survey of Tax Advisers, 2011, conducted by Euromoney, International Tax Review, has rated Ernst & Young as Tier One Tax Advisory Firm in India for the sixth consecutive year, reaffirming our dominance in the Indian tax services arena. Key differentiators Ernst & Young India's Financial Services Group provides services to a diverse set of clients in the financial services industry, including regulatory authorities, leading Indian and multinational financial services companies, FIIs, mutual funds, large retail banks, international wholesale banks, investment banks, insurance companies, broking institutions, custodial service agencies and stock exchanges. Our areas of expertise include advisory and compliance work related to FIIs, venture capital and mutual funds, asset managers, banks, nonbanking finance companies, capital market intermediaries and insurance companies. We also specialize in providing tax advice on specific finance transactions including structured finance products, derivatives, stock lending transactions and securitization. Ernst & Young India FII services Ernst & Young India provides ongoing tax compliance and advisory services to FIIs out of our Mumbai office. We have set up specific systems and processes and put together dedicated teams of professionals who efficiently manage the ongoing tax compliance requirements of FIIs in India. Our FII client base has been multiplying over the years and boasts of a substantial market share of the total FII investment in India. We have a deep understanding of the global and Indian financial markets and are fully conversant with Indian regulations, reporting requirements and operating processes. Further, we have good working relationships with all the leading Indian custodians providing custody services to FIIs investing into India. Our team of experts has an in-depth knowledge of local laws, as well as practical experience with issues relating to FII investments into Indian. We have one of the largest teams in this area which provides proactive, efficient and timely advice to our clients. We have been servicing more than 600 FII/sub-account clients for well over a decade and have created a niche for ourselves in this industry.

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