On September 23, 2019, the Securities and EXCHANGE Board of India (“SEBI”) notified the SEBI (Foreign Portfolio Investors) Regulations, 2019 (“New FPI Regulations”), overhauling the erstwhile SEBI (Foreign Portfolio Investors) Regulations, 2014 (“Erstwhile FPI Regulations”). Under the New FPI Regulations, SEBI recategorised FPIs in to two categories (as against the three categories under the Erstwhile FPI Regulations), based on their regulatory status and jurisdiction of residence. Under the New FPI Regulations, Category I FPIs include sovereign wealth funds, pension funds, appropriately regulated entities, certain endowments and other entities from the Financial Action Task Force (FATF) member countries, which are appropriately regulated funds or unregulated funds whose investment manager is appropriately regulated and registered as Category I FPI or is owned to the extent of at least 75% by certain Category I FPIs. Category II FPIs include entities that do not qualify for Category I status under the New FPI Regulations. Further, on account of the overhauling and recategorisation under the New FPI Regulations, those Category II FPIs under the Erstwhile FPI Regulations, which did not qualify to be recategorised as Category I FPIs under the New FPI Regulations got recategorised as Category II FPIs under the New FPI Regulations, along with Category III FPIs under the Erstwhile FPI Regulations. Hence, with one stroke of the pen, Mauritius based FPIs became disentitled for Category I status as Mauritius is not an FATF member.
For the uninitiated, the FATF is the global money laundering and terrorist financing watchdog and has 37 countries as its members. The inter-governmental body sets international standards that aim to prevent these illegal activities and more than 200 jurisdictions have committed to implementing the FATF Recommendations through the strong global network of FATF-Style Regional Bodies (FSRBs) and FATF memberships. There are multiple criteria that are applied before considering a country as a potential candidate for FATF membership, including strategic importance test, quantitative indicators (e.g. size of the GDP of the applicant country), qualitative indicators (e.g. impact on the global financial system, including the degree of openness of the financial sector and its interaction with international markets) and other considerations (e.g. participation in other relevant international organisations). Thus, to become a full member of FATF is a privilege conferred on the few that meet all the above qualifiers. Mauritius, as it is widely assumed, may not be able to meet the GDP quantitative criteria, thereby may not satisfy the Category I eligibility threshold under the New FPI Regulations.
Hence, with the advent of the New FPI Regulations, the Category II FPIs based in Mauritius, Cayman Islands, Cyprus, Taiwan, United Arab Emirates and other non-FATF member countries were gobsmacked. In comparison to their peers based in FATF member countries (such as Singapore, Luxembourg, USA and others), these FPIs suddenly faced a retroactive change in regulatory regime, whereby they could no longer enjoy the benefits that they enjoyed as Category II FPIs under the Erstwhile FPI Regulations since these benefits would now only be available to Category I FPIs under the New FPI Regulations.
Benefits available to Category I FPI under the New FPI Regulations
Regulatory advantages: Under the New FPI Regulations, only Category I FPIs are eligible to deal in, issue or subscribe to offshore derivative instruments or Participatory Note (“p-notes”), subject to certain restrictions. Further, Category I FPIs from low risk jurisdictions are subject to slightly relaxed KYC norms. Category I FPIs are eligible for qualified institutional investor allocation in initial public offerings by Indian companies. Also, with respect to trades, Category I FPIs are entitled to post margin money on T+1 basis.
From a tax perspective, the tremors of Vodafone tax (i.e. “indirect transfer” tax regime) were felt in the FPI universe as well. To provide context, if there is a transfer of shares of offshore entity / entities at offshore levels in a tiered FPI fund structure, then subject to triggering the thresholds of value and percentage shareholding, India deems the share or interest in the offshore entity (including FPI) to be situated in India and hence such Non Resident-to-Non Resident transaction to result in capital gains arising in India, subject to tax in India. To assuage the worries of FPIs, the Income-tax Act exempted Category I and Category II FPIs under Erstwhile FPI Regulations from the rigours of indirect transfer tax regime. The Finance Act 2020 (which received Presidential assent in end-March 2020) aligned the Income-tax Act with the New FPI Regulations and extended the exemption from indirect tax transfer to Category I FPIs. Thus, from a tax perspective, Category II FPIs under the Erstwhile FPI Regulations, which could not be recategorised as Category I FPIs under the New FPI Regulations lost this exemption.
Recent amendments that add a new lease of life to Mauritius FPI fund structures
Considering that Mauritius alone accounts for 13% of assets under management of all FPIs investing in India, industry and advocacy efforts were expected on account of the regulatory and tax fallout of the New FPI Regulations. Perhaps, in continuation of the dialogue with the industry, co-regulators of other countries and commitment of the Government of India to make India an attractive investment destination, SEBI amended the New FPI Regulations on April 7, 2020, and introduced Central Government’s power to notify certain non-FATF member countries as eligible jurisdictions for seeking registration as Category I FPIs.
Soon thereafter, on April 13, 2020, the Government of India’s Department of Economic Affairs (“DEA”) notified Mauritius as an eligible jurisdiction for seeking registration as Category I FPI, thereby removing the stigma and restoring the regulatory and tax benefits for Mauritius-based FPIs. This development stems once again from the long-standing socio-economic-political ties that India shares with Mauritius. It would be pertinent to note that Mauritius is one of the few countries with which India has had a tax treaty and trade relation since the pre-independence era.
With Mauritius’ status getting restored, it is expected that the designated depository participants (“DDPs”) would recategorise eligible Mauritius based FPIs from Category II to Category I under the New FPI Regulations. However, neither the DEA order nor the April 7 amendment to New FPI Regulations confer the recategorisation retroactively. Hence, recategorised Mauritius based FPIs may be precluded from claiming Category I status for the period between New FPI Regulations coming into effect (viz. September 23, 2019) and this DEA order. Hence, to this extent, the Mauritius based FPIs will remain exposed to the adverse tax implications for trades made during the period between September 23, 2019, and recategorisation as Category I FPIs. A clarification in this regard by the CBDT would go a long way in achieving the desired result and restoring the position of Mauritius FPIs fully.
The DEA order, amidst the COVID-19 lockdown and the weak markets, sends a positive signal to the foreign investor community and will help managers to position Mauritius as a jurisdiction of choice to investors for setting up fund vehicles. However, this conversation for the managers is not yet an easy one, as Mauritius has yet to exorcise the FATF grey list ghost. In mid Feb 2020, Mauritius was named in FATF’s grey list being the list of jurisdictions with strategic deficiencies in their regimes to counter money laundering, terrorist financing, and proliferation financing. Hence, the ball now squarely lies in Mauritius’ court to ensure it puts its house in order to get itself removed from the grey list and send an emphatic message to global investors of its permanent seat in the league of preferred fund jurisdictions.