Gujarat International Fin-Tec City (“GIFT City”) is being developed as a global financial and IT Services hub on the lines of globally benchmarked financial centres. It includes a Special Economic Zone having the status of an International Finance Services Centre (“IFSC”). The IFSC is set up to undertake financial services transactions that are currently carried out outside India by overseas financial institutions and overseas branches/ subsidiaries of Indian financial institutions.
As part of the overall regulatory endeavor to facilitate growth of financial services intermediaries in IFSC, remarkable regulatory reforms have been introduced in the regulatory regime governing funds in IFSC. As a result, IFSC is fast emerging as an attractive alternative to globally renowned funds jurisdictions, such as Singapore, Mauritius etc.
Fig 1: Funds in IFSC
The following ‘Frequently Asked Questions’ or FAQ provide insights on the key regulatory and structuring considerations relevant to setting up and operations of funds in IFSC.
B. FAQ on Regulatory and Structuring Considerations
1. What is an IFSC?
The Central Government has created a framework for setting up of an IFSC under the Special Economic Zones Act, 2005. IFSC has been envisioned as an area for financial service providers to offer financial services / products to customers in foreign currencies (i.e. non-INR currencies).
‘Units’ and entities in an IFSC are treated as ‘persons resident outside India’ for the purposes of the exchange control laws of India.
GIFT City is being developed in Gandhinagar, Gujarat as a global financial and IT services hub to rival globally benchmarked financial centres. It is India’s only approved IFSC, having been demarcated as a Special Economic Zone (“SEZ”). This special status of IFSC makes it an attractive jurisdiction for pooling and managing global capital.
2. Is it possible to set up Alternative Investment Funds in IFSC?
Yes, all three categories of Alternative Investment Funds (“AIFs”) (viz Category I, Category II and Category III) can be set up in an IFSC, including fund of funds.
Further, AIFs in IFSC are governed by the terms of SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”). However, special dispensations have been granted to AIFs in IFSCs to equip them with higher operational flexibility while maintaining tax efficiency. Please refer to Query  below for details of tax benefits of setting up funds in IFSC.
3. Whether conditions related to minimum fund size, minimum commitment size, sponsor commitment etc. have been prescribed for GIFT AIFs?
The Operating Guidelines for Alternative Investment Funds in International Financial Services Centres issued by the Securities and Exchange Board of India (“SEBI”) vide its circular dated November 26, 2018 (“Operating Guidelines”), provide for the following conditions that are applicable for AIFs in IFSC:
(i) minimum scheme size of at least USD 3 million;
(ii) a continuing, minimum sponsor commitment of the lower of: (a) USD 0.75 million or 2.5% of the corpus of the fund for Category I and II AIFs; and (b) USD 1.5 million or 5% of the corpus of the fund for Category III AIFs; and
(iii) minimum investment (a) by investors – USD 150 thousand; and (b) by employees/directors of manager of the AIF -USD 40 thousand.
4. Whether the regulatory regime prescribed by SEBI for setting up of AIFs also governs AIFs incorporated in GIFT City?
SEBI, the capital markets regulator in India, which regulates AIF structures in India has issued specific guidelines and regulations for setting up of AIFs in GIFT City. The SEBI (IFSC) Guidelines, 2015 read with the Operating Guidelines, and the Foreign Exchange Management (IFSC) Regulations, 2015 are the primary sources of regulation for AIFs in an IFSC. For operating as an AIF, a fund is required to procure registration from the IFSC Authority (as set up under the IFSC Authority Act, 2019).
Additionally, all extant SEBI regulations applicable to non-IFSC AIFs, unless specifically dispensed for IFSC AIFs, are also applicable to IFSC AIFs. Please refer to Query  below for details of tax benefits of setting up funds in IFSC.
5. Whether fund managers are required to set up a presence in IFSC? What options are available for fund managers in this regard?
Fund management entities of IFSC AIFs may be set up either as a branch of an existing entity or as a new entity in the IFSC. Notably, the option of setting up a branch office is available only to existing fund managers. First time managers desirous of raising a fund in an IFSC must first incorporate an entity in that IFSC, which would be responsible for management of that AIF in IFSC.
The process of setting up of a new company or LLP in GIFT City would be subject to Regulation 7 of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (“ODI Regulations”), in light of the status of entities in IFSCs being of a person resident outside India and given the nature of fund management activity. Under Regulation 7, an Indian party engaged in financial services sector is permitted to set up an overseas joint-venture or a subsidiary subject to certain conditions, including the requirement to procure regulatory NOCs from the relevant financial services regulator in India and overseas.
6. What are the alternatives for making sponsor commitment to IFSC AIFs?
The RBI has recently clarified that an Indian party will be permitted to make sponsor commitments to an AIF in IFSC, as required by the SEBI AIF Regulations, subject to fulfilment of the requirements of Regulation 7 of the ODI Regulations.
The sponsor commitment may also be made by a non-resident person or an entity in IFSC. Notably, a branch in IFSC would require prior regulatory approval for making sponsor commitment to an IFSC AIF.
7. What is the procedure to set up AIFs in GIFT City?
The below figure captures the key steps (along with indicative timeline), involved in the set-up of an AIF in GIFT City.
Fig 2: Snapshot of setting up of an AIF in GIFT City
8. What are the key tax benefits of setting up AIFs in IFSC, GIFT City?
From a tax perspective, IFSC offers attractive tax benefits including a 100% tax exemption on business income for 10 consecutive years out of 15 years (“Tax Holiday”) and exemption from levy of GST for entities in IFSC. These benefits can be availed of by AIF managers in respect of their income from fund management.
For Category I and II AIFs, the tax pass through status under Section 115UB of the Income Tax Act, 1961 has been extended. For Category III AIFs, meeting the ‘specified fund’ criteria of lower rate of taxation for income in the nature of capital gains and interest is applicable. Further, Category III AIFs having business income should be able to claim Tax Holiday as explained above.
A 100% tax exemption has been granted to Category III AIFs in IFSC for transfer of specific securities where (a) consideration for transfer of these securities is payable in a foreign currency; and (b) all units of the AIF are held by non-resident(s) (barring those held by the sponsor and/or manager of the AIF).
The applicable rates on different types of income earned by a Category I or Category II AIF in IFSC are summarised as under:
|Income||Rate of Tax (subject to levy of applicable surcharge and cess) for non-resident investors||Rate of Tax (subject to levy of applicable surcharge and education cess) for Resident investors|
|WHT at AIF level||At the applicable rates below||10% (balance tax is recovered from the investors as per below rates)|
|Taxability in the hands of the investors|
|Short term capital gains on which STT has been paid||15%||15%|
|Other short-term capital gains||
40% for offshore companies;
30% for offshore LLPs/firms
|Long term capital gains||
10% for gains from transfer of listed securities where STT is paid as well as if STT is not paid;
10% for transfer of unlisted securities (without indexation);
20% for other long-term capital gains
10% for gains from transfer of listed securities where STT is paid;
10% for gains from transfer of listed securities/20% (with indexation) if STT is not paid;
20% for transfer of unlisted securities (with indexation);
20% for Other long-term capital gains
Notwithstanding the above, in case the income of the IFSC AIF is characterized as business income, the same shall be taxable in the hands of the IFSC AIF at a rate of 30% and any distribution of such income should be exempt from tax in the hands of the investors of the IFSC AIF.
The IFSC AIF may claim a tax holiday under section 80LA of the ITA with respect to its business income, subject to conditions. This tax holiday can be availed for a period of 10 consecutive years out of the first 15 years.
The applicable rates on different types of income earned by a Category III AIF in IFSC (which qualifies as a ‘Specified Fund’) are summarized as under:
|Nature of income in the hand of Specified Fund*||Rate of Taxation at AIF level (excluding surcharge and cess)|
|LTCG (112A of ITA – STT paid) (on income above INR 1,00,000)||10%|
|LTCG (other than 112A of ITA – STT paid)||10%|
|STCG (111A of ITA – STT paid)||15%|
|Other STCG (not covered under 111A)||30%|
|WHT at AIF level||Nil|
|Taxability of investors||Exempt from Indian tax|
9. Are there any tax benefits for non-resident investors making investments in IFSC AIFs?
Non-resident investors making investments in units of an IFSC AIF are not required to obtain a Permanent Account Number (PAN), or file income tax returns in India, provided they do not have any other taxable income from their activities or investments in India.
Further, income accruing to or received by non-resident investors from offshore investments made by a GIFT City AIF should not be taxable in India.
10. Whether the routes of FDI, FPI, and FVCI may be utilised by IFSC AIFs to invest in India?
Yes, all three routes of investment into India are available to IFSC entities. This flexibility under the foreign exchange regulations complements AIF Regulations well, making the IFSC platform attractive for funds of a wide range of strategies viz. angel funds, VC funds, PE funds, infrastructure funds, credit funds, real estate funds, hedge funds etc. The application for registration as an FPI or FVCI could be made by an IFSC AIF before the IFSC Authority.
11. Whether AIFs in GIFT City are permitted to make investments in overseas companies?
Yes, since AIFs set up in an IFSC are deemed to be non-resident Indians under the existing foreign exchange laws in India, they may freely invest in overseas companies without separate regulatory approvals.
12. Whether AIFs in GIFT City are eligible for any non-tax benefits, particularly granting higher operational and structuring flexibility?
The IFSC Authority has, vide its circular dated December 09, 2020, provided IFSC AIFs with the following dispensations:
(i) Undertake leverage without restrictions, subject to disclosures to and consent of its investors, and mitigation of risks arising from leverage;
(ii) Create separate unit classes earmarked for co-investing alongside the AIF in portfolio companies with segregated portfolios, subject to disclosures to investors, provided the co-investments are not on more beneficial terms than the AIF;
(iii) Invest up to 100% of its funds in a single investee company, as against the concentration limits imposed on non-IFSC AIFs; and
(iv) Invest up to 100% of their investible funds outside India in securities of overseas companies, as against the limits imposed on non-IFSC AIFs.
The above dispensations grant higher operational and structuring flexibility to AIFs bringing them at par with offshore funds.
13. What are the key considerations for fundraising by GIFT City AIFs? Whether Indian resident individuals are permitted to invest in GIFT City AIFs for making overseas investments?
Persons resident in India, with a minimum networth of USD 1 million during the preceding financial year are permitted to invest in GIFT City AIFs, subject to the limits under the Liberalised Remittance Scheme of the RBI (which is currently USD 250,000). Notably, AIFs may invest funds raised only from resident individuals into overseas investee companies or schemes.
Additionally, funds raising capital from Indian residents should ensure that investments are made in in a manner which does not lead to ‘round tripping’ of funds in India.
14. Are any additional regulatory advancements expected in near future concerning IFSC AIFs?
In most prominent global financial jurisdictions, corporate structures like protected cell companies, multi-share class vehicles or variable capital companies (“VCCs”) are preferred for setting up funds. Such structures have flexibility in making distributions from capital of the fund entity, without being subjected to the restrictions on capital redemption and reduction as commonly applicable to corporate structures.
In India, while the AIF Regulations permit AIFs to be set up as companies and body corporates, an overwhelming number of AIFs set up in India are structured as trusts. Besides relative ease of setting up and operations, a trust structure is not subject to the solvency tests and restrictions on capital redemption or reduction.
The IFSC Authority, by an Order dated September 22, 2020, constituted an Expert Committee (“Committee”) to examine the relevance and adaptability of the VCCs in the IFSC. Notably, VCCs have been introduced in Singapore a couple of years back and the pilot project of the Monetary Authority of Singapore witnessed keen interest from industry players, with over a 100 VCCs already registered in 2020 itself.
The Committee has provided a detailed report recommending the broad framework for the implementation of the VCC structure in the IFSC including principles for incorporation of VCC/sub-fund, capital funding, corporate governance, etc.
Once incorporated as law, VCCs would provide the option of setting up IFSC AIFs in an internationally accepted legal form, providing greater comfort to the international LP community.
The key features of VCCs as proposed by the Committee are:
(i) The share capital of the VCC should be variable in nature. In other words, it should cater to the frequent entry and exit of shareholders without the need for any significant regulatory filings and approval.
(ii) The VCC can be set up as a standalone investment fund or structured as an umbrella fund with underlying sub-funds, holding segregated portfolios. The VCC must issue a separate class or classes of shares for each sub-fund within the VCC.
(iii) The sub-fund of a VCC should not be a legal person separate from the VCC.
(iv) To address the key risk of cross-cell contagion, that is, to prevent the assets of one sub-fund from being utilised for/ set-off against the liabilities of another sub-fund, the requirements of asset and liability segregation should override all other requirements applicable to the VCC. All contracts that the VCC enters must contain a provision that restricts any contractual claim to the relevant counterparty to the assets of the sub-fund only.
(v) For the purpose of tax laws, each sub-fund of a VCC, should be treated as a separate entity, with a separate PAN. Further, for the purpose of insolvency proceedings, the sub-funds may be treated as a separate entity.
(vi) A VCC could have a mix of both open and closed ended fund, with ability to covert from an open ended to a closed ended strategy, and vice versa.
 These include global depository receipts, rupee denominated bonds of an Indian company, derivatives, foreign currency denominated bonds, units of a mutual fund, units of a business trust, and foreign currency denominated equity shares of a company or unit of an AIF listed on a stock exchange located in an IFSC.
 The above rates are subject to further benefits available to non-resident investors under any applicable tax treaty.
 Securities Transaction Tax
 Specified Fund is a fund established in the form of a trust or a company or a limited liability partnership or a body corporate:
- which has been granted a certificate of registration as a Category III Alternative Investment Fund and is regulated under the AIF Regulations;
- which is located in an IFSC; and
- of which all the units are held by non-residents other than unit held by a sponsor or manager.
 Long Term Capital Gains
 Short Term Capital Gains
 Limited Partner