Union Budget 2021: Govt should consider light touch regulatory regime to attract global lenders in IFSC

The International Financial Services Centre (IFSC)’s Gujarat International Finance Tech-City (GIFT) is the first smart city in India that is fast emerging as an attractive destination for financial services players. After the setting up of the International Financial Services Centre Authority (IFSCA) [being the Unified Regulator for IFSC], it has witnessed some path-breaking regulations and policy announcements in a very short span of time for different aspects of financial services such as banking, stock-broking, investors in IFSC, etc.

Recently, the IFSCA permitted Global In-House Centres (GICs) of financial companies to be set up in IFSC. The Alternative Investment Funds regime is also attractive and it should see funds/fund managers setting up base in IFSC soon. One must also applaud the IFSCA on being very open to suggestions from investors and pro-development. The IFSCA works closely with the government to address the changing business environment/needs and providing more business opportunities/competitive advantages for units in IFSC. Whilst a lot has already been done, some of the key tax considerations which the government may address in the Budget 2021 to make IFSC more attractive are:

Banking units in IFSC

Banks set up in IFSC can invest through Foreign Portfolio Investment (FPI) route (post-seeking FPI license) into the domestic market and such income from FPI activity shall be governed by Section 115AD (special tax regime applicable for FPI). Such income is not eligible for a tax holiday. However, in order to encourage banks to set up in IFSC and to make it simpler for them to operate, the entire income of the banking unit, including income from FPI activity should be eligible for deduction under section 80LA.

Recently, non-delivery based forward trading has been permitted to banks in IFSC. In order to encourage their clients, i.e. the bank’s clients, such as hedge funds to also trade in the IFSC market, a tax exemption could be proposed for the foreign funds earning income from such trading, to move their trading to IFSC.  Without clarity on the taxation of NDF trades, there is an apprehension that it may be taxed at the maximum rate and hence the market may not pick up.

Relaxation of MAT for stock broking

The IFSCA has permitted eligible foreign entities to set up a branch office as a stockbroker or GIC. The income from such a branch would be eligible for tax holiday [section 80LA]. However, such a branch would be liable to pay tax on its book profits under the Minimum Alternate Tax (MAT) provisions disregarding tax holiday otherwise available. These units should be exempted from MAT provisions or MAT rate should be reduced. This would reduce the imbalance between the overall tax cost for such branches vis-a-vis stock broking units of domestic entities in IFSC which would be paying tax under the concessional tax regime provided under section 115BAA of the Act (post-the tax holiday period) and to whom MAT provisions are not applicable.

Objective criteria for fund managers

In order to address the likely invocation of General Anti-Avoidance Rules (‘GAAR’) by tax officers, objective criteria for fund managers in IFSC (e.g. certain minimum activities, employees, etc.) must be laid down. Further, the criteria could vary depending on the size of the fund or it could be spelt out for each fund while granting approval depending on the peculiarities of each structure. This would address subjectivity around the applicability and invocation of the GAAR provisions and provide certainty.

Dividend, repatriation of funds

The earlier benefit of dividend being tax-free should be reinstated for dividend income earned by the parent companies from their subsidiaries incorporated in IFSC. Also, the buy-back/income distribution tax should not be made applicable to companies set up in IFSC. This shall allow companies in IFSC to upstream profits / repatriate the capital in a tax-efficient manner. For all foreign investors/lenders, the ability to repatriate capital and ease of winding up operations is very important. 

Therefore, this would give a good boost to foreign investors. Equally important is the ease of winding up operations and repatriating balance capital. These ease of business measures would go a long way in boosting the confidence of foreign investors to come to IFSC.

The above are only a few thoughts to make IFSC more attractive. There’s lots more coming up in IFSC like aircraft leasing, which has been recently recognized as a financial services activity.  It is important that a light-touch regulatory regime be put in place to attract global lenders.

On the tax front also, it is important to make it easy for both the lessor and lessee to avoid tax leakage. The authority could consider blanket exemption from withholding tax for interest received/earned by financer (i.e. entity undertaking lending to entities engaged in aircraft leasing activity) on loan advanced to the entity undertaking aircraft leasing activity; to the interest portion of finance lease rentals earned/received by SPV from the airlines; and lease rentals payable by airlines to SPV.

This would reduce the administrative burden of obtaining Nil withholding tax certificate under section 197 of the Act given that units in IFSC (i.e. Financer/SPV) would be claiming tax holiday.

The mutual funds and foreign lending companies are other new and exciting businesses in IFSC to watch out for.  Here also it will be important to put in easy and lucid tax and regulatory policies. 

So far one of the key complaints of the foreign investors was on the ease of doing business in India. IFSCA, with its attractive policies, a very proactive regulator and a conducive business environment seems to have addressed these concerns.

The writer is Partner and Head, Financial Services Tax, KPMG in India and Nilesh Pal, CA

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Sunil Badala