CBDT sets a minimum fee for managers of India-based offshore funds

The government has set a minimum fee to be received by fund managers in India, managing offshore funds, under the safe harbour route.

The Finance Act, 2015, had introduced Section 9A to encourage fund management activity from India and provide a safe harbour to onshore managements of offshore funds.

The objective was to ensure these funds did not pay incremental tax just because they were managed in India and the risk of constituting business connections or a permanent establishment in India was mitigated. Without the benefit of this section, an offshore fund managed in India becomes a tax resident.

Earlier, one condition to qualify for the safe harbour was for the eligible fund manager to receive an arm’s length remuneration, and for the transaction between the eligible investment fund and eligible fund manager to be deemed an international transaction (subject to transfer pricing provisions).

This condition was widely perceived to be onerous in nature, which is why the government — through the Finance Act, 2019 —removed the requirement, replacing it with a minimum fee to be prescribed by the Central Board of Direct Taxes (CBDT). On December 5, the CBDT released the draft rules prescribing the minimum fee. This has been notified now.

Experts say the intention behind fixing minimum remuneration is to ensure appropriate tax revenues are collected with respect to the fund management activity in India.

 

 

The minimum remuneration for Category-I FPIs is 0.1 per cent of assets under management (AUM). For others, it is 0.3 per cent of the AUM, or 10 per cent of profits derived by the fund in excess of the specified hurdle rate — where the remuneration is profit-linked.

Where the fund is paying a management fee to another fund manager too, 50 per cent share of the management fee (from the management activity undertaken by the eligible fund manager), as reduced by the amount incurred towards operational expenses including distribution expenses, if any, should be paid. In case the remuneration is lower than the amount arrived at as prescribed, the fund has to seek the CBDT’s approval. 

“Since the offshore fund will continue paying lower tax as FPI or FVCI or FDI investor on its gains from India at capital gains rates, or even nil if treaty benefits are available, the government expects minimum income to be reported by the Indian fund manager. Category-I FPIs have been given favourable treatment as compared to Category-II FPIs with a lower floor rate. Private equity funds and AIFs will have to report higher fees in India,” said Sunil Gidwani, partner, Nangia Andersen.

According to him, the replacement of the arm’s length price — determined in accordance with a fixed percentage as a minimum amount — does away with the use of transfer pricing methodologies and makes it easy for fund managers to plan and conceive a structure, before getting it approved by the CBDT.

“The notification considers different remuneration models prevalent, which is a percentage of AUM or share in the fund’s profits, or a split in the management fee, among different participants. Further, the decision to prescribe a lower threshold for certain sophisticated Category-I FPIs like pension or sovereign funds, recognising the commercial realities of the fund management industry, is positive,” said Tejas Desai, partner, EY India. 

The government has been incrementally relaxing norms over the past few years. Yet, only a handful of funds have got the nod under Section 9A so far, which is why Desai believes bolder reforms are required and several restrictive conditions in the section need a re-look.

Experts believe relaxing section 9A norms will allow MFs and portfolio managers that currently provide advisory services to these funds to start managing them directly from India and thus earn higher fees.
 

Several offshore fund managers of Indian origin, who manage the India units of their global portfolios, are keen to shift to the country as it will help them connect locally with bankers, analysts, institutional investors, and the company’s management.