FPIs may set up SPVs in Mauritius, Singapore to avoid surcharge hike

Foreign portfolio investors (FPIs) are exploring options to route their investment through corporate structures in countries such as Mauritius, Singapore, France, and the Netherlands to bypass the additional surcharge levied in the Union Budget.
 
The government on Thursday ruled out a rollback of the “super-rich” tax on FPIs organised as trusts or association of persons.
 
This could affect 40-50 per cent of the FPIs.
 
“FPIs are looking at forming special purpose vehicles (SPVs) in regions such as the Mauritius, Singapore, the Netherlands, and France for investing in India. This is one way to avoid the surcharge hike,” said Girish Vanvari, founder, Transaction Square.
 
The SPV will be set up in the form of a company, and will have to be created specifically to route India investments. Vanvari added this practice was prevalent and there were countries where FPIs route their investment through SPVs despite having an underlying ‘trust’ structure.
 
This is possible because SPVs are not created at the fund level, but are only meant to channel a small portion of the investments. That said, it may not be possible for FPIs to route their existing investments through the SPV route, primarily because any transfer of shares to an SPV may lead to a significant tax outgo. 
 
“One of the options is for FPIs to continue to hold their existing investment through the current structure. New investments can be routed through a corporate structure, which could be incorporated in countries such as the Mauritius, Singapore, and the Netherlands,” said Pranay Bhatia, partner, BDO India, adding that the new company will have to take up fresh registration with the Securities and Exchange Board of India (Sebi).
 
The cost of setting up companies in these regions is nominal at $5,000-10,000, said experts.
 
Setting up new companies could lead to a surge in FPI registrations, currently around 9,500.
 
Not all FPIs affected by the surcharge may be in favour of routing investments through the SPV route, though.

This is because such arrangements could come under the ambit of the domestic general anti-avoidance rules (GAAR) if the FPI does not have enough substance in the country in which such companies are created.
 
This is one reason why only the larger FPIs and those with a significant presence in such regions may be in favour of such structures.
 
“Certain pension funds are mandated by their operating law to operate as investment trusts. These are long-term pools of capital and are some of the most sought-after investor classes globally. It would not be practical to expect them to reset their structures,” said Richie Sancheti, leader (funds practice), Nishith Desai Associates. 
 
Another conundrum will be how the capital will be returned to investors in case of redemption requests. This is because ordinarily, for companies, the capital invested by shareholders cannot be returned, except out of the profits the company makes.
 
The surcharge on FPIs earning more than Rs 2 crore but less than Rs 5 crore has risen to 25 per cent from 15 per cent earlier. The surcharge on income above Rs 5 crore has increased to 37 per cent from 15 per cent. This means that the effective taxation on long-term capital gains for FPIs has risen to a maximum of 14.25 per cent. Tax on short-term capital gains at the highest level has risen to a maximum of 42.74 per cent.
 
Globally, most mutual funds and pension funds are organised as non-corporate vehicles, specifically trusts as they represent the interests of small investors and invest for the long term.
 
According to experts, there is no basis to tax FPIs organised in different legal forms in their home country on a differential basis.
 
“FPI funds that invest in India are either set up as trusts or are in corporate form depending on what is prevalent in the jurisdiction of their establishment. Increasing the surcharge on non-corporate FPIs will hurt those FPI funds that are set up as trusts and thereby inadvertently discriminate against some jurisdictions over others for the same activity,” said Asia Securities Industry & Financial Markets Association, an industry body for FPIs.