Introduction: Delve into the realm of possibilities as we unravel the process of setting up an Alternative Investment Firm (AIF) Category II in the Gujarat International Finance Tec-City (GIFT City), India’s sole International Financial Service Centre (IFSC). From understanding the regulatory landscape of IFSCs to the intricacies of AIF categories, this guide offers a comprehensive roadmap. Unlock the potential of leveraging, explore tax benefits, and discover the expansive investment avenues that await global financial service providers in this strategic financial hub.
♦ What is International Financial Service Centre (IFSC)?
An International Financial Service Centre is a jurisdiction where the global financial service provider’s offer financial products/services to global customers in foreign currencies. In India, the role of an International Financial Service Centre is to undertake financial services transactions that are currently carried on outside India by overseas financial institutions and subsidiaries /overseas branches of Indian financial institutions.
Gujarat International Finance Tec-City (GIFT City) is India’s only approved IFSC located in the city of Gandhinagar, Gujarat.
♦ How is an IFSC regulated?
An International Financial Service Centre has to be approved by the Central Government under the Special Economic Zones (SEZ) Act, 2005 and is also governed by several Financial Services regulators such as Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and Insurance Regulatory and Development Authority (IRDAI).
♦ How can an Alternative Investment Firm be set up in IFSC?
An Alternative Investment Firm can be set up in the form of a company, LLP, trust or body corporate in the IFSC.
♦ What are different categories of AIF’s permitted to be set up in IFSC?
SEBI IFSC guidelines read along with the SEBI Alternative Investment Firm regulations recognizes the following types of AIF’s:
(a) Category I AIF: Funds which invest in early-stage ventures, start-ups, small and medium enterprises, social ventures, infrastructure sector or areas which GOI consider as desirable.
(b) Category II AIF: Residual category i.e., other than Category I and III AIF and do not undertake leverage other than to meet day-to-day operational requirements as per SEBI AIF Regulations.
(c) Category III AIF: Funds which employ diverse or complex trading strategies and leverage including through investment in listed or derivatives /unlisted securities.
♦ Who is permitted to invest in an AIF set up in IFSC?
Permissible investors in an AIF are as follows:
(a) a person resident outside India.
(b) a non-resident Indian.
(c) institutional investor resident in India eligible under exchange regulations to invest funds offshore – to the extent of outward investment permitted.
(d) person resident in India (having minimum net worth of USD 1 million during preceding financial year) eligible under Foreign Exchange Management Act,1999 to invest funds offshore – to the extent allowed in Liberalized Remittance Scheme (LRS).
♦ What are the key steps for setting up GIFT AIF, GIFT AIF Manager and GIFT AIF Sponsor?
1. Apply for availability of name for Sponsor and/or AIF Manager.
2. Identification of office space in GIFT City and obtaining NOC from GIFT SEZ.
3. Apply for company/LLP incorporation for AIF Manager and/or Sponsor and obtain certificate of incorporation.
4. Appoint a trustee for AIF and registration of trust deed.
5. Make an application to the Development Commissioner of SEZ and obtain letter of approval from SEZ Authorities for AIF, Sponsor and/or AIF Manager.
6. Obtain SEBI approval for AIF, Sponsor and/or AIF Manager.
7. Obtain approval of the Reserve Bank of India, if required.
8. On obtaining approvals from SEZ authorities and SEBI, GIFT SEZ to issue Final Letter of Allotment for allocation of space.
9. Execute lease deed / leave and license with the Developer for the allotted space.
♦ Tax Benefits
- Category I and Category II AIFs have tax pass-through status for Indian income-tax purposes (except for business income, which is taxable in the hands of the AIF for which 100% tax holiday can be claimed for a period of 10 consecutive years out of a block of first 15 years).
- Investors are taxed on income arising from investments made by the AIF as if the investments were made directly by them.
- Income arising or accruing or received by non-resident investors from offshore investments through a Category I and II AIF is not taxable in India.
- Investors can claim losses (other than business loss) of AIF on pass through basis, provided the units of such AIF are held for a period of 12 months or more. However, any business loss can be carried forward only at the AIF level.
- Exemption has been provided to non-resident investors from filing return of income, provided they earn income only from investments made in a Category I or Category II AIFs in IFSC and tax has been deducted on the distribution made by such AIFs to non-resident investors. Further, such non-resident investors are also exempted from obtaining PAN in India.
♦ Benefits in the case of Manager/Sponsor.
- 100% corporate tax exemption for 10 consecutive years out of block of 15 years (from date of approval from regulator) in respect of income from business carried on in IFSC.
- The dividend distributed by Manager may be taxable in the hands of its shareholders under the domestic tax law.
- Supply of services by Manager to AIFs in IFSC is exempt from Goods and Services Tax.
- Interest payable to a non-resident in respect of monies borrowed exempt from income tax.
♦ Relaxations for AIF in Gift City (IFSC)?
- AIFs in GIFT City permitted to undertake leverage, subject to satisfaction of prescribed conditions.
- Co-investment in portfolio companies permitted by AIFs in GIFT City through segregated portfolio, provided the investment terms are not favorable than those offered to the common portfolio and appropriate disclosures are made in the placement memorandum.
- AIFs in GIFT City permitted to invest in domestic AIFs, alongside other permissible investments.
- Diversification limits under the AIF Regulations not applicable to AIFs in GIFT City, subject to appropriate disclosures in the placement memorandum
♦ Diversification Limit
Under the AIF Regulations, Category I and II AIFs cannot invest more than 25% of the investable funds in one Investee Company.6 Further, Category III AIFs cannot invest more than 10% of the investable funds in one Investee Company.7 It is common for offshore funds to be set up for investment in a few targeted companies or sectors. Such conditions on diversification may not interact well with the investment strategy of offshore funds.
♦ Leverage Limits
The SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) restricts Category-I / Category-II AIFs from borrowing directly or indirectly or engage in any leverage except for meeting temporary funding requirements for not more than 30 days, on not more than 4 occasions in a year and not more than 10% of the investible funds.
Category-III AIFs are permitted to engage in leverage subject to consent from investors of the fund and subject to maximum limit not exceeding 2 times of the Net Asset Value of the AIF. However, there are no such restrictions on offshore funds which frequently undertake leverage to fund investment opportunities.
The Circular now permits IFSC AIFs to undertake leverage, subject to the following conditions:
1. The maximum leverage by the IFSC Alternative Investment Fund, along with the methodology for calculation of leverage, shall be disclosed in the placement memorandum.
2. The leverage shall be exercised subject to consent of the investors.
3. The IFSC Alternative Investment Fund employing leverage shall have a comprehensive risk management framework appropriate to the complexity, size and risk profile of the fund.
♦ Investment by AIF
IFSC AIF’s have 5 investment avenues to deploy funds-
- Securities issued by companies incorporated in IFSC.
- Securities listed in IFSC.
- Securities issued by companies incorporated in India or foreign jurisdiction.
- Units of an AIF
- Securities which a domestic AIF is permitted to invest in.
For investments in India, FPI/ FDI/ FVCI limits would apply. However, existing conditions on outbound investments by AIFs do not apply to IFSC AIFs i.e., no SEBI approval required for investments outside India.
An AIF is not permitted to invest more than 25% of its investible funds in a single investee entity. This is not applicable to an offshore fund investing in India under the extant foreign Investment laws.
Conclusion: Setting up an AIF Category II in IFCS Gift City unfolds a spectrum of opportunities in the global financial landscape. From favorable tax regimes to regulatory relaxations, this guide provides a holistic understanding of the steps involved. Whether you are an investor exploring new horizons or a financial entity aiming to establish a strong presence, navigating through the nuances of IFSC regulations ensures a strategic and informed approach to harnessing the potential within GIFT City.
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