1

SUGGESTIONS FOR AN OPTIMAL STRUCTURE FOR OFFSHORE FUND

TO INVEST IN INDIAN EQUITIES

PRESENTATION FOR BCP ADVISORS PVT LTD BY: VIKRAMVEER THAKORE

24 JULY 2014

2

Table of ContentsCONTENT PAGE

Foreign Investments in Indian Equities 3

FDI Route 4

FVCI Route 5

FPI Route 6

Comparative analysis of the three routes 8

Key considerations for structuring an offshore fund 9

Fund Structure and functions of its key entities 10

Analysis of GAAR and PE 12

Tax overview of relevant jurisdictions 14

Comparative analysis of jurisdictions. Mauritius vs. Singapore 15

Process of setting up an offshore equity fund 24

3

FOREIGN INVESTMENTS IN INDIAN EQUITIES

All foreign investments in Indian securities are regulated by the Foreign Exchange Management Act 1999 (FEMA).

Three principle routes of foreign equity investments in India are: 1. Foreign Direct Investments (FDI) route2. Foreign Venture Capital Investments (FVCI) route3. Foreign Portfolio Investments (FPI) route

4

FOREIGN INVESTMENTS IN INDIAN EQUITIES

FDI Route FDI can be routed essentially using equity or

instruments convertible into equity shares:1. Equity shares2. Compulsorily Convertible Debentures (CCD)3. Compulsorily Convertible Preference Shares (CCPS)

FDI need to comply with pricing guidelines of the RBI1. For purchases by the foreign investor the price should not be

lower than the fair market value computed on the basis of DCF.

5

FOREIGN INVESTMENTS IN INDIAN EQUITIES

FVCI Route FVCI investments are governed by SEBI (Foreign Venture

Capital Investor Regulations), 2000. FVCI are limited to “Venture Capital Undertakings (VCU)”

in select sectors, i.e. Infrastructure, Bio-technology, IT, R&D in certain sectors, Hotel cum Convention centers.

FVCI investor is required to invest 66.67% of its investable funds in unlisted equity of VCU.

VCU investor is permitted to invest the remaining 33.33% in IPO, Debt instruments where already holding equity, PIPE subject to a one year lock in period.

6

FOREIGN INVESTMENTS IN INDIAN EQUITIES

FPI Route FPI investments are governed by SEBI (Foreign Portfolio Investor

Regulations), 2014 FPI Regulations combine and replace erstwhile regulations regarding

FII and QFI. Existing FIIs and QFIs deemed to be FPIs during the validity of their

existing registration. FPI registration is granted by Designated Depository Participant (DDP) FPI investments are governed by restrictions and conditions broadly

similar to FII. FPI Limits:

• Each FPI can invest up to 10% of any companies equity.• Aggregate FPI/FII/QFI can ordinarily invest up to 24% in any company.• With board and shareholders’ special resolution up to sectoral cap.

7

FOREIGN INVESTMENTS IN INDIAN EQUITIES

Three Categories of FPIs

Category Eligible Investors

Category I Sovereign Investors, Central Banks, Government Agencies, Multilateral Agencies, etc.

Category II Regulated Mutual Funds, Investment Trusts, Banks, AMCs, Insurance Companies, Pension Funds, etc.

Category III All eligible investors not covered above. These include Corporate Bodies, Individuals, Family Offices, Trusts, etc.

8

FOREIGN INVESTMENTS IN INDIAN EQUITIES

FPI FVCI FDI

Nature of investor Eligible foreign investors with track record, and regulated

Institutional foreign investors with track record, and regulated

Institutional / Strategic

Governed by SEBI FPI Regulations SEBI FVCI Regulation FIPB approval / automatic approval

Can invest in

Primary and secondary shares and debentures of listed companies, domestic mutual funds, derivatives on stock exchanges, T bills, G-Secs, CP, NCD of infrastructure cos.

Primary issue of shares in VCUs, and secondary purchase of listed securities of VCUs up to a cap

Primary issue of shares, and secondary purchase of unlisted securities.

Limits for investment Within permitted limits for FPIs

Without need for FIPB approval if within sectoral caps, or FIPB approval required if sectoral caps do not permit

Without need for FIPB approval if within sectoral caps, or FIPB approval required if sectoral caps do not permit

Pricing restrictions If purchased / sold through stock exchanges or IPO, none

Bilateral, not through stock exchanges. No pricing restrictions

Bilateral, not through stock exchanges. Pricing restricted by RBI formula

Lock-in post IPO One Year No lock-in One year

Comparative analysis of the three routes:

9

KEY CONSIDERATIONS FOR STRUCTURING AN OFFSHORE FUND

Compliance with regulations and treaty terms.

Optimize Taxation.

Availability of skilled and knowledgeable manpower.

Ease of Operations.

Permanent Establishment (PE). *

GAAR. *Limit liability/ risk of investors.Ability to raise capital

commitments and distribute sales proceeds.

KEY CONSIDERATIONS FOR STRUCTURING AN OFFSHORE FUND

* Discussed in subsequent slides

10

STRUCTURE OF AN OFFSHORE FUND FOR EQUITY INVESTMENTS

Investor 1 Investor 2 Investor 3

Asset Management Company

Advisory Committee

BCP India Fund (FDI + FPI)

Investment 1 Investment 3Investment 2Advisory Company

Indi

aRe

st o

f Wor

ldM

auriti

us /

Sing

apor

e

BCP India Fund Sub (FVCI)

100% Sub

Advi

sory

Ser

vice

s

Management Services

11

FUNCTION OF KEY ENTITIES IN THE STRUCTURE

Entity Function1. Fund a. Register with DDP as FPI.

b. Route all FDI and FPI investments.

2. Subsidiary a. Register with SEBI as FVCI.b. Route all FVCI investments in VCUs.

3. AMC a. Make all investment decisions in accordance with Private Placement Memorandum (PPM)/mandate.

4. Advisory Company

a. Recommend investment opportunities to AMC.b. No authority to make any investment decisions.

5. Advisory Committee

a. Resolve conflicts of interest.b. Approve investments beyond threshold levels.c. Corporate governance and compliance.

12

GENERAL ANTI-AVOIDANCE RULES (GAAR)

GAAR has been introduced in the Finance Act, 2012 but cannot be applied before April 1, 2015.

GAAR can be applied retrospectively for any part of transaction affected post August 30, 2010.

GAAR provisions override international treaties. GAAR empowers tax authorities to disregard transactions if they

believe “Impermissible Avoidance Arrangements” are used to obtain tax benefits.

Impermissible Avoidance Arrangements are:a. Transactions not at arms-length.b. Abuse of provisions of Income Tax Act.c. Lack of commercial substance.d. Non bona fide purpose.e. Existence of Permanent Establishment.

GAAR subject to threshold of INR 30 million.

13

PERMANENT ESTABLISHMENT If Indian tax authorities establish that an offshore fund has a “Permanent

Establishment (PE)” or “Business Connections” in India, then its profits are liable to be taxed in India irrespective of treaty benefits.

PE maybe established in the following cases (non exhaustive):a. If Fund’s investment decisions are routinely managed by a team in India.b. If a fixed base (office) is available in India to an offshore fund on a regular

basis to manage the fund.c. If employees of an offshore fund routinely provide service to it from India.d. If an independent agents activities are mostly conducted on behalf of an

offshore fund.e. If transactions between an offshore fund and its Indian agent are not

conducted on an arms-length basis.

Therefore, it is important to establish that the Advisory Company in the proposed structure provides only recommendatory services, on a non-exclusive basis, and on arms-length terms.

14

TAX OVERVIEW OF RELEVANT JURISDICTIONS

NATURE OF TAX BASIC TAX RATEINDIA MAURITIUS SINGAPORE

1. Short Term Capital Gain (STCG):< 12 months for STT transactions< 36 months for non STT transactions

15%30% NIL NIL

2. Long Term Capital Gain (LTCG):> 12 months for STT transactions> 36 months for non STT transactions:

Without indexationWith indexation

NIL

10%20%

NIL NIL

3. Securities Transactions Tax for equity (STT)

0.01% for sell side 0.01% for sell side 0.01% for sell side

4. Dividend Income (DDT of 15%) NIL NIL NIL

5. Interest Income FPI/FII 30% 21-43% 15%6. Withholding tax on interest 5% No relief 10%7. Local Corporate Tax 30% Effective 3% 17%

15

COMPARITIVE ANALYSIS OF JURISDICTIONS:MAURITIUS vs. SINGAPORE

Advantages of Mauritius Domiciled Funds (1/2):1. India-Mauritius Tax Treaty backed by CBDT Circular and upheld by

Supreme Court of India.2. Hitherto tried and tested jurisdiction for making investments into

India. 3. Exemption of tax on capital gains.4. Relatively simpler regulatory processes and low set-up / operating

cost with easier time lines for set-up.5. Flexible Company Law and other Regulatory framework in

Mauritius for efficient repatriation.6. Flexibility to have multi layer structure in Mauritius.

16

COMPARITIVE ANALYSIS OF JURISDICTIONS:MAURITIUS vs. SINGAPORE

Advantages of Mauritius Domiciled Funds (2/2):7. Other Income taxable only in Mauritius as per India-Mauritius Tax Treaty.8. Circular 789 on India-Mauritius Tax Treaty recommended to be respected

by Expert Committee on GAAR.9. No thin capitalization rules.10. Lower taxation rate in Mauritius:

a. Local tax rate of 15% in Mauritius can be effectively reduced to 3% on account of deemed tax credit of 80% on foreign sourced income.

b. Dividend income from India not taxable, after claiming credit.c. No tax on Capital Gains in Mauritius.

11. Protection for investors under Bilateral Investment Promotion and Protection Agreement (BIPA).

a. Mauritius BIPA effective from June 2000.

17

COMPARITIVE ANALYSIS OF JURISDICTIONS:MAURITIUS vs. SINGAPORE

Disadvantages of Mauritius:1. Interest income taxable at 21.63% / 43.26% (as per domestic

tax laws).2. Not a very popular jurisdiction for relocating investment

professionals on account of lack of activity in that jurisdiction.3. India-Mauritius Tax Treaty under scanner of the Tax

Authorities – number of attempts made to deny Treaty benefits alleging lack of substance and misuse.

4. Practical challenges in case of secondary sale where buyer could insist for tax withholding where a Mauritius entity is a seller.

18

COMPARITIVE ANALYSIS OF JURISDICTIONS:MAURITIUS vs. SINGAPORE

Advantages of Singapore Domiciled Fund (1/2):1. Established financial center and may be looked at as an attractive

jurisdiction by the Investors. 2. Flexibility for relocating investment professionals to Singapore.3. India-Singapore Tax Treaty not yet under the scanner of Indian Tax

Authorities.4. Highly regulated jurisdiction, optically could provide comfort to

India Tax Authorities for substance in that jurisdiction.5. Complete exemption from tax on capital gains, subject to LOB

clause.6. Lower tax withholding of 15% for interest paid by Indian Company

under India-Singapore Tax Treaty; lower tax rate available subject to interest being actually remitted to Singapore and recipient being the beneficial owner of such interest income.

19

COMPARITIVE ANALYSIS OF JURISDICTIONS:MAURITIUS vs. SINGAPORE

Advantages of Singapore Domiciled Fund (2/2):7. India-Singapore Tax Treaty has Limitation of Benefit (LoB) Clause for

Capital Gains exemption:a. Singapore entity not set up for availing treaty benefits and undertakes bona

fide business activities.b. Singapore entity is not treated as shell / conduit company (i.e. total annual

expenditure on operations is >S$ 200,000 during preceding 24 months from date of gains OR is a legal entity listed on recognized stock exchange in Singapore).

8. Local tax exemption in Singapore:a. No tax on capital gains in Singapore.b. Dividend income from India not taxable, subject to fulfillment of certain

conditions.

9. No thin capitalization rules in Singapore.10. Tax efficient for making both convertible debt and equity

investments.

20

COMPARITIVE ANALYSIS OF JURISDICTIONS:MAURITIUS vs. SINGAPORE

Disadvantages of Singapore:1. Stringent approval processes and relatively stricter Regulatory

regime.2. Capital gains exemption under India-Singapore tax treaty (subject to

LOB clause).3. Extended time line for obtaining licenses and setting up Fund

entities in Singapore.4. Management fees to be paid at Singapore level - taxable at 10% in

Singapore subject to Manager qualifying for FSI-FM Award scheme, or else taxable at 17%.

6. High setup and operating cost. 7. Applicability of GST on management fees in Singapore.8. More difficult to create multi layer structure in Singapore.9. No Bilateral Investor Protection and Promotion Agreement (BIPA).

21

IMPACT OF GAAR:MAURITIUS vs. SINGAPORE

MAURITIUS SINGAPORE1. Lack on investment

professionals in MauritiusPresence of investment professionals in Singapore.

2. No full fledged set up in Mauritius

Full fledged robust operating set up in Singapore.

3. Difficult to substantiate non-tax / commercial reasons for Mauritius structure

Substance can be defended on the basis of a more robust local investment team. MAS is a more reputed regulator.

4. No Limitation of Benefit (LOB) clause yet, therefore higher threat.

Stringent LOB clause therefore lesser threat.

22

COST BENEFIT ANALYSIS OF MAURITIUS AND SINGAPORE

Assumptions: Fund Size: USD 100 Mn Team Size: Management Fees: 2% Partner: 1 No'sCarried Interest: 20% Principal: 1 No's Analysts / associates: 3 No's Support Staff: 2 No's Annual Revenue: USD 2,000,000 USD 2,000,000 One Time Expenses: Mauritius SingaporeFund Raising: USD 300,000 Legal: USD 200,000 Admin / Travel: USD 100,000 USD 600,000 Annual Expenses: Sponsor Remuneration: USD 500,000 Manpower: USD 600,000 Office Overheads: USD 200,000 General, Travel etc.: USD 200,000 USD 1,500,000 USD 1,700,000

23

RECOMMEND SINGAPORE AS THE PREFERRED JURISDICTION FOR THE FUND

In general, it appears that Singapore is a more advantageous jurisdiction for setting up an Offshore Fund for routing equity investments into India due to:1. LoB Clause provides greater substance, and therefore higher protection from

GAAR.2. Greater availability of investment professionals.3. Proximity to India facilitates ease of travel.

From a Cost-Benefit perspective, the final determination of the jurisdiction will probably depend on the following factors specific to each Fund:1. Availability of existing manpower in Singapore or India.2. Ability to relocate existing Indian manpower to Singapore.3. Cost and availability of recruiting additional manpower in Singapore.4. Expected interest earnings of the Fund. Higher the interest earnings of the Fund,

Singapore becomes more attractive.5. Size of the Fund. Singapore’s attractiveness is directly proportional to the Fund

size. The larger the Fund corpus, the easier it is to absorb the minimum fixed costs stipulated in the LoB clause.

24

PROCESS OF SETTING UP OFFSHORE EQUITY FUND

ACTIVITY NATURE OF ACTIVITY RESPONSIBILITY

1. Conceptualization of fund based on key strength of management team.

AMC.

2. Preliminary discussion & feedback from key investor relationships.

AMC.

3. Preparation of fund structure.a. Select appropriate jurisdiction.b. Incorporate fund company and AMC.

AMC, Legal Advisor, Tax Advisor.

4. Preparation of legal and constitutional documents.a. Constitution of fund, FVCI subsidiary, AMC, Advisorb. Investment Management Agreement.c. Investment Advisory Agreement.d. Administration Agreement.e. Private Placement Memorandum (PPM).f. Subscription Agreement.g. Other legal documents.

AMC, Legal Advisor, Tax Advisor.

5. Marketing for commitments / Fundraising AMC, Marketing Advisor, Legal Advisor.

6. Fund Closing and its documentation. AMC, Legal Advisor.

25

IMPORTANT DISCLOSURE

This presentation is an outcome of research done by Vikramveer Thakore under the supervision of BCP Advisors Private Limited as part of his summer project. Contents of this presentation have been substantially obtained from publicly available information and informal discussions with various investment professionals.However the contents of this presentation have not been verified by any legal or tax professional. It is strongly recommended that BCP Advisors Private Limited seeks opinion of respective legal and tax experts before implementing any part of this presentation.

26

THANK YOU