Union Budget 2019: India’s only International Financial Service Centre (IFSC), at GIFT City, Gandhinagar, is one of the most ambitious endeavours of the Government for bringing offshore financial transactions to the Indian territory. Currently, financial sector players such as banks, insurance companies, insurance brokers, stock exchanges, depositaries, mutual funds, alternative investment funds (AIFs), and other SEBI-registered intermediaries are permitted to set up shop at IFSC. Over the past few years, the Government has become increasingly conscious that, in order for it to make commercial sense for global financial players to migrate their operations to IFSC, it will be necessary to rationalise the taxation framework in IFSC so that it is at par with the taxation framework in other global financial centres. This article discusses the tax proposals for IFSC that were announced in the Budget recently.
Existing Tax Incentives for IFSC
Under section 80LA of the Income-tax Act, 1961 (IT Act), units in IFSC have been provided with a profit-linked deduction of 100% of the business profits that are earned from permitted financial activities over the first five years, and 50% of the business profits that are earned over the next five years. Furthermore, corporate assessees, being IFSC units, are also entitled to a concessional Minimum Alternate Tax (MAT) rate of 9% (Alternate Minimum Tax for LLPs), and they are exempted from the payment of dividend distribution tax (DDT) on dividends declared out of current income. Further still, from investors’ perspective, transactions that are entered on recognised stock
exchanges in IFSC are exempt from both securities transaction tax and commodities transaction tax. The Government has also exempted from the charge of capital gains, the gains arising on any transfers of specified bonds, Global Depositary Receipts (GDRs), masala bonds, and derivatives (specified securities) that are made by non-residents on recognised stock exchanges in IFSC.
New Tax SOPs for IFSC
Under the Budget proposals for this year, the tax holiday for IFSC units under section 80LA of the IT Act has been extended to 100% of the business profits for any ten consecutive years out of a period of 15 years, beginning with the year in which the requisite permission for the operation of the IFSC unit was obtained.
Non-residents and foreign companies are taxed at a concessional rate on certain types of income – such as interest, dividends, etc. – on a gross basis, without any expenditures/deductions being allowed therefrom. It has now been clarified that the tax holiday under section 80LA will now be available to non-residents and foreign companies in IFSC, even on such categories of income.
Under the corporate law in India, dividends can either be declared from current profits or from profits of previous years. In order to bring the tax provisions in alignment with the corporate law, the DDT exemption has been extended to dividends that are declared by corporate IFSC units from the income accumulated as an IFSC unit after 1 April 2017. However, there is still no clarity regarding the availability of the concessional MAT / AMT rate and the DDT exemption for assessees having both IFSC and non-IFSC presences.
In order to facilitate external borrowings by IFSC units, it is proposed to exempt the interest income that is earned by non-residents in respect of any monies that are borrowed by IFSC units on or after 1 September 2019. Interest on the existing external borrowings of IFSC units may continue to be taxable, which may lead to the refinancing of such existing borrowings.
Furthermore, in addition to non-residents, the benefit of exemption from capital gains on the transfer of specified securities on recognised stock exchanges in IFSC has also been extended to Category III AIFs located in IFSC, that derive their income solely in convertible foreign currency, and that have only non-residents as unitholders. The Government is also now empowered to notify other securities in respect of which such exemption shall be made available.
Similar to DDT, income distribution by mutual funds is also subject to an additional levy in the hands of the mutual fund under section 115R of the IT Act. The Budget proposes to exempt mutual funds that are located in IFSC from the tax that is chargeable under section 115R, on any distributions of income that have been derived from transactions made on a recognised stock exchange in IFSC. This exemption will be available provided that the mutual fund derives its income solely in convertible foreign currency and that it only has non-residents as its unitholders.
The above exemptions for Category III AIFs and mutual funds are intended to ensure that, from a tax perspective, there is no difference between investments by non-residents in specified securities on recognised stock exchanges in IFSC through Category III AIFs or mutual funds in IFSC vis-à-vis direct investment in these specified securities. To bring about further parity, an extension of the above exemption to income that is derived from investments that have been made outside India by Category III AIFs and mutual funds in IFSC, may also be considered.
The Budget 2019 has proposed certain welcome amendments for IFSC that will contribute to the value proposition of IFSC. Tax aspects aside, the key challenge involves resolving the ambiguities in the regulatory framework for IFSC and improving the ease of doing business. It is hoped that these fiscal incentives, accompanied by the establishment of a unified financial regulator, will finally provide the much-needed impetus for IFSC to become a success in India.
Vishal Gada is Partner, Zeel Jambuwala is a Principal, and Akshi Jain is a Senior Associate with Dhruva Advisors LLP. The views expressed by the authors are their own.