The investment world now understands that politics and related matters of business climate in the Republic of India since the dramatic victory of the Bharatiya Janata Party in 2014. What is less well known is that alternative investment funds have been among the beneficiaries of the broader change.
This story starts two years before the BJP victory, that is, in 2012, when the Securities and Exchange Board of India (SEBI) promulgated its alternative investment funds (AIF) regulations, governing hedge, real estate, and private equity funds registered in that country.
SEBI distinguished three categories of AIF: those funds receiving incentives from the government, those which operate in the country on the understanding that they will not “undertake leverage or borrowing other than to meet day-to-day operational requirements,” and those that may employ leverage “including through investment in listed or unlisted derivatives.” These are known, straightforwardly, as Category I, II, and III.
For those who are devotees of the Roman numeral system: category I consists of infrastructure funds and others thought to have positive externalities for society at large; category II consists of PE, VC, and debt funds; category III of hedge funds.
The three categories were treated in significantly disparate ways by the laws in India. One difference was that funds in each of the first two categories have been able to use tax pass-through status, but hedge funds were not.
After the Election
After some experience with that three tiered system, and after the formation of a new government by Narendra Modi in 201, SEBI established an Alternative Investments Policy Advisory Committee to study “the further development of the alternative investment and startup ecosystem in India.” The chair of this committee was and is N.R. Narayana Murthy, who is also the founder of Infosys, an India based technology consulting and services multinational.
Since then, the committee has provided SEBI with two new reports on AIFs, one quite early in 2016, and the other as the year ended. The first report suggested various tax and regulatory changes that might facilitate the capital raising ability of AIFs. The second report was in the nature of a follow up.
These reports represent an increasing sense among the Indian elite that alternative investment vehicles are good for the country. As the January 2016 report said, between 2001 and 2015, “venture capital and private equity of more than $103 billion was invested in Indian companies … in more than 3,100 companies across 12 major sectors, including those critical for the country’s development” such as mobile telecomm and information technologies.
To a large extent this is money drawn into India by the existence of opportunity, and it often passes through convenient hubs, especially Mauritius or Singapore, on its way.
The second SEBI report on this subject in 2016, further detailed the new approach. It pointed out that not all the money entering alternative vehicles was coming from abroad, that “the domestic funding of AIFs has grown rapidly by approximately … 108% during the last 12 months.”
Further, this report praised the May 2016 India-Mauritius Double Tax Avoidance Agreement (DTAA), designed to encourage the flow of money through Mauritius on its way to India.
Double taxation avoidance is often a good idea, then, both with regard to pass-through countries and with regard to pass-through entities. One of the keys to the two reports’ recommendations is a proposal to offer pass-through tax status to Category III AIFs.
Also, the recommendations include a waiver of the service tax paid by funds on the management fee, introduction of a securities transaction tax, and the application of the capital gains tax to certain income of category II funds.
Another point the second report on AIFs makes involves transparency: what should the investor in an India AIF know and when should he/she/it know this? In essence, the report says that SEBI should stipulate that quarterly reports to all AIF investors include: a summary management discussion and analysis letter; a balance sheet; period-end schedule of investments; statement of operations; cash flow statement; partners’ capital account statement.
Also, “the process for the transfer of units should be clearly stated in the placement memorandum to provide a mechanism for investors to transfer units before the end of a Fund’s life.”