Establishing Alternative Investment Fund (AIF) in GIFT City

 Gujarat International Fin-Tec City (GIFT City) is being built as a worldwide financial and IT services hub, similar to globally benchmarked financial centres. It features an International Finance Services Centre ("IFSC")-designated Special Economic Zone. The IFSC was established to handle financial services transactions now carried out outside of India by foreign financial institutions and Indian financial institutions' overseas branches and subsidiaries.

 

The regulatory framework controlling funds in the IFSC has undergone significant regulatory modifications as part of the broader regulatory effort to support the expansion of financial services intermediaries in the IFSC. As a result, the IFSC is quickly establishing itself as a viable alternative to well-known fund jurisdictions like Singapore and Mauritius.

 

 

1. What is an International Financial Services Company (IFSC)?

Under the Special Economic Zones Act of 2005, the Central Government established a framework for the establishment of an IFSC. The IFSC was created to allow financial service companies to offer foreign currency financial services and products to their consumers (i.e. non-INR currencies).

For the purposes of India's exchange control regulations, "units" and "entities" in an IFSC are considered as "person resident outside India."

In Gandhinagar, Gujarat, GIFT City is being created as a worldwide financial and IT services hub to compete with globally benchmarked financial centres. It was designated as a Special Economic Zone ("SEZ") and is India's only certified IFSC. Because of its unique position, the IFSC is a desirable jurisdiction for pooling and managing global money.

2. Can Alternative Investment Funds be established in the IFSC?

Yes, all three types of Alternative Investment Funds (“AIFs”) (Category I, Category II, and Category III), as well as funds of funds, can be established in an IFSC.

The SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) also apply to AIFs in the IFSC. AIFs in IFSCs, on the other hand, have been granted specific dispensations to provide them with greater operational freedom while preserving tax efficiency. Please see Query [8] for more information on the tax advantages of establishing funds in an IFSC.

3. Are there any requirements for GIFT AIFs in terms of minimum fund size, minimum commitment size, sponsor commitment, and so on?

The Securities and Exchange Board of India ("SEBI") published Operating Guidelines for Alternative Investment Funds in International Financial Services Centres on November 26, 2018 ("Operating Guidelines"), which stipulate the following requirements for AIFs in IFSCs:

1. a continuous, minimum sponsor commitment of the lowest of:

1. USD 0.75 million, or 2.5 percent of the fund's corpus for Category I and II AIFs;
2.  USD 1.5 million, or 5% of the fund's corpus for Category III AIFs;

2. a minimum scheme size of at least USD 3 million;
3.  minimum investment

(a) by investors – USD 150 thousand; and

(b) by employees/directors of the AIF's manager – USD 40 thousand.

4. Does the regulatory framework established by SEBI for the formation of AIFs also apply to AIFs incorporated in GIFT City?

SEBI, India's capital markets regulator, which oversees AIF structures, has established special rules and restrictions for AIF formation in GIFT City. The Foreign Exchange Management (IFSC) Regulations, 2015, and the SEBI (IFSC) Guidelines, 2015, read with the Operating Guidelines, are the primary sources of regulation for AIFs in an IFSC. A fund must get registration from the IFSC Authority in order to operate as an AIF (as set up under the IFSC Authority Act, 2019).

5. Is it necessary for fund managers to establish a presence in the IFSC? What options do fund managers have in this situation?

IFSC AIF fund management entities can be established as a branch of an existing entity or as a separate entity in the IFSC. Notably, only existing fund managers have the option of establishing a branch office. Managers who want to raise a fund in an IFSC for the first time must first create an entity in that IFSC that will be responsible for the management of that AIF in that IFSC.

Because the status of entities in IFSCs is that of a person resident outside India and given the nature of fund management activity, the process of forming a new company or LLP in GIFT City would be governed by Regulation 7 of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (“ODI Regulations”). Regulation 7 allows an Indian party engaged in the financial services sector to establish an overseas joint-venture or subsidiary subject to certain conditions, including obtaining regulatory NOCs from the relevant financial services regulators in India and abroad.

6. What are the other options for committing sponsors to IFSC AIFs?

The RBI recently clarified that an Indian party will be permitted to make sponsor commitments to an AIF in IFSC, as required by the SEBI AIF Regulations if the ODI Regulations are met.

A non-resident person or an entity in the IFSC can also make a sponsor commitment. A branch in the IFSC, for example, would need regulatory approval before making a sponsor commitment to an IFSC AIF.

7. What is the process for establishing AIFs in GIFT City?

The diagram below depicts the key steps (along with a rough timeline) involved in establishing an AIF in GIFT City.

 

 

8. What are the main tax advantages of forming AIFs in the IFSC, GIFT City?

From a tax standpoint, IFSC provides appealing tax benefits such as a 100 percent tax exemption on business income for 10 consecutive years out of 15 years (“Tax Holiday”) and GST exemption for IFSC entities. AIF managers can take advantage of these benefits in relation to their fund management income.

The tax pass-through status under Section 115UB of the Income Tax Act of 1961 has been extended to Category I and II AIFs. Meeting the ‘specified fund' criteria of a lower rate of taxation for income in the form of capital gains and interest is applicable to Category III AIFs. Furthermore, as previously stated, Category III AIFs with business income should be able to claim the Tax Holiday.

For the transfer of specific securities[1], a 100 percent tax exemption has been granted to Category III AIFs in the IFSC where (a) the consideration for the transfer is payable in a foreign currency; and (b) all units of the AIF are held by non-residents (except those held by the sponsor and/or manager of the AIF).

The following are the rates that apply to various types of income earned by a Category I or Category II AIF in the IFSC: