In this blog post, Ashutosh Singh, a student of Department of Law, University Of Calcutta, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, provides investment information to foreigners intending to invest in mutual funds in India.
What is a Mutual Fund?
Before we get into the complexities relating to norms for foreigners investing in Mutual Funds in India, we need to get certain basics clear, and this is the definition and other key elements of a Mutual Fund. The SEBI (Mutual Funds) Regulations 1993 defines a Mutual Fund (MF) as a fund established in the form of a trust by a sponsor to raise money by the Trustees through the sale of units to the public under one or more schemes for investing in securities in accordance with these rules and regulations this is the official definition now let us deconstruct it into smaller parts. So typically we have to emphasize upon the following –
- Mutual Fund – Every MF needs to be registered with SEBI structured as a Trust according to the provisions of the Indian Trusts Act of 1882 and the deed needs to be signed by the sponsor and the Trustees only then can it be registered under the Registration Act of 1908.
- Sponsor-Is required to have a sound track record and contributing 40% of the net worth of the Asset Management Company (AMC), he is also liable for his acts and that of others.
- Trustees– Each MF must have an independent board of trustees 2/3rd of who have to be independent without any relation to the sponsors of the fund. They are required to maintain all the systems relating to the auditors and registrars in place before any scheme is launched; they also have to prevent any differential treatment between the associates of the fund and individual unit holders.
- Asset Management Company – The sponsor or the trustees are required to appoint an Asset Management Company to manage the assets of the fund. They have to comply with the mutual fund regulations and SEBI guidelines some of which include aspects such as – the AMC should at all times maintain a minimum net worth of a 100 million, the board of the AMC must have 50% such members who are not related in any manner either the sponsors or the trustees of the fund and also the chairman of the AMC must not be a trustee of any mutual fund etc.
- Custodian- Every mutual fund under the mutual fund regulations id requires to have a custodian appointed to carry out the custodial services of the fund the precursor to be being appointed as a custodian includes the presence of the necessary infrastructure and organizational strength. It must also be made clear that the custodian must have no relation to the AMC and must be registered with SEBI under the Custodian of Securities Guidelines, 1996.
So a diagrammatic representation of a general mutual fund would appear like this-
Now having discussed the basic structure we move on with foreigners investing in mutual funds, there are three ways of securing investment under this head they are –
- Ownership of AMC and mutual fund – This happens when international players like Prudential of UK, Alliance, ANZ Grind lays decide to set shop in the domestic market by having their own Asset Management Companies . in doing so they have to be careful towards the foreign investment guidelines prescribed by the Foreign Investment Promotion Board (FIPB), under the current rules this form of asset creation comes under the NBFC – non-banking finance activity in accordance with the sectorial capitalisation norms:
What this cap on capital investments have done is that a lot of foreign investors have adopted the joint venture model of investment through the direct route and this requires no prior approval of the FIPB.
- Offshore mutual fund route – This method of investment is suited for those foreign investors who are not willing to enter the domestic market themselves but are willing to participate in the domestic capital market operations. They are done by setting up of funds in a favorable tax jurisdiction the monies for this fund are raised from overseas investors and are invested into the domestic Indian mutual funds. The scheme is structured as such that all units are available to the overseas fund, and then these funds are invested in securities of Indian companies. The AMC along with the overseas fund both need to be registered with SEBI. SEBI looks into the following criteria before granting sanction -.
This method of funding has been successfully undertaken by the UTI to raise funds from overseas investors and includes in itself the benefits which are provided under the DTAA (Double Tax Avoidance Agreement) Mauritius route.
- Foreign Institutional Investors (FII) – For investment through this route, prior approval of RBI is under the guidelines of the Foreign Exchange Management Act 1999. SEBI, however, provides a single window clearance under this route for all operations in the domestic market under the SEBI (Foreign Institutional Investors) Regulation 1995. After obtaining permission under this, the FII are free to perform a wide array of activities like buy – sell securities issued by an Indian company, realize capital gains on an investment made through the initial amount , subscribe to or renounce right offerings of shares, appoint a domestic custodian, etc.
Now having mentioned the ways of obtaining foreign investment we must throw some light upon the recent developments in this field by the UK Sinha Committee report on Working Foreign Investment, the basic contentions of the report are as such –
- The committee is called for the restructuring of the capital flow management system.
- It is also called for a single window registration and investment administration process and a creation of a new category of investors called the Qualified Foreign Investor.
- Providing such a framework of Qualified Depository Participants (DP) with a wide branched network responsible for enforcing OECD and standard KYC requirements.
- The committee also prescribed detailed background checks for such high capital DP’s operating in the country,
- It has also suggested the abolishing of NRI’s and FII’s as a separate investor class.
Globally countries including the likes of Brazil, South Korea, and Turkey do not fragment their markets by distinguishing between the types of investors.
Benefits due to these recommendations in the Mutual Fund Market –
- The Global Depository Participants would meet the KYC requirements.
- The mutual funds would not have to go through the hassles of setting up of an offshore vehicle for marketing their products.
- The cost of compliance would come down, significantly.
- The Prevention of Money Laundering Act, 2002 guidelines for suspicious transactions, would be dealt with by the DP’s.
Foreign Investment Routes
Now we discuss the two basic routes for foreign investment assuming the foreign country of investment to be the United States of America.
Capital gains tax is not taxed in India as well as Mauritius per DTAA between India and Mauritius.
Capital gains tax is to be in India.
Now comparing these two models of investment the first option is more favorable from the point of view of the foreign investor because –
- No withholding of tax in India if invested through the Mauritius route and no capital gains tax as Mauritius is a tax heaven.
- Subjects of countries with whom a bilateral trade treaty exists are subject to no tax or favorable tax as compared to those of other countries which in this case is Mauritius.
- Thus the need for a residence-based system of taxation instead of a source based system was recommended by the committee.
Thus, these are the various aspects which along with the sectoral compliances are to be kept in mind by a foreign investor while investing in Mutual Funds in the Indian market.