Faced with shortage of domestic capital and compelling need to accelerate the rate of economic growth, successive governments have taken steps to attract foreign investment.
Strictly speaking, the capital inflows to India should be sourced from income generated from business or otherwise – by persons located in foreign jurisdictions. The persons could be foreigners or non-resident Indians [NRIs] or persons of Indian origin [PIOs] or overseas citizens of India [OCIs]. In case however, the inflow happens to be Indian money which left our shores in a clandestine manner and comes back in the garb of foreign capital [also known as ‘rounding tripping’ in common parlance] then, it raises many eyebrows.
Until a few years ago, the extant policy and regulatory environment hugely facilitated ‘rounding tripping’. Thus, there was little regulatory oversight on money leaving and there were tax haven jurisdictions ever ready to attract it. The shell companies [albeit owned by persons to whom the money belonged] set up in those jurisdictions would then, invest in India fully leveraging benevolent tax treaties between India and those countries.
For instance, under the then India-Mauritius double taxation avoidance agreement [DTAA], India granted tax exemption on capital gains made by investors resident in Mauritius [the definition of ‘resident’ was so generous that even post-box/shell companies were eligible] from sale of shares of Indian companies. Since, no capital gain tax is levied in Mauritius either, the income accruing from such gains escaped tax in both countries. The same dispensation applied to investors from Singapore.
In the first decade of 2000s, the investment from these countries was made mostly in offshore derivative instruments [ODIs] or Participatory notes [P-notes in common parlance]. ODIs are instruments issued by foreign portfolio investors [FPIs] registered with Securities and Exchange Board of India [SEBI] against Indian stocks to overseas subscribers who themselves do not wish to get registered with the national regulator.
Though, the stated rationale for allowing investment through this route was to avoid hassles of extensive documentation and compliance that go with registration, its real intent was to offer a veil of secrecy to those [read round trippers] who were making such investment. No wonder, investment via ODI/P-notes reached a crescendo in 2007 when these accounted for 56% of total portfolio inflows.
Since 2011, SEBI initiated a series of steps which on the one hand, simplified and rationalized process of direct registration and on the other, tightened norms for investment via P-notes. It started exercising greater regulatory oversight over the FPIs issuing such instruments. But, that did not help much as the root cause viz. veil of secrecy surrounding these instruments remained un-addressed.
Unlike domestic investors who were subject to onerous Indian KYC [know your customer] norms, FPIs and subscribers of P-notes had only to comply with KYC norms of the jurisdiction where these entities are located. The latter were very liberal.
Modi – government has waged a battle on ‘round tripping’ by (i) enactment of a law on Black Money [2015]; (ii) revision in tax treaties with safe haven jurisdictions to bring the tax treatment for investors from there at par with domestic investors and (iii) tightening the norms for foreign investment.
The SEBI now subject foreign investors to the same KYC norms as applicable to domestic investors. Their KYC status has to be reviewed annually. The FPIs are required to report information regarding their investment on monthly basis. The P-notes status has to be updated every six months. The issuer should immediately inform the financial intelligence unit [FIU] when unusually high volumes of P-notes change hands. These instruments are not allowed to be issued to resident Indians, NRIs or PIOs.
The above requirements have sought to lift the veil of secrecy surrounding foreign investment coming via FPI and bring clarity about the beneficial owners.
Meanwhile, in April, 2018, SEBI issued a circular proposing a new set of conditions to be complied by September 30, 2018. The deadline has since been extended till December 31, 2018.
This time, the focus of the regulator is on determination of the beneficial ownership [BO] of the FPIs which manage foreign investment. In addition to the ‘economic criteria’ [it goes solely by majority shareholding of an entity], it includes ‘control’ as well. A person may not hold any shares yet, he has full authority to run the show.
If, in this sweeping sense, an NRI or PIO happens to be the BO of the FPI then, the entity won’t be in compliance with the KYC norm and hence, becomes ineligible.
Apart from India-dedicated funds set up by NRIs, there are global FPIs who have appointed NRIs and PIOs as their fund managers. Under the norms now proposed by SEBI [April 2018 circular], all of them will stand disqualified from investing in India. No wonder, a lobby group named AMRI [Asset Management Roundtable of India] has gone that far to say that this would lead to withdrawal of USD 75-billion investment causing mayhem in the stock market and building more pressure on the Rupee.
There is an inherent flaw in the SEBI’s approach. It is mixing up the beneficiaries of foreign investment [the sole concern due to ‘round tripping’ is centred around them] with the ownership and control of FPIs whose job is merely to manage the funds. The regulator should prevail upon the latter to keep tab on the former in preventing any wrongdoing.
While, SEBI has every right to shut the door to an FPI for abetting wrongdoing by its subscribers, but to do so merely because it is owned and controlled by NRI/PIO is an abhorrent idea. The bottom-line is to exercise due diligence on investors irrespective of who manages the fund – a Indian resident or foreigner.
The powers that be should stop juggling around the ownership and control of FPIs [a committee under ex-deputy governor, RBI, HR Khan has recommended 25%/50% shareholding of NRIs/OCIs, exemptions for PIOs etc to get over the rigors of SEBI circular] as this is not relevant to the main issue. Instead, the focus should be entirely on ensuring full compliance with KYC norms for the investors.
This will address the concerns due to ’round tripping’ without undermining the interest of foreign investors in India.