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Direct Tax Alert - CBDT notifies income attribution mechanism for beneficial tax treatment to specified funds in IFSC

20 August 2021

Background

Section 10(4D) of the Income-tax Act, 1961 (IT Act) was inserted by Finance Act, 2019 w.e.f. 1 April 2020 in order to grant exemption to ‘specified funds’ on income from transfer of capital asset specified1 under section 47(viiab) of the IT Act, on a recognised stock exchange of an International Financial Services Centre (IFSC) where consideration is paid/ payable in convertible foreign exchange.

‘Specified funds’ initially included only Category - III AIF (Alternate Investment Funds) regulated by the Securities and Exchange board of India (SEBI) AIF Rules, that were located in an IFSC and where all the units of such AIF were held by non-residents (other than the units held by sponsor/manager). The Finance Act, 2020 also restricted the exemption to income attributable to units held by non-residents.

The Finance Act, 2021 extended the scope of ‘specified funds’ to also include the Investment Division of an Offshore Banking Unit (OBU) which has been granted Category-I FPI (Foreign Portfolio Investor) license under the relevant SEBI (FPI) Rules, w.e.f. from 1 April 2022 provided the fund commences its operations before 31 March 2024, fulfilling certain conditions, including maintenance of separate account for its investment division.

The aforesaid exemption to the Specified Funds is available in respect of following incomes:

  • Income from transfer of a capital asset specified Section 47(viiab) of the IT Act on a recognised stock exchange of an IFSC where consideration is paid/ payable in convertible foreign exchange;
  • Income from transfer of securities (other than shares in a company resident in India);
  • Income from securities issued by a non-resident (not being a Permanent Establishment of a non-resident in India) and where such income otherwise does not accrue or arise in India;
  • Income from a securitisation trust which is chargeable under the head ‘Profits and gains from business or profession’.

Section 115AD of the IT Act provides beneficial tax rates to Foreign Portfolio Investors on incomes earned from securities in India. The Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 w.e.f. 1 April 2021 enhanced the scope of this provision and extended beneficial tax rates to income earned by units of ‘Specified Funds’ held by non-residents, not being a Permanent Establishment of a non-resident in India.

The aforesaid amended provisions did not prescribe the mechanism for computing the allowable exemption and or determination to income of such specified fund. Hence, the Central Board of Direct Taxes (CBDT) vide its notification2 dated 9 August 2021 inserted following rules to Income-tax Rules, 1962 (IT Rules) wherein the mechanism for computing the allowable exemption is prescribed:

  • Rule 21AI – Computation of exempt income of specified fund prescribed under section 10(4D) of the IT Act;
  • Rule 21AJ – Determination of income of a specified fund attributable to units held by non-residents under section 115AD(1A) of the IT Act.

Rule 21AI of the IT Rules

Income attributable to units held by non-resident [not being a Permanent Establishment (PE) of a non-resident in India] in a specified fund shall be computed using the following mentioned formula.

Exemption under section 10(4D) = A*C1 + B*C2 + D*F1 + E*F2

Where,

  • A - refers to income earned by a specified fund from transfer of capital assets specified under section 47(viiab), as mentioned above, the consideration for which is paid/payable in convertible foreign exchange;
  • B - refers to any income earned by the specified fund as a result of transfer of securities, other than shares of a resident Indian Company;
  • C1 - 

Aggregate of daily Assets under Management (AUM) of the Specified fund held by non-resident unit holders (not being the PE of a non-resident in India)


Aggregate of daily total AUM of specified fund from date of acquisition to transfer of capital asset specified in section 47(viiab) of the IT Act

  • C2 -

 Aggregate of daily AUM of the Specified fund held by non-resident unit holders (not being the PE of a non-resident in India) 


Aggregate of daily total AUM of specified fund from date of acquisition to transfer of the security (other than shares in a company resident in India)

  • D - refers to income accrued or arisen or received by specified fund from securities issued by a non-resident (not being a PE of a non-resident in India), where such income otherwise does not accrue or arise in India;
  • E - refers to an income accrued or arisen to, or received by a specified fund from a securitization trust which is chargeable under the head of ‘profits and gains of business or profession; and
  • F1 -  

AUM of the specified fund held by the non-resident unit holders (not being the PE of a non-resident in India)


Total AUM of the specified fund as on date of receipt of such income from securities issued by a non-resident (not being a PE of a non-resident in India) and where such income otherwise does not accrue or arise in India;

  • F2 -  

AUM of the specified fund held by the non-resident unit holders (not being the PE of a non-resident in India)


Total AUM of the specified fund as on date of receipt of such income from securitisation trust which is chargeable under the head ‘profits and gains of business or profession’. 

In order to claim the said exemption, the specified fund shall furnish an annual statement of exempt income in Form No, 10IG electronically, before due date of filing Return of Income, under digital signature verified in manner prescribed therein.

The Principal Director General of  Income-Tax (Systems) or the Director General of Income Tax (Systems) shall specify the manner of filing Form 10IG and procedures revolving the same.

Rule 21AJ of the IT Rules

Income of a specified fund by way of short term or long term gains, referred to in section 115AD(1)(b) of the IT Act, attributable to the units held by non-resident (not being the PE of a non-resident in India) shall be computed using the below mentioned formula.

Formula for computing income attributable to units held by non-resident - A = B * C

Where,

  • A - refers to income attributable to units held by a non-resident (not being the PE of a non-resident in India)
  • B - refers to income arising from transfer of security
  • C - 

Daily AUM of the specified fund held by the non-resident unit holders (not being the PE of a non-resident in India)


Aggregate daily total AUM of the specified fund from the date of acquisition to date of transfer of such security

Similarly, the income by way of income received in respect of securities attributable to the units held by non-resident (not being the PE of a non-resident in India) shall be computed using the below mentioned formula.

Formula for computing income attributable to units held by non-resident - X = Y * Z

Where,

  • X - refers to income attributable to units held by non-resident (not being the PE of a non-resident in India);
  • Y - refers to income received in respect of securities
  • Z - 

AUM of the specified fund held by the non-resident unit holders (not being the PE of a non-resident in India)


AUM of the specified fund as on date of receipt of such income

The specified fund shall furnish an annual statement of income for concessional taxation in Form No. 10IH electronically before the due date of filing Return of Income, via digital signature.

The Principal Director General of Income-Tax (Systems) or the Director General of Income Tax (Systems) shall specify the manner of filing Form 10IH and procedures revolving the same.

The said notification also incorporates the format of Forms 10IG and 10IH and specifies the supporting documents to be submitted to avail the said exemptions/concessions.

Conclusion

The above notification prescribes the manner of computation of income earned from Category-III AIFs and OBUs located in the IFSC, registered as Category-I FPIs. This provides much-needed clarity on the manner of claiming exemptions and/or benefits granted under the Act in respect of these funds, making them an attractive investment prospect for non-resident investors. This will aid in augmenting inflows from several foreign countries in the Indian IFSC. Moreover, a prescribed formula for computing exempt income will lead to lesser tax litigation and more certainty for the foreign taxpayers looking to set-up a fund/ invest in India.


1Bonds, Global Depository Receipts, Rupee Denominated Bonds of an Indian company, Derivatives or any other specified security

2Notification no. 90/2021 dated August 09, 2021