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Regulatory Alert - Tax and Regulatory update on Foreign Portfolio Investors (FPI) and International Financial Services Centre (IFSC) – April 2021 to June 2021

21 July 2021

Financial Year (FY) 2021-22 in India has ushered with regulatory and tax reforms for foreign investors. The Covid-19 pandemic has scarred a long-lasting impact on the world and has also changed the investment dynamics across globe. We have summarized below the reforms/ updates which the Indian government has announced in the foregoing quarter to promote foreign investment in India.

Regulatory Updates – FPI

1. Republic of Cyprus now notified as a Category I jurisdiction

Ministry of Finance vide its order dated 14 June 20211 has notified Republic of Cyprus as an eligible country for the purpose of granting Category I2 license to entities proposing to invest in India under the FPI route.

As per the SEBI (FPI) Regulations, 2019 Category-I FPIs includes entities from the Financial Action Task Force (FATF) member countries or from any other country specified by the Central Government of India, by way of an order or an agreement or treaty with other sovereign Governments. Thus, with the recent order dated 14 June 2021, the funds/ entities in Republic of Cyprus will be eligible to opt for category I registration and consequently, such funds will be outside the net of Indirect transfer provisions3, have lower KYC requirements, higher derivatives limit etc.

2. ‘Off-market’ transfer of securities by FPI

In order to further incentivize investments in IFSC, the government provided tax incentives to foreign funds relocating in IFSC in Finance Act 2021. To facilitate the relocation of funds in IFSC, SEBI vide its circular dated 1 June 20214 has permitted a one time off-market transfer of securities by an existing FPI or its wholly-owned special purpose vehicle to the resultant fund in IFSC. The FPIs may approach its Designated Depository Participant (DDP) for approval for off-market transfer and the DDP after carrying out the necessary due diligence can accord its approval for a one-time off-market transfer of securities for such relocation.

3. Regulatory relaxations provided to ease operational constraints faced by FPI dealing in Government Securities (G-Secs)

Payment of margin money for transactions in G-Secs

  • Every transaction in G-Secs undertaken outside the recognized stock exchanges are settled on a guaranteed basis by the Clearing Corporation of India Ltd. (CCIL) which acts as the central counter party.
  • In order to further boost investments by FPIs in the Indian debt market, the RBI vide its circular dated 4, June 20215 have allowed banks having Authorised Dealer Category – 1 (AD) license to place margin money on behalf of the FPIs as per their credit risk management framework with CCIL for settlement of transactions in G-Secs.
  • Requisite changes have been made in the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 vide notification dated 24 May 20216 allowing AD in India to lend money for margin payments in relation to payments for settlements involving G-Secs.

Timeline for Reporting of transactions in G-Secs

  • As per the current regulatory provisions, transactions undertaken over-the-counter (OTC) in the secondary market are to be mandatorily reported on the Negotiated Dealing System – Order Matching (NDS-OM) platform for settlement.
  • Due to operational issues faced by the FPIs, Reserve Bank of India (RBI) vide its notification dated 7 June 20217 has provided operational flexibility to the FPIs for reporting of such transactions on the NDS-OM within 3 hours after the close of the trading hours for G-Secs market.
  • Clearcorp Dealing Systems (India) Ltd. (CDSL) shall disseminate the information about the trades undertaken by the domestic counterparties with FPIs when it is reported on the NDS-OM platform by the domestic counterparties.
  • The existing reporting obligations of the domestic market participants including domestic counterparties will continue as per the existing practices. CDSL will issue necessary operational guidelines in this respect.

4. Relaxation in timelines for compliance with regulatory requirements

Due to COVID-19 pandemic, SEBI through its various circulars had relaxed timelines for compliance with various regulatory requirements like maintaining call recordings of orders / instructions received from clients, client funding reporting, operating the trading terminals from designated alternate locations, KYC form and support documents uploading on the KRA system and issue of Annual Global Statement to clients. SEBI vide its circular dated 30 June 20218 have given a further extension in timeline for the filing of the above regulatory compliances to 31 July 2021 due to the prevailing situation of the COVID-19 pandemic.

Regulatory Updates –IFSC

1. Offering of Portfolio Management Service (PMS) and Investment Advisory Service (IAS) by Banking Units (BUs)

The International Financial Services Centres Authority (IFSCA) had notified IFSC (Banking) (Amendment) Regulations, 2021 (Banking Regulation) on 25 March 2021 which permitted BUs to offer PMS and IAS services to person resident in India and outside India. The IFSCA vide its circular dated 26 April 20219 has enlisted the below guidelines for BUs:

  • Operational Guidelines issued by SEBI dated 9 September 202010 for Portfolio Managers in IFSC shall be applicable to the BUs.
  • BUs which are permitted to offer PMS by IFSCA need to maintain a ‘Clients Portfolio Account’ for funds received by it for portfolio management on a daily basis. The undeployed funds, if any, shall be treated as outside borrowings of BUs.
  • BUs shall maintain functional separation of trading and back-office processes for its own investments and PMS clients’ account.
  • The BUs that are permitted to offer PMS are also permitted to provide investments advice to their PMS clients in IFSC.

2. Clarification on criteria for BUs to become trading/clearing members of IFSCA recognized stock exchanges

The IFSC Banking Regulation 2020-Directions for implementation dated 4 December 202011 had laid down certain criteria for BUs to become trading / clearing member of IFSC stock exchanges by adopting RBI (Financial Services Provided by Banks) Directions, 2016 (RBI Directions) dated 26 May 2016. One of the criteria listed in the RBI Directions para 21(a) have been modified as under:

BUs cannot become a trading member in interest rate and currency derivatives segment and /or clearing member in any derivatives segment of IFSC stock exchanges unless its parent bank satisfies the minimum prescribed capital requirement (including Capital Conservation Buffer) specified by the home regulator of the parent bank. In case the criteria are not fulfilled, BUs may participate only in currency derivative as a client.

As per the earlier RBI Directions, no Authorised Dealer (AD) – I category bank could become a trading / clearing member of the currency derivatives segment of a SEBI recognized stock exchange unless it had a minimum worth of INR 500 crore, minimum prescribed capital (including Capital Conservation Buffer), net NPA does not exceed 3% and has made a net profit in the preceding 3 financial years.

3. Alternative Investment Funds (AIFs) in International Financial Services Centres

AIFs in IFSC have been setting up as per the SEBI (IFSC) Guidelines, 2015 and the Operating Guidelines for AIFs in IFSC dated 26 November 201813. Subsequently, the IFSCA vide its circular dated 9 December 202014 had modified the framework for AIFs in IFSC. The IFSCA vide its circular dated 25 June 2021 have amended the following norms for AIFs in IFSC:

  • For facilitating relocation of funds established or incorporated or registered outside India to IFSC, the continuing interest requirement15 to be fulfilled by the Manager or Sponsor of the AIF as per the operating guidelines shall be voluntary.
  • AIFs in IFSC are permitted to invest in units of schemes launched by mutual fund regulated in FATF compliant jurisdiction (including India).

Tax Updates

1. Relaxation of conditions for Pension Funds (PFs) claiming exemption under Section 10(23FE)

  • The Finance Act of 2020 had introduced Section 10(23FE) for exempting specified investors, including PFs from tax on interests, dividends, long term capital gains from investments made in ‘Specified Sectors’ like Infrastructure Companies, Category I & II AIFs, having their investments in ReITs and InvITs.
  • Further,  CBDT had issued a notification in 2020 prescribing conditions to be satisfied by the PF for claiming exemption under Section 10(23FE) of the Act. This has been summarized in our earlier update dated 12 October 202016.
  • The CBDT vide its notifications dated 15 April 202117 and 26 April 202118 have amended Rule 2DB to update the conditions to be satisfied by PF under Section 10(23FE) of the IT Act which are as follows:
    • Clause (ii) of Rule 2DB provides for administering or investing the assets to fulfil the statutory obligations and defined contributions of one or more funds for providing retirement, social security, employment, disability, death benefits or any similar compensation to the participants or beneficiaries of such funds or plans, as the case maybe. The aforesaid condition mentioned will be deemed to be fulfilled provided the fund fulfills the conditions prescribed therein in relation to value of assets and ownership/ vesting of assets.
    • Further, Clause (iii) of Rule 2DB provides that the earnings and assets of the PF are to be used for meeting statutory obligations and defined contributions for participants or beneficiaries of funds or plans and restrict the benefits to any private person. However, CBDT has now provided certain exclusions to the aforesaid condition.
    • Moreover, the Clause (iv) of Rule 2DB which restricted PFs from undertaking any commercial activity has now been omitted.
  • For detailed discussion on the relaxations provided, please refer to our alert on the same at:

2. Eligible Foreign Investors (EFIs) dealing in IFSC-listed securities exempted from obtaining Permanent Account Number (PAN) in India

  • Previously, Rule 114AAB of the Income-tax Rules, 1962 (IT Rules) provided an exemption to non-resident investors/unit holders who earned income from investment in Alternative Investment Funds (AIFs) set-up in IFSC, from the requirement of obtaining PAN under section 139A of the Income-tax Act, 1961 (Act) subject to certain conditions.
  • In order to provide exemption under Rule 114AAB of the IT Rules to EFIs, the CBDT vide its notification dated 4 May 202119 have provided exemption to EFIs who have undertaken transactions in foreign currency in the following capital assets referred to in Section 47(viiab) of the Act, listed on a recognized stock exchange in any IFSC.
    • Bond or Global Depository Receipt;
    • Rupee denominated bond of an Indian company; or
    • Derivative; or
    • Such other securities as may be notified by the Central Government.
  • The above exemption will be available only on fulfillment of the prescribed conditions.
  • Stockbrokers of EFI should furnish a quarterly statement with details and documents received by it as mentioned above in Form 49BA within 15 days from the end of the quarter of the financial year to which such statement relates to the appropriate authority.
  • Further, while Rule 114AAB of the IT Rules earlier covered only Category – I and Category – II AIFs located in IFSC, the amended Rule also includes Category – III AIFs located in IFSC. Accordingly, investors in Category – III AIFs in IFSC, which qualify as ‘specified funds’, will also be eligible to avail the exemption from obtaining PAN in India.
  • For detailed discussion on the amendment, please refer to our alert on the same at:


1. Short Term Capital Loss (STCL) to be carried forward despite the gains being exempt under India-Singapore DTAA

The Mumbai Income Tax Appellate Tribunal (ITAT) in a recent judgement20 has allowed the carry forward of STCL, despite capital gains being exempt under the India-Singapore DTAA.

The assessee was a tax resident of Singapore and registered with SEBI as an FPI. The assessee had incurred STCL and filed its return of income claiming carry-forward of  losses. The Assessing Officer (AO) rejected assessee’s claim of carry forward of losses.

The Mumbai ITAT heard the matter and ruled in favour of the assessee. The Mumbai ITAT made following observations in its judgement:

  • While determining taxability of the income earned, if the provisions of the Act are more beneficial then the tax treaty, then the beneficial provisions will apply as per the Act.
  • Reliance was placed on the ruling passed by the co-ordinate bench for a similar issue in the case of assessee’s sister concern, Goldman Sachs Investments (Mauritius) Ltd.21 Therefore, basis judicial precedents, tax treaty cannot be forced upon the assessee merely because it is a tax resident of a country with which India has signed a tax treaty or on the AO’s perception that the assessee might claim treaty benefit for the subsequent years.
  • Basis the above, the assessee is considered eligible to carry forward the losses.

2. Income from IDRs exempt under Article 22 of India-Mauritius DTAA

Mumbai ITAT in a recent judgement22 examined the taxability of income derived from Indian Depository Receipts (IDR) by a company who is tax resident of Mauritius.

The Mumbai ITAT, after taking into consideration of the contentions of the assessee and the tax authorities ruled, in favour of the assessee stating the following:

  • There is a significant business connection in India as:
    • The underlying shares through which the IDR derived its value were held by the Domestic Depository and constituted the property of the Domestic Depository.
    • The IDRs in respect of which these monies are received are issued in India by the Indian branch.
    • The IDRs are listed in Indian stock exchanges.
    • The management and operations of the Domestic Depository is in India.

Therefore, the dividend can be taxed in India due to the business connection, i.e., the assets being situated in India as per Section 9(1)(i) of the Act.

  • As per section 9(1)(iv) of the Act, dividend paid by an Indian company outside India is deemed to accrue or arise in India. In the given case, the dividend is not paid by an India company. The Mumbai ITAT accepted the contention of the tax authorities that Section 9(1)(iv) of the Act does not start with a non-obstante clause, therefore, dividend income which cannot be taxed under Section 9(1)(iv) of the Act can be taxed under Section 9(1)(i) of the Act.
  • Article 10 of the India-Mauritius DTAA will only apply when a resident of Mauritius or India pays dividend to the resident of other country. In the given case, dividend was paid by the Indian branch of a UK Bank (PE of UK Bank), therefore, not an Indian resident. The recipient of dividend is a Mauritius resident and therefore, taxability under Article 10 of the India-Mauritius DTAA will not apply.
  • Consequently, incomes not coming under the ambit of any specific articles of the India-Mauritius DTAA shall be covered by Article 22 – Other Income. As per the erstwhile Article 22 prior to 1 April 2017, the residuary income which was not specifically covered by any of the specific DTAA articles and not covered by the exclusion of clause Article 22(2), could only be taxed in the residence jurisdiction.
  • Therefore, dividend received by the assessee cannot be taxed in India under Article 22 of the India-Mauritius DTAA.

However, it is imperative to note that Clause (3) was inserted under Article 22 of the India-Mauritius DTAA w.e.f. 1 April 2017, which gives permits source-based taxation rights for residual incomes. Accordingly, dividend income from IDRs pertaining to periods prior to fiscal year 2017-18 are taxable in the country of residence of the taxpayer under the India-Mauritius DTAA. However, dividends on IDRs earned post 1 April 2017 can be brought to tax in India under clause (3) to Article 22 of the India-Mauritius DTAA.

For detailed analysis of the judgement, please refer to our alert on the same at:


1F. No 10/6/2019-EM dtd.: 14 June 2021

2Category I FPI includes government and government related investors, pension funds, university funds, insurance/ reinsurance entities, investment advisors, banks, etc. and entities from FATF member countries which appropriately regulated funds, university related endowment and unregulated funds subject to certain prescribed conditions.

3The indirect transfer provisions state that the shares of a foreign company or entity deriving substantial value directly or indirectly from assets located in India shall be deemed to have been situated in India and therefore, any capital gain arising from the transfer of such shares would be taxable in India.

4SEBI/HO/FPI&C/P/CIR/2021/0569 dtd.: 1 June 2021   

5RBI/2021-22/48 A.P. (DIR Series) Circular No.06 dtd.: 4 June 2021

6FEMA. 3(R)2/2021-RB dtd.: 24 May 2021

7FMRD.FMID.No.05/14.01.006/2021-22 dtd.: 7 June 2021

8SEBI/HO/MIRSD/DOP/P/CIR/2021/587 dtd.: 30 June 2021

9F.No.110/IFSCA/Banking Regulation/2021-22/1 dtd.: 26 April 2021

10Circular no. SEBI/HO/IMD/DF1/CIR/P/2020/169 dtd.: 9 September 2020

11F.No.110/IFSCA/Banking Regulation/2020-21/1 dtd.: 4 December 2020

12RBI/DBR/2015-16/25, Master Direction/DBR.FSD.No.101/24.01.041/2015-16 dtd.: 26 May 2016

13SEBI/HO/IMD/DF1/CIR/P/143/2018 dtd.: 26 November 2018

14F. No. 81/IFSCA/AIFs/2020-21 dtd.: 9 December 2020

15Category I and II AIF Continuing interest shall be 2.5% of the corpus or USD 0.75mn, whichever is lower, in the form of investment in the AIF and such interest shall not be through the waiver of management fees. However, for Category III AIF Continuing interest shall be 5% of the corpus or USD 1.5 million, which ever is lower.


17Notification no. 32/2021 dtd.: 15 April 2021

18Notification no. 37/2021 dtd.: 26 April 2021

19Notification No. 42/2021 dtd.: 4 May 2021

20Goldman Sachs India Investments (Singapore) PTE Limited [TS-294-ITAT-2021(Mum)]

21Goldman Sachs Investments (Mauritius) Ltd. Vs. DCIT (2020) 120 23 (Mum-Trib.)

22ITA No.: 7388/Mum/19