Budget 2023 and Gift IFSC: Making Things Happen

Anirudh Grover, Executive | finserv@vinodkothari.com

Background and Existing Framework

The International Financial Services Centre (“IFSC”) situated in the GIFT city is deemed to be a quasi-foreign territory from the lens of Foreign Exchange Management Act, 1999 however a domestic area under the tax regime. The objective of setting up specified territory lies in the benefits an IFSC jurisdiction provides in the form of free flow of foreign transactions and investor confidence; this setting up is commonly termed as onshoring the offshore. 

In order to materialize the underlying objective, a specific regulatory framework has been designed which includes the incorporation of the following major entities:

1. Finance Companies: The concept of Finance Companies are pari materia to the concept of non-banking financial companies, the unified regulator IFSCA has issued regulations specifically dealing with the concept of Finance Companies. The detailed write up of which can be found in our write up.
2. Fund Management Entities (‘FMEs’): FMEs are entities which act as pooling vehicles for various kinds of investors, this concept of FME’s is equivalent to the concept of Alternative Investment Fund. A designated regulatory framework has been specially established by the unified regulatory for governing the framework of FMEs in IFSC, the details of which can be captured from our write up
3. Banking Units: As far as Banking Units are concerned, the IFSCA has outlined a framework through which Indian banks or foreign banks can set up their shop in the form of branches in IFSC GIFT City. The IFSCA (Banking) Regulations, 2020 are the principal regulations governing the Banking Units established in the IFSC GIFT City. My colleague has already covered the regulatory overview on this aspect in our write up. 

Apart from these entities there are other entities as well which are running their businesses from IFSC GIFT City which includes Fintech Entities, Capital Market Intermediaries and Insurance Intermediaries. The Union Budget of 2022 paved the way for bringing fundamental changes in the IFSC jurisdiction which resulted in the establishment of a regulatory framework namely IFSCA (Setting up and Operation of International Branch Campuses and Offshore Education Centres) Regulations, 2022. By virtue of these regulations now Foreign Universities have been allowed to set up their base in IFSC. Further the Union Budget 2022 also laid the ground for establishment of an Arbitration Centre which would allow disputes to be resolved in record time. 

Albeit these announcements came out to be a key in evincing interest in the IFSC jurisdiction however it is perceived that there are certain pivotal areas of law which require further modifications/clarifications which is expected to be a part of the Union Budget of 2023.

Is IFSC GIFT City a dream too far off?

The role of IFSCA in materializing the two-fold objectives of the GIFT City cannot be less emphasized and therefore to fulfill these objectives, IFSCA is facilitating a favorable and comprehensive ecosystem to enable the financial institutions, products and services to gravitate towards the IFSC. However, in order to ascertain whether these objectives have been really effective one needs to capture the flow of transactions and the magnitude of transactions which have undertaken premised on the framework issued by the IFSCA.

The Annual Report of 2021-22  published by the IFSCA showcases a comparative data of the magnitude of transactions undertaken by various types of entities

Banking Ecosystem in IFSC^[1]

Particulars	FY 2020-21	FY 2021-22
No. of IBUs as at end of the period	15	15
Total Assets outstanding in USD Mn at end of the period	14,977	29,381
Turnover (volume of business in USD Mn) during the period	21,110	1,06,982
No. of employees as at end of the period	118	162

Capital Market Ecosystem in IFSC^[2]

1. Notional Turnover on Exchanges (Million USD): The notional turnover on the recognised stock exchanges in IFSC increased to USD 2,867 billion during FY 2021-22 compared to USD 1,980 billion during FY 2020-21. Therefore, the notional turnover during FY 2021-22 increased by approximately 45% compared to previous year. Additionally, the year on year growth from 2016 can be portrayed from the below graph wherein it can be clearly seen that with each passing year the turnover is increasing.

Fig A: Notional Turnover on Exchanges

2. Debt Listings on IFSC Exchanges

Fig B: Debt Listings on IFSC Exchanges

The cumulative listing of debt securities increased by around 67 per cent at the end of FY 2021-22 over the previous financial year

3. Alternate Investment Funds

The number of funds registered with IFSCA also gathered momentum in 2021-22. There are a total of 24 AIFs in IFSC as on March 31, 2022. Out of these 24 AIFs, 10 belong to Category 1 and Category 2 AIF having a total committed funds of USD 4,081 million while 14 are under Category 3 AIF with total committed funds of USD 1,072 million.

Recommendations vis a vis Tax^[3]

Despite the numbers above showcase a green shot in the growth trajectory of the IFSC Gift City still there are certain key areas which require further clarity in terms of taxation structure in IFSC and regulatory approach. This need for clarity stems from the India-UK Financial Partnership (IUKFP) which was set up to develop recommendations to transform GIFT City into a global services hub.

The Report which was published in the year 2021 highlighted the importance of certain key recommendations which are considered essential for improving the existing taxation system in IFSC.

1. Consolidate IFSC Related Provisions under the Income Tax Act: The provisions as applicable to IFSC have been laid down under various parts of the Income Tax Act, 1961 which creates a sense discomfort for the investors and therefore it is believed that there is a requirement for the authorities to issue a consolidated chapter covering solely the regulatory overarch of IFSC.
2. Relief from General Anti Avoidance Rule: The provisions pertaining to GAAR should not apply in respect of tax benefits/concessions claimed by an IFSC unit/investors with respect to tax concessions provided for their IFSC investments or any IFSC related tax benefits.
3. Exemption from Capital Gains in the hands of shareholder on sale of shares of IFSC units:  Capital gain exemption should be rendered on sale of shares of IFSC units by non-resident shareholders which would in turn incentivise investments into these units
4. Exemption from filing return of Income by Eligible Foreign Investors (EFI): The need to file India compliances for an EFI may lead to rigour and genuine hardships for EFIs. This approach may be required for the domestic market; however, an IFSC regime needs to be more investor friendly in terms of compliance requirements and therefore EFIs, which exclusively invest in the IFSC exchanges, should be exempt from filing of returns on income in India.
5. Special Tax Regime for Taxation of Reinsurance Business: Considering the unique nature of the global reinsurance business, in the absence of specific provisions for the taxation of reinsurance, there are likely to be ambiguities in the allocation of expenses to the FRBs by their Head Offices. Thus, introducing a special tax regime for taxation of reinsurance business to streamline its taxability and remove any ambiguities and possibilities of litigation. Tax computation rules for income of FRBs may be notified by way of a circular. For insurance business in the IFSC, a special (simplified) tax regime can be provided.
6. Other Tax Exemptions: GIFT City will need to compete with other more tax-friendly jurisdictions such as Hong Kong (with only a territorial system of taxation – where offshore income is exempt), or Singapore (where offshore income is taxed only if brought into Singapore) or Dubai (where most business activities do not attract any income tax). In this regard, the following steps shall be undertaken:
   1. Income earned by IFSC units from services rendered outside India should be completely exempt from income tax – in short, adopt a territorial system of taxation.
   2. Commit that any concessions granted will not be taken away for at least 25 years.
   3. Any payment to an IFSC unit should not be subject to withholding of tax, where such a unit in the IFSC is claiming a tax holiday. This can be made subject to a declaration furnished by the unit undertaking to fulfil the conditions necessary to avail of the tax holiday

Budget Analysis

As was expected from the Industry Body, the government’s dream project of IFSC Gift City was given impetus in the Budget of 2023. The Finance Minister in its speech announced measures some of which were in line with the recommendations issued by the India UK Financial Partnership study report

Taxation Measures

1. Increased in Scope of Exempted Income: The Finance Bill 2023 has recognized that income accrued or arising to or by a non resident as a result of transfer of offshore derivative contract, non-deliverable forward contracts or over the counter derivatives with a banking unit of an IFSC shall be excluded from the ambit of the total income subject to certain additional conditions which may be prescribed. Additionally, the distribution of income on offshore derivative contracts will also be considered to be outside the scope of the total income. This change will certainly attract more investment into the IFSC Gift City.
2. Extension of timeline for relocation of a fund: The government has further extended the timeline from March 31,2023 to March 31,2025 for funds to relocate to IFSC Gift City. Further it has also expanded the definition of resultant fund to include a fund incorporated in line with the IFSCA (Fund Management) Regulations, 2022.
3. Investment Fund : The Finance Bill has increased the horizon of the definition of Investment fund to include the funds particularly Cat I & Cat II AIF regulated and incorporated under the International Financial Services Centres Authority (Fund Management) Regulations, 2022.  This proposed amendment is in reference to Section 115UB which is the charging section for income of investment funds and its unit holders which essentially provides for a pass through certificate to accordingly tax the investors and not the investment fund. 

Other Measures

Fig. C: Comparative view of the India UK Financial Partnership Report and the Budget 2023

Apart from these measures, the Speech of the Finance Minister also paved the way for certain new activities to be undertaken which are as follows:

1. The Banking Units of Foreign Banks will be permitted to undertake acquisition financing: Acquisition finance is the finance used by corporations to acquire other entities. For the purposes of providing finance to such acquisition, Banks in India were restricted by RBI to service its funds for acquiring equity shares.^[4] However with the advent of this measure the government has allowed foreign banks who have set up their base in the IFSC to provide or service its funds for the purposes of acquisition finance which will eventually increase the sources of funds for corporates which were heavily dependent on NCDs or finance from NBFCs.
2. Establishment of a subsidiary of EXIM Bank for trade refinancing: The government in line with the vision of transcending much beyond traditional finance and thereby to increase the sources of financing will be establishing the a subsidiary of the EXIM Bank that will offer specifically trade refinancing options.
3. Recognizing offshore derivative instruments as valid contracts: Section 18A of the Securities Contract Regulation Act, 1956 provides for conditions to be complied with in order to validate or legalize a derivative contract. The Budget seeks to amend this provision to include offshore derivative instruments as valid contracts. This change will certainly attract more investment into the IFSC Gift City.
4. Data Embassy:  As we all know the benefits of paperless governance policy are immense, however such measures are intertwined with the problem of how to secure the data that could become vulnerable on account of major natural disaster or cyber, terrorist or military attack. To tackle this issue, the Finance Minister introduced a new concept of Data Embassy.  Countries facing such risks can easily be immune from this risk if they set up data embassies offshore and therefore the government has allowed the setting up of data embassies in GIFT IFSC City to countries that are looking to secure their crucial data.

Conclusion

Although the proposed amendments are welcome, it is asserted that the expectations from the industry body particularly relating to the taxation framework are still not being met through this Budget and therefore the it can be said that the dream project of the government is still far away from reaching the global standards that are being offered by other IFSCs.

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^[1] https://ifsca.gov.in/Viewer/ReportandPublication/45

^[2] Id.

^[3]https://www.thecityuk.com/media/04od4n2k/iukfp-developing-gift-city-into-a-global-services-hub.pdf

^[4] Master Circular- Loans and Advances – Statutory and Other Restrictions, https://rbidocs.rbi.org.in/rdocs/notification/PDFs/95MND246C0F34D0041F6831205AB5D695422.PDF