Tax-wary PE Funds Look to Recast Investment Arms
Experts say tax could be near 20% of the returns for PE firms under the new framework PoEM
Mumbai: Some Indian private equity funds are looking to restructure their intermediary or investment arms registered outside India to avoid tax implications under place of effective management (PoEM), people in the know said. PoEM is a tax framework recently amended by the government to determine the tax liability of any foreign company that for all purposes is managed from India but do not pay tax domestically.
“Indian private equity funds managed from India having investment vehicle outside India could run a risk of capital gains tax under the PoEM framework. Such PE firms would now need to demonstrate that the commercial and key policy decisions are in real sense taken in their host jurisdiction through an appropriate Board & Management composition,” said Amrish Shah, senior advisor — Transaction Tax, EY.
Many Indian private equity firms, which have created overseas structures to raise and pool capital but deploy the money in India, are in a quandry with the amendment as they would be liable to be taxed from next year. The government has introduced PoEM as many Indian multinationals hold foreign companies through intermediary companies registered in tax-friendly countries like Mauritius and Singapore. These companies are only used for col- lecting dividend or interest. The government has taken a view that since such shell companies are only brought in as part of tax planning, they should pay tax in India. PE firms are already putting in place new structures to nullify tax burden under PoEM. Some firms are hiring investment managers and creating investment committees at such locations.
Experts say the tax rate could be near 20% of the returns for PE funds. Many Indian funds have a registered subsidiaries outside India which is used for pooling money and making investments in India. However, these are just pass-through vehicles and no actual decisions are taken at these companies.
“The risk of PoEM is also on those private equity funds who invest primarily in India and have Indian investors, but have intermediary companies registered outside India in tax-friendly jurisdictions. The challenge will be if the decision making of the overseas entities is driven from India — the fund could run into difficulty,” said Vaibhav Manek, partner — KNAV, an international tax, accounting and advisory firm.
On the advice from tax experts, some funds have already started appointing local directors to beef up the intermediary companies, people in the know said.
However, many tax experts opine that such tax demands cannot be made in such a situation as the government gave a leeway under permanent establishment rules. This year’s budget also articulated regulations on the fund size a PE fund should maintain during a year.
“As per section 9 (Income-Tax Act) foreign funds that satisfy certain conditions and who appointed fund managers in India will not constitute any business connections in India. In this year’s budget, the limit of average corpus of ₹ 100 crore is also diluted in the year in which the fund is wound up,” said senior tax expert Dilip Lakhani.
Many experts also hope that the income-tax department would take a “benevolent” view and not scrutinise intermediary companies of all Indian companies. This also comes around the time when foreign portfolio investors and PE funds would also see stricter tax guidelines due to general anti avoidance rules (GAAR). “PoEM and GAAR provisions could change the way business is done by these PE funds and they need to think through and look at alternative operational structures,” said Manek.