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

The Economic Times - - Economy: Macro, Micro & More - Sachin.Dave@ times­

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.

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