Sunday, February 7, 2016

Recommendations of the Companies Law Committee: A Proposed Overhaul of the Private Placement Regime

[The following guest post is contributed by Amitabh Robin Singh, who is an Associate at DSK Legal]

The recently released Companies Law Committee report (“Report”) has recommended a plethora of amendments to the current company law regime. However, some of the most sweeping changes have been proposed in relation to private placement of securities. In this post, some of the key changes proposed on this front will be discussed.

Under the Companies Act, 2013 (“Act”), private placement of securities is governed by Section 42 read with Section 62. One major requirement for a preferential allotment of securities is the circulation and filing of a private placement offer letter in the form PAS-4, which is prescribed under the Companies (Prospectus and Allotment of Securities) Rules, 2014. This requirement was often said to be cumbersome for a private placement due to the fact that a form PAS-4 entailed extra time and costs while the subscribers to the securities were relatively small in number.

In a sweeping recommendation, the Report has proposed doing away with form PAS-4. However, to ensure adequate disclosure and investor protection, certain disclosures which are to be made in an explanatory note sent along with a notice for the general meeting convened to pass the requisite special resolution for preferential allotment of securities have been recommended to be incorporated in the application form for the private placement. These disclosures relate to the objects of the issue, the price/price band of the issue along with the valuation report of the securities, the intention of promoters, directors or key managerial personnel to subscribe to the offer, the name of the proposed allottees and percentage of the capital they will hold post the offer, whether there will be a change of control pursuant to the issue and if so the nature of the change, among other things.

The Report also goes on to propose that other important information which is currently contained in form PAS-4 can be moved into the abovementioned explanatory notice. This information may consist of matters such as any investigations conducted on the company under the Act or any previous company law in the last 3 financial years, related party transactions entered into by the offeree in the last 3 financial years, summary of reservations or adverse remarks made by the auditors in the last 5 financial years, etc.

The requirement of circulating and filing a form PAS-4 for preferential allotment of shares to persons who are existing members of the company has been rather dynamic. From April 1, 2014 (when the relevant sections were brought into force) until March 18, 2015 (the date on which the Companies (Share Capital and Debentures) Amendment Rules 2015 (“Share Capital Amendment Rules) were brought into force), there was a requirement of circulating and filing a form PAS-4 for a preferential allotment even to persons who were existing members of the company. Following the Share Capital Amendment Rules, it is no longer necessary for a form PAS-4 to be circulated and filed for a preferential offer of shares to existing members of the company. This has helped companies issue shares to existing members of the company without having to either circulate and file a form PAS-4 or go through the entire rights issue process and having the members who are not to subscribe to the offered shares waive their rights.

Now, as we can see from the Report the form PAS-4 has been recommended to be discontinued altogether. This appears to be a good move as it will make raising of capital easier, but with the suggested added disclosures to the securities application form it will not excessively imperil the investors.

Another very interesting point raised in the Report is the right to renounce securities offered to a member in pursuance to a rights issue. Section 62(1)(a)(ii) states that shares offered to a person pursuant to a rights issue may be renounced in favour of “any other person”. Then section 62(1)(a)(iii) goes on to state that after the rights issue period has expired (between 15 and 30 days as per Section 62) or the person to whom the shares has been offered declines to subscribe to them and does not renounce in anyone’s favour, then the board of the company may dispose of the shares in a manner “which is not disadvantageous to the shareholders and the company;”.

The committee has noted that this provision for renouncing in favour of a non-member or letting the offer period expire and then allotting the shares at the boards discretion is being misused to circumvent the preferential allotment mechanism which mandates the passing of a special resolution at a general meeting of the company and also currently requires a form PAS-4 to be circulated and filed. These activities result in both extra costs and take more time to execute due to the time and expenses involved to convene an extraordinary general meeting.

To control such circumvention of the process of the preferential allotment mechanism, the Report recommends looking into the procedure given in the (English) Companies Act, 2006 (“English Act”). Section 756(4)(a) of the English Act states that an offer will be regarded as a private concern of the person receiving it if it is only made to a person already connected with the company and this person may only renounce his/her/its rights in favour of another person who is connected with the company.

The English Act has also gone on to define the term “person already connected with the company” as:

(a) an existing member or employee of the company,

(b) a member of the family of a person who is or was a member or employee of the company,

(c) the widow or widower, or surviving civil partner, of a person who was a member or employee of the company,

(d) an existing debenture holder of the company, or

(e) a trustee (acting in his capacity as such) of a trust of which the principal beneficiary is a person within any of paragraphs (a) to (d).”

An interesting point raised on this provision is that the relative of a former member will be eligible to have renunciation in his favour, but a former member or employee him/herself of the company is not eligible to be the beneficiary of renunciation.[1]

While there may be loopholes in this system provided by the English Act, it is a good base to work from while formulating a similar provision for India to curtail misuse of renunciation of shares offered on a rights basis.

Interestingly, also in the case of rights issues of shares to foreign investors, the shares are allowed be freely issued by the Foreign Exchange Management Act, 1999. In the case of an unlisted company, the shares are required to be offered to the foreign investors at a price which is not less than what has been offered to domestic investors. This means that rights issues to foreign investors are exempt from having to be at least at the price determined as per the valuation report done by a merchant banker registered with the Securities and Exchange Board of India or a chartered accountant.

As it can be seen, the recommendation of the committee to curtail the practice of misusing the rights issue process to actually allot securities to designated non-members seems to be a welcome step, so that when the pre-emption rights of the current shareholders is by-passed it is with the proper sanction of the company at a general meeting.

The last major change that will be examined in this post relates to the number of offers of securities that a company can keep open simultaneously. Currently Section 42(3) of the Act prohibits making a fresh offer or invitation unless the allotments with regard to any earlier offer or invitation have been completed or it has been withdrawn or abandoned. The Report recommends allowing a company to keep open more than one offer of securities simultaneously to specific classes of investors which may be prescribed by rules. This is a welcome recommendation because if this is made into law, then a company can then allot of securities through different offers simultaneously and will not have to wait for full allotment of securities under one offer before commencing the other.

Looking at the above discussed proposals, it can be said that the recommendations made in the Report appear to both liberalize the environment for doing business by making fund raising simpler for companies while also trying to plug loopholes which may be detrimental to the interests of the companies and their shareholders.

- Amitabh Robin Singh

[1] "Share Issues By Private Companies", Institute of Directors, available at: section 756 of the english companies act

Revision of FEMA Regulations – Promoting Ease of Doing Business

[The following guest post is contributed by Ananya Banerjee, who is a Fifth Year B.A.LL.B (Honours) Student at the University of Calcutta (Department of Law)]

The Reserve Bank of India (“RBI”), through several notifications dated December 29, 2015, January 12, 2016 and January 21, 2016, has consolidated and revised nine sets of Regulations under the Foreign Exchange Management Act, 1999. The update is said to be in line with the evolving business environment and changing practices in cross-border transactions. The step has also been taken to promote and facilitate ease of doing business in India. This post contains excerpts of such revised Regulations.

Acquisition and Transfer of Immovable Property outside India

The Foreign Exchange Management (Acquisition and Transfer of Immovable Property outside India) Regulations, 2000, and all its subsequent amendments were repealed and replaced by the 2015 Regulations. Through A.P. (DIR Series) Circular No. 43/2015-16 [(1)/7(R)] dated February 4, 2016, the RBI has instructed the authorized dealers (“AD”) of the same. The new Regulations have laid down six exceptions under which a person resident in India would not require RBI approval for acquisition or transfer of immovable property outside India. Indian companies having overseas offices shall be eligible to acquire such property for business and residential purposes subject to the threshold of total remittances as prescribed. The initial expense must not exceed 15% of the average annual sales/income or turnover of the Indian entity during the last 2 financial years, or 25% of the net worth of the entity, whichever is higher. The recurring expenses must not exceed 10% of the average annual sales/income during the preceding 2 financial years. These Regulations have come into effect from January 21, 2016.

Definition of Currency

Through A.P. (DIR Series) Circular No.48/2015-16 [(1)/15(R)], dated February 4, 2016, the RBI has informed the Ads that the Notification No. FEMA 15 (R)/2015 – RB has superseded the previous notification dated May 3, 2000, from December 29, 2015, although, the definition of currency has been kept similar to the earlier notification.

Possession and Retention of Foreign Currency

The Foreign Exchange Management (Possession and Retention of Foreign Currency) Regulations, 2000, with all its subsequent amendments has been repealed and replaced by the Foreign Exchange Management (Possession and Retention of Foreign Currency) Regulations, 2015, which has come into effect on December 29, 2015. The RBI has directed the ADs regarding the limits for possession or retention of foreign currency or foreign coins. While an authorised person within the scope of his authority shall not be subjected to any limit and any person can possess foreign coins without any limit, retention of foreign currency notes, bank notes and foreign currency traveler’s cheques shall be subject to a limit of USD 2,000 in aggregate, which shall also have further conditions as provided under the new Regulations. However, a person resident in India but not permanently residing herein shall have no such limit, provided the foreign currency was acquired, held or owned by him when the person was resident outside India and he brought such currency in accordance with the applicable laws.

Realisation, Repatriation and Surrender of Foreign Exchange

The Foreign Exchange Management (Realisation, Repatriation and Surrender of Foreign Exchange) Regulations, 2015 have superseded the old Regulations with all subsequent amendments. A person resident in India shall, with the general or special permission of RBI, take all reasonable steps to repatriate any foreign exchange due or accrued to him. Such person shall not do anything or refrain from doing anything which results in delay or cessation of receipt of such foreign exchange. The manner of repatriation would include –

(i)        selling to an authorised person in India in exchange of Indian currency;

(ii)       retaining the amount in an account kept with an AD, subject to the extent specified by RBI; or

(iii)      using it to discharge a debt or liability in accordance with the guidelines of the RBI.

Repatriation would be deemed to occur once the person receives payment in Indian currency in India, from any account (maintained with an AD) of a bank or exchange house, situated overseas.

Time Limit for Repatriation: Every person, not being an individual, must repatriate the amount so received within seven days from the date of receipt in case the foreign exchange becomes due or accrued as: a) remuneration for rendering services; b) settlement of lawful obligation; c) income on assets held outside India; or b) inheritance, settlement or gift.

In all other cases, such foreign exchange must be repatriated within 90 days from the date of receipt. When a person, not being an individual resident, acquires or purchases any foreign exchange for the purposes mentioned in his declaration (in accordance with applicable law), such person shall surrender such amount or any unused portion thereof within 60 days of such acquisition or purchase.

Any unspent foreign exchange acquired or purchased by any person not being an individual resident of India, for the purpose of foreign travel, must be repatriated within 90 days of return of such traveler to India, provided however, in case of such foreign exchange is in the form of traveller’s cheques.

For a resident individual, the time limit of surrender of any foreign exchange, received, realized, unspent or unused by such person, would be 180 days from the relevant date.

Export and Import of Currency

The Foreign Exchange Management (Export and Import of Currency) Regulations, 2000 and all amendments thereto are superseded by the 2015 Regulations, with effect from December 29, 2015.

Export and Import of Indian Currency: A person resident in India (i) may take outside India currency notes of Government of India and RBI notes of an amount not exceeding Rs. 25,000/- in aggregate; (ii) may take or send outside India up to two commemorative coins;[1] and (iii) may bring in India, currency notes and RBI notes up to an amount of Rs. 25,000/- while returning to India after a temporary visit to a place outside the country. However, Nepal and Bhutan shall not be considered for deciding a place outside India.

Import of Foreign Exchange: Foreign exchange can be sent into India without any limit, except in the form of foreign currency notes, bank notes and traveler’s cheques. A person may bring into India foreign exchange (except for unissued notes) without any limit, subject to a declaration made in the Currency Declaration Form (“CDF”), at the time of his arrival in India. However, no such declaration would be required if the aggregate amount brought by such person, through currency notes, bank notes or traveler’s cheques, at one time, does not exceed USD 10,000 or its equivalent and/or if the foreign exchange value of the currency notes brought is within USD 5,000 or its equivalent.

Export of Foreign Exchange and Currency Notes: While an authorised person shall be eligible to send out any foreign exchange acquired in normal course of business, any other person shall be subjected to the conditions specified for this purpose. However, any person resident outside India may take out of India any unspent foreign exchange, provided, such amount does not exceed the amount brought by him and declared by him in the CDF upon arrival.

Export and Import to or from Nepal and Bhutan: While there is no limit in export and import of currency to and from Nepal and Bhutan, a person travelling from India to those two countries shall be permitted to carry up to Rs. 25,000/- in currency notes of denomination Rs. 500 and Rs. 1,000. However, in no circumstance, any currency note of denomination Rs. 100 shall be taken, sent or carried out of India to those two countries.

Prohibition of Export of Coins: No person shall be allowed to take or send out of India any Indian coins covered under the Antique and Art Treasure Act of 1972.

Foreign Currency Accounts by Person Residents in India

The regulations issued under the Foreign Exchange Management (Foreign Currency Accounts by a person resident in India) Regulations, 2000, as amended from time to time, have been replaced by the new Regulations through a notification dated January 21, 2016. A person resident in India may open, hold and maintain with an AD in India, the following accounts:

(i)        Exchange Earner’s Foreign Currency Account;

(ii)       Resident Foreign Currency Account;

(iii)      Resident Foreign Currency (Domestic) Account;

(iv)      Diamond Dollar Account.

For opening, holding and maintaining either of the above-mentioned accounts, the relevant regulations have to be followed.

In addition to and subject to the foregoing, the following person, resident in India, shall also be eligible to open a foreign currency account, viz. (i) any unit in a Special Economic Zone; (ii) an exporter, provided he/it either is exporting services and engineering goods on deferred payment terms, or, has undertaken a turnkey project or a construction contract abroad; (iii) the Indian agents of foreign airlines/shipping companies; (iv) ship manning/crew managing agencies; (v) project offices set up in India in accordance with relevant FEMA regulations; (vi) Indian companies receiving foreign direct investment; and (vii) organizers of international seminars/conferences/conventions etc.

Subject to the conditions specified hereinabove, ADs having branch/head office/correspondence outside India; a branch of an Indian bank; an Indian body corporate (including company and firm) in the name of its foreign branch/representative; an Indian Party making overseas investment; a person raising external commercial borrowing; a person going abroad for studies; and such other person resident in India, as specified, shall be eligible to open foreign currency accounts outside India. Subject to other conditions, the accounts can be current, savings or term deposit accounts, unless otherwise provided, in case of accounts opened by individuals and in the form of current or term deposit accounts, in case of others. Such account can be held jointly or singly in the name of the eligible person.

Postal Orders/Money Orders

The Post Office (Postal Orders/Money Orders), 2015 has superseded the original Notification No.FEMA.18/2000-RB, with effect from December 29, 2015. Vide the notification the RBI has given general permission to any person to buy foreign exchange in the form of postal order or money order from any Indian Post Office.

Export of Goods and Services

The RBI, through FEMA 23(R)/2015-RB, dated January 12, 2016, has notified the Foreign Exchange Management (Export of Goods & Services) Regulations, 2015, replacing the old Regulations dated May 3, 2000.

Declaration of Exports: The exporters of goods and software in physical or any other form, carrying out export through Customs manual ports, are required to furnish declaration specifying the relevant particulars in the manner and form set out for that purpose. Such declaration shall mention the full export value (or the value which the exporter expects to receive). In case of export of services, where no Form is specified in these Regulations, no declaration would be required. However, the exporter shall be liable to realize the amount of foreign exchange and to repatriate the same to India in accordance with the applicable laws.

Declaration in Form EDF shall be submitted in duplicate to the Commissioner of Customs. Declaration in Form SOFTEX shall be submitted for export of computer/audio/video/ television software, in triplicate to the designated official of Ministry of Information Technology, Government of India at the Software Technology Parks (“STPs”) of India or at the Free Trade Zones or Special Economic Zones (“SEZ”) in India. Each copy of the declaration must include Importer-Exporter Code number. Each declaration must also be backed up by evidences supporting such declaration.

Exemption: Regulation 4 exempts certain export of goods and/or software from the liability of declaration which includes export of: trade samples; personal effects of travelers; ship’s stores, trans-shipment cargo etc. under such circumstance as specified; gift of goods not exceeding 5 lakh rupees (which would require the declaration of the exporter to that effect); aircrafts/aircraft engines for repair/overhauling activities, subject to re-import within six months; goods, free of cost, on re-export basis; goods found defective, for the purpose of replacement; goods imported from foreign entities on loan; goods permitted by relevant authorities as prescribed; goods sent outside for testing, subject to re-import and such other goods as mentioned in the Regulations.

Other Provisions: Unless otherwise authorised by the RBI, the amount of export shall be realized in accordance with the provisions of the Foreign Exchange Management (Manner of Receipt and Payment) Regulations, 2000 as amended from time to time, through an AD. The full export value shall be realized and repatriated within nine months from the date of export, provided that, if such goods are exported to a foreign warehouse with RBI’s permission, such value shall be paid to the AD as soon as the value is realized and in any case, within 15 months of the shipment of goods. However, the RBI may extend the time limit in case there is any reasonable cause. In case of export from SEZ, STPs, Export Oriented Units etc., the full export value must be repatriated within nine months from the date of export.

The documents pertaining to export shall be submitted to the authorised dealer mentioned in the relevant export declaration form, within 21 days from the date of export, or from the date of certification of the SOFTEX Form. Certain exports regarding trade agreements, rupee credit etc. would be subjected to RBI guidelines and would require prior approval. The Regulations also lay down provisions which prohibit any person from doing any act/omission which would result in delay of realization of the value of export. An exporter shall also be eligible to receive advance payment, subject to the provisions of Regulation 15.

Insurance Regulations

Through a notification dated December 29, 2015, the RBI has replaced the Foreign Exchange Management (Insurance) Regulations, 2000 with the Foreign Exchange Management (Insurance) Regulations, 2015. These regulations control the general and life insurance policies issued by an insurer outside India, to a person resident in India.

General Insurance: A person resident in India may take or continue to hold a health insurance policy issued by an insurer outside India on a condition that the total remittance does not exceed the limit prescribed under the Liberalised Remittance Scheme (Currently, upto USD 250,000 can be remitted under the Scheme in a financial year for any permitted current or capital account transaction or a combination of both). No person shall, without the approval of Insurance Regulatory Development Authority, take out/renew any insurance policy for any property in India or ship/vessel/aircraft registered in India with any insurer whose principal place of business is outside India. However, a person can take out/continue to hold a general insurance issued by such insurer mentioned above if such policy is held under a specific/general permission granted by the Central Government.

If a person, resident in India, holds a general insurance policy taken from an insurer outside India during a time such person was a resident outside India, he may continue to hold such policy. Where the premium of a general insurance policy is remitted from India, the maturity proceeds or any claim amount shall be repatriated through normal banking channels within seven days from the receipt of such amount.

Life Insurance: A resident may take or continue to hold life insurance coming under the purview of these Regulations under a specific or general permission of the RBI. Regulation 4 of these Regulations also lays down provisions regarding repatriation of the maturity benefits and/or claim amounts.


The Foreign Exchange Management Act, 1999 came into effect from June 1, 2000. There are several Regulations framed under the main Act and there have been several amendments to these Regulations, making it cumbersome to follow. The revised Regulations discussed above have replaced all the relevant Regulations along with their amendments. This revision not only facilitates ease of doing business, it has successfully captured the current business trend. Hence, the supersession of nine sets of Regulations under the Act by fresh set of Regulations has been welcomed by parties interested in carrying out cross-border transactions.

- Ananya Banerjee

[1] 'Commemorative Coin' includes coin issued by Government of India Mint to commemorate any specific occasion or event and expressed in Indian currency.

Friday, February 5, 2016

SEBI takes into account social media connection of parties in insider trading case

This order of SEBI is otherwise just another case where parties were found to have allegedly profited from insider trading. The only noteworthy point is that the connection between two of the parties was detected because they had common friends on social media. To my recollection, this is perhaps the first case where SEBI investigated the social media profile of the parties. The Hon'ble Wholetime Member observed :
"Mr. Pirani Amyn Abdul Aziz is also found to be connected to Mr. Ameen Khwaja through mutual friends on ‘Facebook’. "
Needless to add, SEBI also found the transactions of the party otherwise suspicious too. Social media connections are often used to do background checks. On their own, they can rarely be reliable indicators of connections.

Thursday, February 4, 2016

Update: Proposed Amendments to the AIF Regulations

[The following post is contributed by Bhushan Shah and Labdhi Shah from Mansukhlal Hiralal & Company]

Alternative Investment Funds (AIF(s)) play a vital role in Indian economy as they drive economic growth and contribute significantly to nation building. To regulate AIFs under one single regime, the Securities and Exchange Board of India (SEBI) in 2012 notified SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). In 2013, SEBI further notified amendments to AIF Regulations.

In 2015, SEBI established the Alternative Investment Policy Advisory Committee (AIPAC), which was headed by Mr Narayana Murthy for further development of alternative investments by removing hurdles. AIPAC very recently submitted its Report and SEBI has invited comments on this Report by 10 February 2016.

In this update, we have briefly summarised recommendations made by AIPAC in the Report:

1.                 Taxation

1.1.             To Make Tax Pass-Through Work Effectively: Given that AIFs are simply vehicles that pool the savings of investors for professional fund management over a long-term period, it is imperative that the tax pass-through system is made simple and effective. In this regard, the Report recommends the following: (a) the exempt income of AIFs should not suffer tax deducted at source (TDS) of 10%; (b) exempt investors should not suffer tax withholding of 10%; (c) investment gains of AIFs should be deemed to be ‘capital gains’ in nature; (d) the tax rules applicable to ‘investment funds’ in Chapter XII-B of the Income Act, 1961 (IT Act) should be extended to all categories of AIFs; (e) losses incurred by AIFs should be available for set-off to their investors; (f) non-resident investors should be subject to tax rates in force in the respective Double Tax Avoidance Agreements (DTAA).

1.2.             Eliminate Deemed Income: Given that the income of an AIF arises only when it receives dividend or interest income during the holding period in a portfolio company, or realises capital gains at the time of exit from the portfolio company, it is important to understand that investments made in portfolio companies are capital contributions and not the income of the portfolio company. Thus, in light of these principles, it is recommended that AIFs as well as portfolio companies are exempted from Section 56(2)(viia)and 56(2)(viib), respectively, of the IT Act.

1.3.             Clarify Indirect Transfers: The Report recommends seeking clarification from CBDT that investors in the holding companies or entities above eligible investment funds investing in India are not subject to the indirect transfer provisions.

1.4.             Make Safe-Harbour Effective for Managing Funds from India: Given that the safe harbour rules enacted by the Government under Section 9A of the IT Act have not been effective so far, the Report recommends changes inthe conditions provided thereunder, namely: (a) investor diversification; (b) control or management of portfolio companies; (c) tax residence; (d) arm’s length remuneration of fund managers; and (e) annual reporting requirements. These changes will help fund managers to manage their investments from India.

1.5.             Make Foreign Direct Investment (FDI) in AIFs Work Efficiently: While the Government’s move to allow FDI in SEBI-registered AIF is a welcome measure, in order to make the same effective, the Report recommends that the Government should: (a) clarify the rules for investment by non-resident Indian investors in AIFs on a non-repatriation basis; (b) eliminate ambiguity to enable NRIs to invest in AIFs using funds in their rupee NRO accounts; (c) provide for TDS on distribution of income to non-resident investors in AIFs in accordance with DTAA tax rates in force; (d) grant permission to LLPs to act as sponsors and/or managers of AIFs; and (e) relax Indian tax compliance obligations for non-resident investors in AIFs.

1.6.             Securities Transaction Tax (STT): The Report recommends that Government should introduce STT at an appropriate rate on all gross distributions of AIFs and investments, short-term gains and other income and eliminate any withholding of tax. Post the levy of STT, income from AIFs should also be tax free to investors.

2.                 Unlocking Domestic Capital Pools: The Report observes that merely 10-15% of the equity capital required by start-ups, medium enterprises and large companies is funded from domestic sources, and the remaining is funded from overseas, owing to constraints on the traditional sources of funding to supply risk capital. Given this scenario, the Report inter alia recommends that: (a) regulators such as RBI and IRDA must be convinced to encourage institutions regulated by them to invest in AIF asset class; (b) all banks, pensions, provident funds, insurance companies and charitable endowments which invest in equities mustutilize a minimum of 2-5% of the corpus or annual contribution of that amount in SEBI approved Category 1 AIF; (c) investment limits for banks and insurance companies in AIF must be increased from 10% to 20%; (d) For banks, investments in AIF should be treated as priority sector investments and it should not impact the banks’ capital market exposure; and (e) charitable or religious funds should be permitted to invest in SEBI – registered Social Venture Funds.

3.                 Promoting Onshore Fund Management: The Report observes that currently, approximately 95% of venture capital (VC) and private equity capital (PE) is contributed by overseas investors and the majority of overseas investors (i.e. 98% of total foreign VC/PE capital) and their managers prefer to domicile their funds offshore, i.e. in countries with stable and favourable tax and regulatory regimes on fund management, since their FDI and Foreign Portfolio Investment (FPI) regimes are considered to be far more consistent in contrast to the changing tax and regulatory regimes specific to VC/PE Funds in India. Two major factors which have led to this situation are (a) the lack of clarity in taxation; and (b) severe restrictions on the operational freedom of fund managers domiciled in India. In order to overcome this, the Report recommends: (a) creating parity between Indian and offshore regulations and with their respective DTAA; (b) allowing foreign investment from international limited partners directly into domestic AIFs by bringing changes to the FDI policy/FEMA and the policy on TDS; (c) creating level playing field between the fund managers domiciled in India and those located offshore, which is not the case in India currently; (d) enablingmore foreign funds to be domiciled in India and brought under the purview of SEBI by ensuring clear policies and their consistent application over the entire life of fund vehicles; (e) an immediate clarification from CBDT that exemptsthe income flowing through AIFs from suffering any withholding tax; (f) amending the safe-harbour norms for ease of doing business.

4.                 Reforming the AIF Regulatory Regime: The Report observes that most regulatory efforts have rightly focused on protecting minority shareholder interests and improving compliances, however, there has been a limited direct regulatory effort focused on PE and VC industry itself. Thus, the Report recommends the following:

4.1.             Regulation ofthe Fund Manager and not the Fund:  The Report recommends the repeal of (i) SEBI (Portfolio Manager) Regulations, 1993, (ii) SEBI (Alternative Investment Funds) Regulations, 2012; and (iii) SEBI (Investment Adviser) Regulations, 2013 and the introduction of a regulatory framework / policy to govern the fund manager such that the fund manager is responsible for all the investment activities of the client. The Report further recommends that new SEBI (Alternative Investment Fund Managers) Regulations (AIFM Regulations) shouldreplace all the above-mentioned Regulations. A registered Investment manager under the AIFM Regulations willprovide discretionary or non-discretionary investment advisory/ management services to investors who could be individuals/ a group of individuals or open-ended/ close-endedfunds or clients seeking customized products. Investment manager will have specific capitalization requirements, which could provide for sub-categories based on the nature of the AIFM’s business (i.e. discretionary, non-discretionary, customized or collective investments). The funds raised by registered investment manager will follow the SEBI guidelines and notify SEBI under an appropriate reporting framework.

4.2.             Amendments in AIF Regulations:It is recommended that the definition of “venture capital fund” in Category I AIF is amended to include funds that invest in “growth” stage ventures.

4.3.             Classification of Category III AIF: The Report recommends creating sub-categories, namely under Category III AIF:  (a) Category III Sub-category A for an AIF which will primarily invest in public markets and will not employ leverage including through investment in listed or unlisted derivatives (except for the purpose of hedging the investments). The said new category will invest on a long-term basis with a minimum life of 3 years; and (b) Category III Sub-category B for ‘Complex Trading Fund’, i.e. funds which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. This classification will segregate a diverse range of strategies under the Category III umbrella into 2 distinct buckets based on investment horizon, underlying securities and investment objectives. This will further aid in matching investors with appropriate strategies.

4.4.             10% Restriction of Investible Funds: Clause 15(d) of the AIF Regulations state that Category III AIF shall invest not more than 10% of the investible funds in a singleInvestee Company. It is recommended that 10% restriction of ‘investible funds’ in a single Investee Company should be replaced with the reference to the ‘market value’ of such securities at the time of investment.

Comment: In a global scenario, where countries compete for capital, the success of alternative investments in India in long-term will depends on its tax policy which require to be globally competitive. AIFs can make a significant contribution to India’s GDP and the implementation of AIPAC’s can help India attract large capital flows.

- Bhushan Shah & Labdhi Shah