On February 1, 2021, India’s government presented the country’s 2021-2022 Union Budget. It was developed to boost India’s economic recovery by introducing incentives across all business sectors, in part to attract foreign investment and make it easier to do business in the country.
The new Budget relies on 6 pillars:
- Health and Well-being
- Physical and Financial Capital, Infrastructure
- Inclusive Development for Aspirational India
- Reinvigorating Human Capital
- Innovation and R&D
- Minimum Government and Maximum Governance
Below we will review the essential business-related provisions of the new Budget and clarify whether they are truly business-friendly, as claimed, or not.
Company regulations updates
One of the key changes relates to incorporation of One Person Companies (OPCs). This concept was introduced in 2013 and it allowed a company to be formed with only 1 director and 1 shareholder. There are fewer compliance requirements for this form of entity than for a private company.
The new Budget further liberalizes the OPC regulations:
- Non-Resident Indians (NRIs) will be allowed to incorporate OPCs in India.
- The residency limit for an Indian citizen to set up an OPC will be reduced from 182 days to 120 days.
- One Person Companies may be transformed into any other type of company at any time.
- OPCs may grow without any restriction on paid-up capital and turnover.
The Budget also proposes to revise the definition of Small Companies under the Companies Act by increasing the thresholds of paid-up capital and annual turnover. Earlier, these figures were INR 5 million (about US $68,000) and up to INR 20 million (about US $272,000), respectively. From now on, the threshold of paid-up capital for small companies will be INR 20 million (about US $272,000), and the turnover limit will be increased to INR 200 million (US $2.7 million). This change will grant “small company” status to a large number of firms and consequently ease compliance requirements for such businesses.
Tax incentives for the International Financial Services Center (IFSC)
The Minimum Government, Maximum Governance pillar includes changes in the field of taxation. Updates to tax regulations aim to create an efficient and transparent tax system that will promote investments in the country with low burden on taxpayers.
In 2015, the International Financial Services Center (IFSC) was established in Gujarat as a part of the Special Economic Zone (SEZ). The key features of the regulations governing the business activities in this smart-city are the following ones:
- An IFSC financial institution must be treated as a non-resident company;
- Such a company must conduct business in any foreign currency except for the Indian Rupees;
- Such company’s business activities are covered only by special regulations applicable to companies in the IFSC.
Incentives for aircraft leasing companies
To reduce the impact of the COVID-19 pandemic for businesses operating in India, the Government proposes not only to extend tax the holidays for India’s startups by one year (till March 31, 2022) but also to expand the tax holiday to the income of aircraft leasing companies located in the IFSC GIFT City (Gujarat International Finance Tec-City). The new Budget introduces tax exemptions for aircraft lease rentals paid to foreign lessors. The Government also exempts from tax any income of a company established in the IFSC for sale of aircraft or aircraft engines. The sole requirement is that such a company must commence operations before March 31, 2024.
Currently, no major aircraft companies are located in India. A large part of the country’s aircraft fleet has been leased from foreign companies registered mainly in Dublin, Dubai, and Hong Kong. The above incentives are aimed at attracting large leasing companies to establish their presence in the IFSC so that Indian airlines could make rental payments in rupees instead of US dollars, as they are currently doing. This will assist Indian carriers that lack working capital due to financial effects of the COVID-19 pandemic. From a global perspective, this is a step toward transforming the IFSC GIFT City into a world financial hub.
This amendment is proposed to come into effect on April 1, 2022.
Tax exemption for foreign banks located in the IFSC
Bank units located in the IFSC already enjoy certain government incentives. To make a location in the GIFT City even more attractive, the Budget introduces tax exemptions for the investment divisions of foreign banks (offshore banking units) located in the IFSC.
Currently, the legislation provides that profits and business income earned by Category-III Alternative Investment Funds (AIF) are exempt from income tax. Various types of funds in India, such as hedge funds and Private Investment in Public Equity (PIPE) Funds, are registered as Category-III AIFs and enjoy these tax privileges.
The Budget proposes that the Category-III AIFs registration procedure be applied to the investment divisions of offshore banking units located in the IFSC. The sole requirement is to maintain separate books for each such investment division.
As a result, a bank having an offshore banking unit in the IFSC and investing in the Indian debt and derivative segment will also enjoy such tax exemption.
Benefits of relocating foreign funds to the IFSC
The Budget introduces several tax incentives for relocating foreign funds to the IFSC. The main change is the tax exemption on relocating offshore funds to the GIFT City. The Government proposes to exempt from capital-gains tax the transfer of capital assets by an original fund (offshore fund) to a newly setup fund (called resultant fund) upon relocation to the IFSC before March 31, 2023.
The original fund is a fund that is:
- Non-resident in India
- Resident in a country having a tax treaty with India; and
- Subject to investors protection regulations.
The resultant fund is a fund that is:
- Incorporated in India;
- Located in the IFSC; and
- Registered as AIF.
The final change proposes that a fund manager of an offshore fund set up in the IFSC and the fund itself will not need to meet certain conditions to get the structure approved by revenue authorities. Currently, the structure approval is required for offshore funds in order for them to be protected from the risk that their place of effective management or a taxable presence may be deemed to be India which would jeopardise their offshore status. The conditions that can be waived will be further notified by the Government.
Tax exemption for foreign banks located in the IFSC
Bank units located in the IFSC already enjoy certain government incentives. To make a location in the GIFT City even more attractive, the Budget introduces tax exemptions for the investment divisions of foreign banks (offshore banking units) located in the IFSC.
Currently, the legislation provides that profits and business income earned by Category-III Alternative Investment Funds (AIF) are exempt from income tax. Various types of funds in India, such as hedge funds and Private Investment in Public Equity (PIPE) Funds, are registered as Category-III AIFs and enjoy these tax privileges.
The Budget proposes that the Category-III AIFs registration procedure be applied to the investment divisions of offshore banking units located in the IFSC. The sole requirement is to maintain separate books for each such investment division.
As a result, a bank having an offshore banking unit in the IFSC and investing in the Indian debt and derivative segment will also enjoy such tax exemption.
Benefits of relocating foreign funds to the IFSC
The Budget introduces several tax incentives for relocating foreign funds to the IFSC. The main change is the tax exemption on relocating offshore funds to the GIFT City. The Government proposes to exempt from capital-gains tax the transfer of capital assets by an original fund (offshore fund) to a newly setup fund (called resultant fund) upon relocation to the IFSC before March 31, 2023.
The original fund is a fund that is:
- Non-resident in India
- Resident in a country having a tax treaty with India; and
- Subject to investors protection regulations.
The resultant fund is a fund that is:
- Incorporated in India;
- Located in the IFSC; and
- Registered as AIF.
The final change proposes that a fund manager of an offshore fund set up in the IFSC and the fund itself will not need to meet certain conditions to get the structure approved by revenue authorities. Currently, the structure approval is required for offshore funds in order for them to be protected from the risk that their place of effective management or a taxable presence may be deemed to be India which would jeopardise their offshore status. The conditions that can be waived will be further notified by the Government.
Foreign investment climate: changes in other fields
The Indian Government announced steps to liberalize Foreign Direct Investments (FDI) in certain key sectors such as insurance, infrastructure, pharma, etc.
Insurance sector
The Budget proposes to increase the permissible foreign shareholding limit in the insurance sector from 49% to 74%. The higher FDI limit may pave the way for foreign investors who want to bring in new products and guarantee better market penetration in India.
The Government also proposes to allow foreign ownership and control, with safeguards. Currently, only residents of India are allowed to be owners of any company in the insurance field. Under the proposed structure, the requirement is that the majority of the board of directors and key managers should be resident Indians, with at least 50 percent of directors being independent.
Infrastructure
To attract Foreign Investments into the infrastructure sector, the Government has relaxed some conditions that prohibited private funding in certain infrastructure subsectors and placed restrictions on commercial activities and direct investments.
The main change proposed by the Budget allows Infrastructure Debt Funds to raise money by issuing Zero Coupon Bonds (ZCB). ZCB are bonds where no payment or benefit is received before maturity or redemption. Currently, ZCBs can be issued only by an infrastructure capital company, infrastructure capital fund, public sector company, or certain types of banks.
This amendment will take effect on April 1, 2022.
Investments through Singapore: Does it make sense?
It is evident that the Indian Government is attempting to increase the attractiveness of the country to foreign investors by introducing tax incentives, such as tax exemptions for the investment divisions of foreign banks located in the IFSC, or tax facilitation for relocating foreign funds in the IFSC. Unfortunately, the new Budget maintains the same overall complicated tax system, with tax rates that are uncompetitive globally. Entrepreneurs will continue to seek more business-oriented and tax-efficient jurisdictions where they can establish holding companies and then invest in India.
The global leader among such countries is Singapore. It is ranked 1st in the Foreign Direct Investment into India rating for the third consecutive year. Even during the COVID-19 pandemic, total FDIs into India from Singapore amounted to US$8.3 billion. The main reason for this is the country’s numerous business incentives and an attractive tax system that establishes no capital-gains tax regime, a low corporate tax rate, and dividend income tax exemption. For example, Singapore provides full tax exemption for resident holding companies that receive foreign-sourced dividends from subsidiaries that have been taxed abroad at a corporate income tax rate of at least 15% (which is satisfied in the case of India).
These benefits have made it possible for Singapore to outpace other countries investing in India. We anticipate that strategic thinking entrepreneurs will continue to incorporate a holding company in Singapore and establish subsidiary operational entities in India and other countries as their venture grows internationally.
You can find the full details of the 2021 Union Budget of India.
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