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Foreign investors should be aware of the tax changes in sovereign wealth funds and pension funds as Mukesh Butani, of BMR Legal, explains.

The Indian Parliament passed the finance proposals of the Indian government for FY 2020–21. As general practice, substantial changes in the tax laws have been effected by way of amendments to the fiscal laws.

Certain amendments, viewed together, clearly highlight an attempt by the government to woo foreign investors at this time of crisis that is gripping the globe. Measures are specifically targeted at sovereign wealth funds (SWFs) and pension funds (PFs), who are expected to invest in Indian entities and are assured tax exemptions for various classes of income, whether dividends, interests or capital gains.

Exemption on Infra-Investment by Sovereign Funds and Pension Funds

Complete exemption is provided to income earned in the form of dividend, interest and long-term capital gains by SWFs. In fact, wholly-owned subsidiaries of the Abu Dhabi Investment Authority are specifically identified to this end. The exemption is available if such entities invest in an Indian business engaged in infrastructure projects.

The investments are subject to a minimum holding period of three years. The sunset clause for obtaining the relaxation is set to be March 2024. The list of eligible investors extends to foreign PFs. India anticipates that foreign PFs who manage several trillions of dollars representing the largest category of investors ahead of mutual funds, insurance companies, currency reserves, etc., will now look for avenues in India that offer tax breaks. The fact that they have been specifically mentioned as an eligible class signals the clear intention of the Indian government that will play host to this class of investors (previously neglected).

It is interesting to note that the law does not specify the conditions which must be observed by the PF before they become eligible to obtain the tax concessions. In fact, the highest tax administrative body, the Central Board of Direct Taxes, has been empowered to evolve and notify the eligibility criteria for PFs to qualify for concessions. This must be understood to mean that the government will undertake a stakeholder consultation and seek to evolve best practices so as to incentivize PF investments in India.

Another major change is to widen the sphere of investment by including within the coverage investment made in real estate investment trusts (REIT) and infrastructure investment trusts (InvIT).

As such, though the regulatory mechanism for both forms of investors has been popular for the past few years, barring the last two years, the global response towards this class of investors has been subdued. Besides, India’s success has been patchy, partly owing to changes in its taxation regime, particularly its ability to clarify vexatious aspects on tax benefit and regulatory compliance.

In the past three successive budgets, India has been focusing on making such structures lucrative for investment, both from a regulatory and tax perspective. Under the former regime, dividends paid by such trusts were tax-free, both in the hands of the trusts and their contributors. Two changes have been made with the recent legislative amendments.

First, the definition of business trusts is amended to include unlisted trusts registered with the Indian capital market regulator (SEBI), whereby they will also enjoy the benefits offered to listed trusts. Second, there is an across-the-board change in the dividend taxation regime, an aspect explained later.

Additionally, to promote alternative investment funds (AIFs) in India, they have been added to the list of eligible investments, thereby rationalizing the provisions for all three categories of investors i.e. REIT, InvIT and AIF.

However, to qualify, the AIF should either be a Category-I or Category-II fund registered with SEBI and solely investing in an eligible Indian entity. AIFs are funds set up in India and raise capital funds from Indian and foreign investors. Category-I AIFs invest in start-ups or early stage ventures in sectors which government recognizes as socially or economically desirable. Private equity (PE) funds and funds devoted to distressed assets are typically registered as Category-II AIFs. It is important to note that the infrastructure sector has been recognized by the Indian government as economically desirable.

Recent developments are clearly suggestive of India’s resolve to prioritize foreign investment in real estate and infrastructure to keep the growth engines of the economy moving and simultaneously offer employment opportunities, given the opportunity in these sectors.

State-owned PFs or SWFs can invest in India through special purpose vehicles (SPVs), which are generally structured as trusts. Overall, the new regime reveals that the intent is to push such funds to invest long-term in India, particularly in light of the out-flight India has experienced in the past couple of months in foreign portfolio investors (FPIs). As the U.S. interest rates and easing gathers momentum due to Covid-19 challenges, India will have to be braced for more FPI exits and hence, the need to attract SWFs and PFs in long-term infrastructure projects seems logical.

According to official data, India has received $36 billion FDI in the first nine months of the just-ended FY 2019–20. The figure is high, compared to FY 2018–19’s nine-month figure of $33 billion. Indeed, this trend may not continue and will have to be revisited post-Covid-19 crisis.

In the wake of the economic crisis which may engulf India, the government is expected to be flexible to large investment proposals to boost economic activity. All eyes are on the Covid-19 Economic Response Task Force which has been formed under the chairmanship of the Finance Minister.

Besides changes on procedural tax laws to deal with delays and bankruptcy of small businesses, major fiscal policy announcements are awaited. The Task Force, which is expected to seek feedback from all stakeholders, will also ensure that all steps taken to reduce the economic difficulties are effectively implemented.

Given the legislative sanction to recent changes on tax incentives, it would not be surprising that India will roll out the red carpet for SWFs and large PF investors. It could well result in a favorable impact on the overall investment cycle in the midst of the post-Covid-19 crisis as it settles down.

Taxation of Dividend Income

Effective from April 1, 2020, India has changed its tax policy for taxing dividend income. Previously, tax was levied in the hands of the Indian company (as an additional tax) paying the dividend (Dividend Distribution Tax, or DDT) and such dividends were tax-free in the hands of the recipient shareholder, irrespective of whether Indian residents or nonresidents

There was significant criticism of this policy, which was implemented in 1997, on the principal ground that it was inequitable as all shareholders (irrespective of their respective tax status) were taxed alike. Additionally, since the tax was not levied in the hands of the shareholders, no credit of DDT was available to nonresident shareholders. Consequently, foreign equity investment was disincentivized.

Under the new regime, DDT is abolished and the tax on dividend income will depend upon the tax status of the recipient shareholder. Subject to the satisfaction of the conditions of the tax treaty between India and its respective treaty partner, nonresident shareholders can claim beneficial withholding tax rate on dividends, which varies between 5 and 15%.

Since this announcement, there has been increased activity and planning with offshore holding structure, which are now seeking to liquidate excess cash reserve build-ups in their Indian subsidiaries in the form of dividends.

Planning Points

Eligible SWFs and PFs looking to invest in India must:

identify promising infrastructure investment projects;


impress upon the Indian entities to formulate appropriate SPVs, such as REIT, InvIT, AIF;


engage with the Indian tax administration to obtain guidance on conditions required to be satisfied for using tax exemptions.


Mukesh Butani is Managing Partner at BMR Legal, India.

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