Capital market participants have made a strong case for reforms to the ‘safe harbour’ clause under Section 9A of the Income Tax Act, which has hindered fund managers from relocating offshore funds to India.

While it was introduced to attract offshore funds and fund managers by mitigating double taxation risks, the provision has been underutilised due to impractical conditions that many argue are overly stringent and discouraging.

Under the safe harbour clause, a fund and its manager can be exempt from taxation in India if they do not have a business connection in the country. However, establishing the absence of a business connection or tax residence requires meeting certain conditions.

“Asset managers were keen to provide fund management services from India but were challenged by tax rules that could result in higher taxation for offshore funds if managed from India,” said Tushar Sachade, Partner at Price Waterhouse & Co.

He said that while safe harbour rules shield fund managers from double taxation and provide certainty against higher tax incidence, the restrictive conditions have limited their adoption.

One primary concern is the 5% threshold set for individual investor holdings, which is challenging to monitor, particularly when Indian entities participate indirectly. Market participants have proposed raising this limit to 10%, believing it to be more feasible and less restrictive.

Another significant issue is the timeline for raising the minimum corpus requirement. Currently, funds must raise an average monthly corpus of at least Rs 100 crore within a year. Participants argue that this time frame is too short and have requested an extension to three or five years.

The cap on fund managers’ remuneration is another point of contention. Under current rules, fund managers and connected entities cannot take more than 20% of the profits made by the fund. Participants argue that this restriction serves as a significant deterrent for fund managers considering moving their operations to India.

Rajarshi Dasgupta, executive director – Tax at AQUILAW, echoed similar thoughts, suggesting a re-evaluation of the safe harbour provisions. She called for rationalising these restrictive conditions on “investment and investor diversification, conditions that bar investment in associate entities as well as conditions that bar the fund from carrying out any other business in India.”

In a recent meeting with Union Finance Minister Nirmala Sitharaman, capital market participants requested a revisiting of these conditions to address concerns over thresholds set for individual investors’ holdings in the fund, the time allotted to meet the minimum corpus requirement, and the cap set on the remuneration of fund managers, among others.

Experts have pointed out that the issue takes a different dimension in the context of the International Financial Services Centre (IFSC) in GIFT City. A fund manager managing an offshore fund from Singapore does not create tax issues for the fund in India, unlike a fund managed from the IFSC.