What are sovereign wealth funds?
A sovereign wealth fund (SWF) is a pool of assets that are managed and controlled directly or indirectly by a country’s government. They are usually government owned entities that are used to invest in overseas debts and equities markets.
Such wealth funds may be established for a multitude of objectives: from diversifying assets, to getting better returns on revenue, to promoting industrialization, to promoting strategic and political alliances, or for other reasons. There has been a growth in SWFs over the last few years, mainly due to the increase in revenue for oil producing nations.
Recent Developments in India for SWFs:
With the increase in activity by SWFs, the Indian government has recognized the opportunity of increasing foreign direct investment in the country through such funds. Since early 2020, the government has introduced a 100% income tax exemption for SWFs, and rules on how to avail them have been notified since.
In November 2020, as per a notification by the Central Government of India, the Abu Dhabi Investment authority (UAE’s SWF) became the first fund to be granted this exemption under the Income Tax Act, 1961. Their application procedure was expedited by the government and was completed within two months of the receipt of their application.
What is the tax exemption provided by India?
In a bid to incentivize investments by foreign SWFs in certain key sectors like infrastructure, the Central government proposed incentives for such SWFs in the Union Budget of 2020- by proposing a 100% exemption from tax on income from dividends, interest, and long-term capital gains earned from the investments made by the SWFs in India.
The Finance Act, 2020 introduced the new exemption which would be available for qualifying investments made by foreign SWFs in specified infrastructure business, if the investment was made during the period of 1st April 2020 to 31st March 20204 and held for a minimum period of three years. This was subsequently amended by the Central Board of Direct Taxes (CBDT) of India to expand the meaning of ‘infrastructure’ to include sectors like energy, sanitation, transport, telecommunication, social and commercial infrastructure (hospitals, tourism, educational institutions, etc.), water, etc. It has been expanded to include all sub-sectors under the Harmonised Infrastructure Master List updated in 2018. These sectors may continue to be expanded by the government in the future.
The investment may be made:
- In units of all types of Infrastructure Investment Trusts (InvITs), or
- Debt, or shares of companies engaged in the specific infrastructure activities mentioned above, or
- All units of Category 1 and Category 2 Alternative Investment Funds which have invested their full funds in companies engaged in the infrastructure activities mentioned above.
Currently, the Abu Dhabi Investment Authority and all notified SWFs and notified pension funds may avail of this exemption.
How to Qualify as an SWF in India?
To qualify as a SWF that can avail this exemption in India, the SWF must comply with the following rules:
- It must be wholly owned and controlled either directly or indirectly by the government of a foreign country.
- It must be set up and regulated as per the laws of that foreign country.
- Ensure that the earnings of the SWF are not credited to any private person. It is credited to the accounts of the government of the foreign country or any account as designated by them.
- The fund does not undertake any commercial activity within or outside India.
- The assets of the fund will vest with the foreign government upon dissolution.
- It is notified by the Central Government, in the Official Gazette, for the purposes of exemption in India.
Conditions may be introduced or removed by the Central Government in such matters.
Even foreign pension funds can also avail this exemption if they qualify and are notified by the central government. To qualify, they have to comply with the following rules:
- They are created or established under the laws of a foreign country, including all state and local laws of the country.
- They are not liable to tax in such foreign countries.
- They satisfy any other conditions as prescribed by the Central Government.
- They are specified by the Central Government, by notification in the Official Gazette, for this purpose.
If an SWF qualifies along the above rules, they have to apply to avail the income tax exemption from the Central Government, to then be notified. For now, the Abu Dhabi SWF is the first fund to be notified by the Indian government.
Further rules of procedure for applying for the exemption have been provided by the central government.
How to apply for notification by the Central Government?
To become notified by the Central Government of India, all SWFs must:
- File an application in Form I (found in Annexure to Circular 15 of 2020 issued by the CBDT)
a) Form I should be filed in the year 2020-21 with the Member (Legislation), Central Board of Direct Taxes (CBDT), Department of Revenue, Ministry of Finance, North Block, New Delhi. For other years, it must be filed to Member, CBDT having supervision and control over the work of foreign tax and tax research division.
b) In the application in Form I, the applicant must include details such as the name of the SWF, address of the SWF, Tax Identification Number of its country of residence, the country of residence of the SWF, and Permanent Account Number (PAN) of the SWF or PAN of the authorized signatory of the SWF.
- File the return of income along with the audit report.
- File a quarterly statement within one month from the end of the quarter, with respect to each investment made during the quarter in Form II (found in Annexure to Circular 15 of 2020 issued by the CBDT).
- Comply with any other conditions deemed necessary as determined by the Director General of Income Tax of India.
This tax exemption introduced by the Central Government of India is a push to increase foreign investments in India, especially in the infrastructure sector. However, it also presents a great opportunity to foreign funds looking to invest in India, especially since the sectors mentioned herein are also receiving further incentives to increase ease of doing business, through the various stimulus packages released by the Central Government in 2020. While the Abu Dhabi SWF is the only fund so far to have been notified by the government, it is a strong indication of the government’s dedication to ease of doing business, that the entire notification process was expedited and completed within two months of the receipt of their application.
As foreign investors divest away from China, and turn to India for investments in infrastructure and manufacturing, this presents a great opportunity for sovereign wealth funds, of all sizes, to invest substantially while availing significant benefits.
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