Debt Investments in India

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Debt Investments in India30 May 2013


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Contents

Landscape of foreign investment in Indian debt

Foreign Institutional Investors vs. Qualified Foreign Investors

Recent changes impacting debt investments in India

Listed non-convertible debentures structure

Advantages

Mechanics

Open issues/ key aspects for consideration

Cyprus update

Cyprus bailout

Way forward for existing as well as new investments

Overview of alternate jurisdictions


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Landscape of foreign investment in Indiandebt


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Landscape of foreign investment in Indiandebt

Foreign Investments

Foreign VentureCapital Investors

Foreign DirectInvestment (FDI)

Optionally convertibledebentures / non-convertibledebentures (NCDs)

Foreign InstitutionalInvestors

(FIIs)/QualifiedForeign Investors

(QFIs)

Governmentsecurities

Listed / unlisted NCDs

Mutual fund debtschemes

Infrastructure debtfunds (IDFs) bondsand units

ExternalCommercial

Borrowings (ECBs)

Optionallyconvertible/ non-convertibleinstruments

Pure loans

Foreign currency

convertible bonds

Foreign currencyexchangeable bonds

Compulsorily andmandatorilyconvertibledebentures


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FIIs vs. QFIs


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FIIs vs. QFIs- Comparison snapshot

FII / Sub-account QFI

Route for making portfolio investments since early

nineties

Introduced by the Government in 2011 Budget. Routeopened up in phased manner from investments in units ofmutual funds, equity shares and in corporate bonds andgovernment securities

Key regulatory aspects

Eligibility criteria Entities like pension funds, mutual funds,

investment trusts, insurance company, asset

management company, investment manager or

advisor, bank or institutional portfolio manager,broad based fund established or incorporated

outside India as well as foreign corporate or

individuals (subject to certain conditions)

Any person resident of one of the specified countries would

qualify for investment

Registration Offshore entity need to obtain FII/ sub account

license from Securities and Exchange Board of

India (SEBI)

No registration required. Know your client (KYC) procedure

to be undertaken through qualified depository participants

(QDP)

Investments Government securities/treasury bills

Units of domestic mutual funds

Listed/unlisted NCDs

Bonds and units of IDFs

Security receipts

Perpetual debt instruments

Government securities/treasury bills

Units of domestic mutual funds

Listed NCDs

Bonds and units of IDFs


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FIIs vs. QFIs- Comparison snapshot

FIIs QFIs

Key tax aspectsTax rates as per

the Indian tax

law**

Discharge of

taxes

FIIs are allowed to remit proceeds on sale/

divestment of securities after discharging

applicable taxes on a self assessment basis

A withholding mechanism prior to

repatriation is presently envisaged under the

QFI scheme

Interest (1 June 13 to 31

May 15)5%

Interest (other than

mentioned above)30%/40%

Short-term Capital gains 30%/40%

Long-term capital gains 10*/20%

* Foreign exchange adjustment possible along with 10% rate. However, there are conflicting judicial precedents on the availability oflower rate of 10%

** Rates

exclusive

of applicable

surcharge

and education cess under the Income-tax

Act, 1961 (the Act)

Interest (1 June 13 to 31

May 15)5%

Interest (other than

mentioned above)20%

Short-term Capital gains 30%

Long-term capital gains 10%


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Recent changes impacting debt investments


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Exemption under Deposit Rules extendedto NCD secured by mortgage of any fixedasset (excluding intangible assets) asagainst only immovable property

Amount of bonds and debentures not to

exceed market value of fixed assets

Finance Act 2013 (FA 2013) provides fora concessional withholding tax rate of 5%on interest payable to FIIs and QFIs onrupee denominated bond of an Indiacompany or Government security for theperiod June 1, 2013 to May 31, 2015

Provided rate of interest on rupee

denominated bonds do not exceed the

prescribed rate

Sector-wise and investor-wise limitsreplaced with single instrument-wiselimits*

Combined limits for FIIs, QFIs and othereligible long term investors#

Government securities USD 25 bn##

Corporate bonds USD 51 bn## [infrastructure(listed / unlisted) as well as non-

infrastructure (listed)]

Auction mechanism withdrawn - replacedby on tap system upto 90% utilization

Concessional income-tax ratesRationalization of debt limits

Widening of exemption under DepositRules

#Long term investors are Sovereign Wealth Funds, Multilateral Agencies, Endowment Funds, Insurance Funds, Pension Funds and ForeignCentral Banks

##Sub-limits specified for investments in Treasury bills (under Government securities) and Commercial papers (Corporate debt category)

*Please refer subsequent slides for detailed comparison ofearlier limits as well as new limits

Reforms to tap current account deficit

and widen debt market

Recent changes impacting debt investments


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Limits for corporate debt

Non Infrastructure Sector Investor Limit Condition

Listed NCDs/ bonds/ commercial paper(CP)

FIIs USD 20 Billion Investment in certificate ofdeposits (CD) is not permitted

Listed NCDs/ bonds FIIs/ long terminvestors

USD 5 Billion Investment in CD and CP is notpermitted

Listed NCDs, listed bonds, listed units ofmutual funds debt schemes, to be listed

corporate bonds

QFI USD 1 Billion

Earlier limits

Infrastructure Investor Limit Condition

Listed/unlisted NCDs/ bonds of IndianCompanies in Infrastructure sector, NCDs/bonds of NBFC-IFC

FIIs USD 12 Billion Residual maturity at the time offirst purchase should be at leastfifteen months

IDF rupee bonds/units registered as NBFCor mutual funds

FIIs/NRIs/long terminvestors/HNIs

registered withSEBI/sub account ofFII or IDF

USD 10 Billion Residual maturity at the time offirst purchase should be at least

fifteen months

Corporate debt non- convertibledebentures/ bonds, non- convertibledebentures / bonds of NBFCs-IFC, units ofdomestic mutual fund debt schemes

QFI USD 3 Billion Original maturity of investmentto be 3 years


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Limits for corporate debt

Corporate debt cumulative Investor Limit Condition

Instruments referred to in schedule 5 ofForeign Exchange Management (Transferor Issue of Security by a Person Residentoutside India) Regulations, 2000*

FIIs/QFIs/longterm investors

USD 51 Billion(upto USD 3.5Billion forcommercialpaper)

New limits

* Listed / proposed to be listed non-convertible debentures/bonds issued by an Indian company, units of domesticmutual funds, commercial papers issued by an Indian company, security receipts, perpetual debt instruments, rupeedenominated bonds/units issued by IDF


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Earlier limits

New limits

Limits for Government securities

Instrument Investor Limit Condition

Government Securities (includingtreasury bills)

FIIs USD 10 billion

Government dated securities (ie.Government bonds and dated securities)

FIIs/long terminvestors

USD 15 billion Investment in treasury bills notpermitted

Instrument Investor Limit Condition

Government securities (includingtreasury bills and Government bonds anddated securities)

FIIs/ long terminvestors/ QFIs

USD 25 billion(investmentsin treasurybills upto USD5.5 billion)


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Tax rates on interest income

Investors

During the period 1 June 2013 to 31 May 2015 Pre-FA 2013 / PostMay 31, 2013Within Limits* Above limits

FIIs 5% 20% 20%

QFIs 5% 30%**/40% 30% /40%

*Concessional tax rate available if the interest rate on corporate bonds do not exceed the rate to be prescribed by the

Central Government

**30% rate applicable to QFIs being non-corporate taxpayers

All the above rates are excluding applicable surcharge and education cess under the Act

Pursuant to the reforms, FII / QFI Listed NCD route to become more attractiveroute for debt investments in India


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Listed NCD structure- Advantages and opportunities

Not treated as FDI or ECB

No sector as well as pricing restrictions

No end use restrictions

Easy repatriation of principal / interest

No restriction on coupon / all-in cost

Tax efficient

Tax rate during the period 1 June 2013 to 31 May 2013 5%, provided the interest rate

does not exceed the rate prescribed

Investee company may get deduction of entire coupon - tax break at rate of 30%

Security possible

Through debenture trustee mechanism

Highly flexible route for debt investments in India


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Listed NCD structure- Mechanics

Indian Co to apply for issue and listing of its NCDs

on the Wholesale Debt Market of a recognized

stock exchange

FIIs (or sub-account) / QFIs to subscribe to the

to be listed NCDs of Indian Co, subject to the

listing of the NCDs being listed within 15 days

Key Aspects

SEBI regulations

Debt listing regulations

Listing agreements with stock exchanges

Corporate laws

Exchange control regulations

OffshoreFund /Investor

Indian Co.

Listed NCDs

Overseas

India

New Investors

FII / sub-account or

QFI

Capital+Interest /

redemptionproceeds


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Listed NCD structure- Open issues/ key aspects for consideration

Notification awaited on rate of interest for corporate bonds awaited

Characterization of redemption premium, if any, paid on maturity

Taxation of discounted securities


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Cyprus update


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Cyprus update

Cyprus one of the most preferred jurisdictions of the foreign funds for making

investments in India

Member of European Union (EU) and reputed financial centre

Wide and favorable tax treaty network

Favorable domestic tax regime

Availability of educated workforce

Major banking crisis in Cyprus

Bailout of Cyprus banks with financial assistance from EU

Various economic and financial measures by Cyprus Government to restructure the financial

sector as a part of the agreement with EU

The debt crisis require cautious approach from investors - existing as well asprospective - to evaluate economic, financial and political stability in Cyprus


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Capital control measures

Restriction on maximum amount of withdrawals and cashless transactions Likely to continue for next 2-3 months expected to gradually phase out

All transactions including domestic banks and / or domestic customers subject torestrictive measures

Restrictions not to apply to:

Funds transferred from abroad to Cyprus

Transactions between foreign bank and international customer as well as amongst

international customers not subject to restrictions

Transactions of domestic customers in overseas bank accounts not subject to restrictions

Foreign banks are prohibited from servicing or even soliciting domestic customers

Impact analysis

Foreign banks and international customers not covered under restrictions

However, subsequent restrictions on them cannot be ruled out

Under the current scenario, investors from Cyprus to be cautious of remitting

accruals into Cyprus bank accounts - critical to monitor the developments closely

Cyprus bailout- Key measures


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Tax measures

Corporate tax rate increased from 10% to 12.5% Special Defence Contribution (SDC) on passive interest income increased from 15%

to 30%

Impact analysis

Additional corporate tax charge of 2.5% (net of expenses)

Additional tax cost in Cyprus post credit of withholding tax of 10% in India under CyprusTreaty

SDC rate only applicable for passive interest income

Structuring to ensure interest income is treated as active income in Cyprus critical

Advance rulings possible

Cyprus bailout- Key measures


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Usage of existing accounts with domestic banks (other than Laiki and Bank of

Cyprus) as well as with foreign banks

However, subsequent restrictions by Cyprus Government cannot be ruled out

Opening of bank account in other jurisdictions

No regulatory restrictions in Cyprus

Tax residency in Cyprus dependant on management and control

Primary requirement board meetings and majority of directors in Cyprus

If above conditions not satisfied - other conditions such as important decisions, bank

accounts, accounting, office etc are to be considered

However, bank accounts outside Cyprus should be controlled and operated from Cyprus

Way forward- Existing investments


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Alternate jurisdictions to Cyprus

Ireland

Luxembourg

Netherlands

Singapore

Way forward- New investments


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Singapore

Corporate as well as fund structures possible

Fund and fund management incentives available in the form ofvarious schemes

Structures and

legal forms

Corporate tax rate of 17% (on net income)

Funds exempt from tax from eligible income under variousschemes

Some of the relevant factors for presence in Singapore

Eligibility to avail exemption under various schemes

Treaty network

Existing presence, availability of investment professionals etc

Repatriation issues

Overview of thejurisdiction


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Singapore

Some of the criterions are as follows:

Important decisions to be taken in Singapore

Majority of the directors to be tax resident of Singapore

Meeting of the Board of Directors and other corporate formalities like

signing of the board resolution, minutes of the meeting to be in

Singapore

Directors to be competent to take independent decisions

Hard copies of commercial documentation (agreements, invoices,

correspondences, etc) should be stored in the office in Singapore

Bank account in Singapore and operated from Singapore

Limitation of Benefit clause in the India-Singapore tax treaty: Not a

shell/conduit company, minimum expenditure of SGD 200,000 in theimmediately preceding period of 24 months from the date of gains

Substance(illustrative)

To demonstrate control and management to obtain TRC for investment companies

in Singapore


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Jurisdictions in EU

Corporate structures use all three jurisdictions somewhat equally

For investment funds, it is primarily Luxembourg and Ireland

Structures

Corporate fully subject to local tax and eligible for treatybenefits

Securitization vehicles commonly subject to a special taxregime which may make them easier to operate but may reducetheir eligibility for tax treaty benefit in some countries

Legal forms

Corporate tax rates in the countries vary between 25% to 29%

Commonly, companies are debt financed in order to reduce theeffective tax rate

No clear-cut best answer per-se, people compare and choose thebest for them

Some factors to consider

an pre-existing business in a given jurisdiction Investor preferences

Specific treaty differences

Tax issues in each of the jurisdictions differ and thus, thestructures too differ

Overview ofjurisdictions


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Jurisdictions in EU

Lawyer Tax advisor

Administrator Corporate service provider

Local Directors

Cost

Formation

requirements

Some of the criterions are as follows:

Management of company is capable of taking decisions and proveits independence

Board meetings physically held in Luxembourg. Ideally a minimumof two a year

Additional meetings are held if necessary for any strategicdecisions that need to be made

All corporate formalities should be maintained in Luxembourg.For example, board meeting minutes properly documented andmaintained at registered office

Day-to-day management should be performed in Luxembourgincluding bookkeeping, reporting, bank accounts, tax and legalcompliance and management of cash flows

Substance

(Luxembourg -illustrative)


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Jurisdictions in EU

Generally, there are three ways to initiate a change in holding

company jurisdiction

Sale of assets to new Hold Co.

Contribution of assets to new Hold Co. in return for debt/equity

Migration of existing entity to new jurisdiction

Change Board of Directors

Convene Board meeting authorizing change

Establish local physical presence

Domestic corporate law is adhered to

Reorganizationpossibilities


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How EY can help


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Tax and regulatory advice in connection with the structuring of debt investments in

India

Obtaining regulatory registration / clarifications

Review of the transaction documents

Assistance in listing of NCDs on stock exchanges

How EY can help


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Thank you

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Debt Investments in India