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QFI: Knights In Shining Armour?

Published on Tue, Jul 03,2012 | 19:28, Updated at Thu, Jul 12 at 08:23Source : 

By:  Ameet Patel, Partner, Sudit K Parekh & Co.

Nowadays, the Indian stock markets cannot seem to decide whether to be bullish or bearish. The statistics on FIIs’ investments in Indian stocks are also confusing. While some of my clients are buying heavily, some are selling equally heavily. The Government continues to be in ‘switched-off’ mode when it comes to taking important decisions. In this gloomy scenario, one particular class of investors that has been in the news recently is Qualified Foreign Investors (QFI).

Although not an expert in the field, I do have some knowledge of the QFI concept and have been trying to understand how this new class of investors will operate and how various service providers connected to QFIs would also operate. Based on my discussions with some of the larger players in the market and based on press reports attributed to the Government, it appears that everyone is hoping that QFIs will be the proverbial knights in armour for India’s stock markets. Very ambitious estimates are being talked about in terms of investments by QFIs in the stock markets over the next 2-3 years.

But will foreign investors bite the bullet? Will they overlook the various negatives that the Indian economy and the Indian political class are jointly parading to the rest of the world? Will QFIs ignore the rating downgrade by S&P? Time will tell. However, it would be interesting to understand some of the issues that may have held QFIs back from kicking off investments in India.

Budget 2011 was the first to introduce the QFI concept to India...the Finance Minister mentioned a new class of investors. Thereafter, there was a lull and nothing moved for a few months. In August 2011, SEBI issued its first circular. The RBI followed suit. Both circulars defined ‘QFI’ and detailed the role of Qualified Depository Participants (QDP). It was only then that we discovered that QFIs are a blessed lot. They do not require registration with SEBI! However, this bliss was short-lived as the fine print of the circulars also revealed several other angles which could be deal breakers. The long list of onerous responsibilities cast on the QDPs has completely stumped the custodian industry. They have been lobbying heavily with the Finance Ministry to get the law changed. Some of their demands have been met while some have not. The QFI regime as announced initially is quite different from the regime as amended vide the latest circular and press release and FAQs issued in June 2012. However, QDPs continue to be saddled with the responsibility of certain income-tax related compliances.

This tax related burden is one of the most important reasons why none of the QDPs (31 entities have registered with SEBI at the time of writing this article) have started accepting investors under this regime. At the same time, most QDPs have been preparing intensely to start operations. Most of them have now started internal discussions on how to provide the tax related compliance services. Obviously, no QDP is in the business (or profession) of tax advisory services. Therefore, they would need to engage tax consultants who in turn would do the actual tax related work. How such arrangements would work remains to be seen. Some QDPs may allow QFIs to tie up directly with the tax consultant while others may enter into tripartite arrangements. Those investors (particularly the large institutional ones) who prefer to go with brands may appoint their own tax consultants based on their global tie ups with larger firms.

The issue of who would be responsible for the tax related compliances is going to be a contentious one. It appears that the Finance Ministry has informed the custodian lobby that no changes would be made in the tax related responsibilities cast on QDPs. Therefore, QDPs will have to live with a sword hanging on their heads. A sword carrying the tag of “Representative Assessee”(under the Income-tax Act). Is it possible that in the event that something goes wrong with a QFI and a huge tax demand is raised against that QFI, the tax department will pursue the QDP as a representative assessee of the QFI? And thereafter, recover the tax demand from the QDP? A prima facie study of the matter suggests that this is highly probable. It is this fear that has put the brakes on the QFI regime. Would a QDP like to take this risk? Can a QDP afford to get involved in a Vodafone type of controversy and be caught at the centre of that dispute? Are the fruits of the labour worth the risks? These are questions that the QDP lobby as a whole and its individual constituents are deliberating upon at present. My personal view is that commercial expediency would prevail and ultimately, one QDP will be brave enough to go ahead and start operations. When that happens, the rest will follow suit. The perceived volume of expected business is too large to ignore or avoid.

What about QFIs themselves? Will the investors breathe easy on the tax front? Here too, there is considerable confusion which, to my mind, is self created. According to me, the law at it stands today is very clear. Every QFI will need a PAN. Every QFI will need to obtain a certificate in Form 15CB before a remittance can be made from India to the QFI’s home country. Most QFIs may be required to pay tax in India unless they earn tax-free long term capital gains or if they are tax residents of a country like Singapore whose tax treaty with India says that capital gains earned by a Singapore resident would not be taxable in India. Every QFI may be required to file a tax return in India. Unless the law is specifically changed by the Government, QFIs would need to comply with all these tax related matters. Once they file a tax return, it is possible that the same may be taken up for scrutiny by the tax officers. This could also lead to litigation if something goes wrong during the assessment. And, of course, the issue of GAAR being applied next year onwards also exists. However, that is for the future. For the time being, the PAN itself is going to be an entry barrier.

In the application form for PAN (Form 49AA), the applicant has to give his foreign address and proof of that address. The documentary evidence that is acceptable to the Govt for this purpose is a very restrictive list unlike the list for resident applicants. As a result, foreigners are going to find it very difficult to provide proof of residence to the Govt. Secondly, the issue of providing an address in India remains. If only a foreign address is given in the PAN application form, then the PAN Card would be couriered to that foreign address. This will take time and it would be at least 15-20 days before which a foreigner would receive his PAN Card. Thereafter, he will need to either resend the original to the QDP or send a consularised copy. In either case, this will entail costs as well as consume more time. This would, in most cases, delay the process of completion of KYC norms which in turn will lead to a delay in the opening of a bank account and other formalities. Can the Govt make life easier for foreigners and allow them to give the address of an Indian tax consultant in the PAN application form only for the purpose of getting the PAN Card in India? Unless this is done, no Indian would like to volunteer his name and address for this purpose since he may be construed to be a Representative Assessee of the QFI in India. This is a huge risk that nobody would like to take on his shoulders. Therefore, there is an urgent need to redesign the PAN application form first. The starting point itself is a problematic one for QFIs. I hope that the Govt wakes up to these ground realities if it is serious about attracting QFI investment into India.


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