Debt Investments in India

30 May 2013

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 Indian debt

Landscape of foreign investment in Indian debt

Foreign Investments
Foreign Institutional Investors (FIIs)/Qualified Foreign Investors (QFIs)

Foreign Direct Investment (FDI)

Foreign Venture Capital Investors

External Commercial Borrowings (ECBs)

Compulsorily and mandatorily convertible debentures

Optionally convertible debentures / nonconvertible debentures (NCDs)

Government securities Listed / unlisted NCDs Mutual fund debt schemes Infrastructure debt funds (IDFs) bonds and units

Optionally convertible/ nonconvertible instruments Pure loans Foreign currency convertible bonds Foreign currency exchangeable bonds

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FIIs vs. QFIs

FIIs vs. QFIs

- Comparison snapshot
FII / Sub-account
Route for making portfolio investments since early nineties

QFI
Introduced by the Government in 2011 Budget. Route opened up in phased manner from investments in units of mutual funds, equity shares and in corporate bonds and government 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) Offshore entity need to obtain FII/ sub account license from Securities and Exchange Board of India (SEBI) Government securities/treasury bills Units of domestic mutual funds Any person resident of one of the specified countries would qualify for investment

Registration

No registration required. Know your client (KYC) procedure to be undertaken through qualified depository participants (QDP) Government securities/treasury bills Units of domestic mutual funds Listed NCDs Bonds and units of IDFs

Investments

Listed/unlisted NCDs
Bonds and units of IDFs Security receipts Perpetual debt instruments

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FIIs vs. QFIs

- Comparison snapshot
FIIs Key tax aspects
Tax rates as per the Indian tax law**
Interest (1 June 13 to 31 May 15) Interest (other than mentioned above) Short-term Capital gains Long-term capital gains 5% 20% 30% 10%

QFIs

Interest (1 June 13 to 31 May 15)

Interest (other than mentioned above) Short-term Capital gains Long-term capital gains

5% 30%/40% 30%/40% 10*/20%

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

* Foreign exchange adjustment possible along with 10% rate. However, there are conflicting judicial precedents on the availability of
lower rate of 10% ** Rates exclusive of applicable surcharge and education cess under the Income-tax Act, 1961 (the Act)

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Recent changes impacting debt investments

Recent changes impacting debt investments

Rationalization of debt limits
Sector-wise and investor-wise limits replaced with single instrument-wise limits* Combined limits for FIIs, QFIs and other eligible long term investors#
Government securities USD 25 bn## Corporate bonds USD 51 bn## [infrastructure (listed / unlisted) as well as noninfrastructure (listed)]

Concessional income-tax rates

Finance Act 2013 (FA 2013) provides for a concessional withholding tax rate of 5% on interest payable to FIIs and QFIs on rupee denominated bond of an India company or Government security for the period June 1, 2013 to May 31, 2015
Provided rate of interest on rupee denominated bonds do not exceed the prescribed rate

Auction mechanism withdrawn - replaced by on tap system upto 90% utilization

Exemption under Deposit Rules extended to NCD secured by mortgage of any fixed asset (excluding intangible assets) as against only immovable property
Amount of bonds and debentures not to exceed market value of fixed assets

Reforms to tap current account deficit and widen debt market

*Please refer subsequent slides for detailed comparison of earlier limits as well as new limits
#Long

Widening of exemption under Deposit Rules

term investors are Sovereign Wealth Funds, Multilateral Agencies, Endowment Funds, Insurance Funds, Pension Funds and Foreign Central Banks
##Sub-limits

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

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Limits for corporate debt

Earlier limits
Non Infrastructure Sector
Listed NCDs/ bonds/ commercial paper (CP) Listed NCDs/ bonds Listed NCDs, listed bonds, listed units of mutual funds debt schemes, to be listed corporate bonds FIIs FIIs/ long term investors QFI

Investor

Limit
USD 20 Billion USD 5 Billion USD 1 Billion

Condition
Investment in certificate of deposits (CD) is not permitted Investment in CD and CP is not permitted

Infrastructure
Listed/unlisted NCDs/ bonds of Indian Companies in Infrastructure sector, NCDs/ bonds of NBFC-IFC IDF rupee bonds/units registered as NBFC or mutual funds FIIs

Investor

Limit
USD 12 Billion

Condition
Residual maturity at the time of first purchase should be at least fifteen months Residual maturity at the time of first purchase should be at least fifteen months

FIIs/NRIs/long term investors/HNIs registered with SEBI/sub account of FII or IDF QFI

USD 10 Billion

Corporate debt non- convertible debentures/ bonds, non- convertible debentures / bonds of NBFCs-IFC, units of domestic mutual fund debt schemes

USD 3 Billion

Original maturity of investment to be 3 years

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Limits for corporate debt

New limits Corporate debt cumulative
Instruments referred to in schedule 5 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000*

Investor
FIIs/QFIs/long term investors

Limit
USD 51 Billion (upto USD 3.5 Billion for commercial paper)

Condition

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

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Limits for Government securities

Earlier limits

Instrument
Government Securities (including treasury bills) Government dated securities (ie. Government bonds and dated securities)

Investor
FIIs FIIs/long term investors

Limit
USD 10 billion USD 15 billion

Condition

Investment in treasury bills not permitted

New limits Instrument

Government securities (including treasury bills and Government bonds and dated securities)

Investor
FIIs/ long term investors/ QFIs

Limit
USD 25 billion (investments in treasury bills upto USD 5.5 billion)

Condition

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Tax rates on interest income

Investors FIIs QFIs

During the period 1 June 2013 to 31 May 2015

Within Limits* 5% 5% Above limits 20% 30%**/40%

Pre-FA 2013 / Post May 31, 2013 20% 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 attractive route 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
New Investors

Indian Co to apply for issue and listing of its NCDs on the Wholesale Debt Market of a recognized stock exchange

Offshore Fund /Investor Overseas India Capital+ Interest / redemption proceeds Listed NCDs

FII / subaccount or QFI

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

Indian Co.

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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

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 as prospective - to evaluate economic, financial and political stability in Cyprus
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Cyprus bailout
- Key measures
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 to restrictive 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

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Cyprus bailout
- Key measures
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 Cyprus Treaty

SDC rate only applicable for passive interest income

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

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Way forward
- Existing investments

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

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Way forward
- New investments
Alternate jurisdictions to Cyprus

Ireland

Luxembourg

Singapore

Netherlands

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Singapore
Structures and legal forms

Corporate as well as fund structures possible Fund and fund management incentives available in the form of various schemes

Overview of the jurisdiction

Corporate tax rate of 17% (on net income) Funds exempt from tax from eligible income under various schemes 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

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Singapore
Substance (illustrative )
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 the immediately preceding period of 24 months from the date of gains

To demonstrate control and management to obtain TRC for investment companies in Singapore

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Jurisdictions in EU
Structures

Corporate structures use all three jurisdictions somewhat equally For investment funds, it is primarily Luxembourg and Ireland Corporate fully subject to local tax and eligible for treaty benefits Securitization vehicles commonly subject to a special tax regime which may make them easier to operate but may reduce their eligibility for tax treaty benefit in some countries Corporate tax rates in the countries vary between 25% to 29% Commonly, companies are debt financed in order to reduce the effective tax rate No clear-cut best answer per-se, people compare and choose the best 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, the structures too differ

Legal forms

Overview of jurisdictions

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Jurisdictions in EU
Formation requirements

Lawyer Tax advisor Administrator Corporate service provider Local Directors Cost

Substance (Luxembourg illustrative)

Some of the criterions are as follows:

Management of company is capable of taking decisions and prove its independence Board meetings physically held in Luxembourg. Ideally a minimum of two a year

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

All corporate formalities should be maintained in Luxembourg. For example, board meeting minutes properly documented and maintained at registered office Day-to-day management should be performed in Luxembourg including bookkeeping, reporting, bank accounts, tax and legal compliance and management of cash flows

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Jurisdictions in EU
Reorganization possibilities
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

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How EY can help

How EY can help

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

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Thank you

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