Retail fund schemes struggle to take off in GIFT City amid regulatory and tax hurdles

Currently, GIFT IFSC has 139 fund management entities (FMEs). Of these, 123 are registered as non-retail schemes with only eight as retail schemes, and the balance as authorised FME schemes

The fund management business in GIFT City may appear thriving, with numerous PMS and AIFs being set up. However, a closer look at the mutual fund segment—or retail schemes—reveals a different story as growth in this space has been sluggish, to say the least.

Currently, GIFT IFSC has 139 fund management entities (FMEs). Of these, 123 are registered as non-retail schemes with only eight as retail schemes, and the balance as authorised FME schemes.

Experts attribute this slow uptake to regulatory uncertainty, restrictions on marketing retail schemes to NRIs, and the absence of significant tax benefits for choosing a retail scheme in GIFT City.

The IFSC fund management regulations allowed retail schemes in IFSC in 2022, but the absence of a tax regime aligning them with offshore funds created uncertainty. As a result, fund managers were hesitant to set up retail schemes.

In January this year, the Central Board of Direct Taxes (CBDT) came out with a circular outlining the conditions. "The conditions prescribed in the circular, such as limits on investment in unlisted securities and associate entities, are quite onerous for retail schemes to satisfy," said Suresh Swamy, partner at Price Waterhouse & Co. He added that a result of this, retail schemes are yet to take off in IFSC.

An official noted that the CBDT circular still lacks clarity on certain aspects. Specifically, there is ambiguity regarding what qualifies as a passive breach and the timeline for rectifying such breaches.

For instance, the official explained that a stock in a retail scheme can have a maximum weightage of 25 percent. However, if this limit is exceeded due to an increase in valuations, the circular does not specify how long fund managers have to bring it back within the permissible range.

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Similarly, another example of a passive breach is the requirement for a fund to have at least 20 clients. If one or two clients exit the fund, the circular does not provide a clear timeline for compliance. This lack of clarity discourages retail schemes from setting up operations in GIFT City, experts say.

Vinod Joseph, partner at Economic Laws Practice said that it is more a matter of who can invest in mutual funds based out of GIFT City.

"If you set up a retail fund in GIFT City for the purpose of investing into India, such retail fund can't raise more than a small percentage of its corpus from Indian investors, because of FEMA restrictions," he added.

While when it comes to foreign investors, he says that there are a lot of restrictions for marketing the funds to retail investors in foreign countries. "Sending a marketing email or even a WhatsApp text to NRIs or foreign retail investors is subject to many restrictions imposed by regulators in those geographies. But in the case of institutional investors and HNIs, collecting money from them is relatively easier because of fewer restrictions on marketing," Joseph added.

No real benefit
There is no real benefit for a retail scheme investing in equities in GIFT City as compared to direct investments in Indian equities from overseas, said Swamy. The reason - the tax rates for both are same.

However, in case of debt investments, retail schemes in GIFT City can be more attractive as the capital gain exemption on the same is prescribed in the law, he adds. "In the case of direct investment from overseas investors, a capital gains tax of 12.5 percent for long-term here is a tax is levied while it is 30 percent for short-term, subject to treaty benefits, he adds.

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