MC Explains: What is the 'safe harbour' clause under Section 9A of Income Tax Act, and why does it need a relook?

Here's a breakdown of what it means and why capital-market experts are seeking a revisit.

What does this clause say?

The clause defines various parameters by which a fund that invests in and operates from India can be exempted from taxation in India. Under this clause, a fund will be exempt if it does not have a business connection in India. To establish that there is no business connection or tax residence in India, the fund and the fund manager have to meet certain conditions.

When was the clause introduced?

It was introduced in 2015 by adding a new section to the Income Tax Act.

Why was it brought in?

It was introduced to encourage investments in India by taking out the double-taxation risk a fund could face by having a fund manager in India.

As a note released by EY in 2020 stated, "The presence of a fund manager in India could entail business connection/ permanent establishment/ tax residence risks for offshore funds in India. In order to encourage fund management of offshore funds from India, the Finance Act, 2015 had introduced a new section 9A in the Income Tax Act, 1961 (Act) to provide a safe harbour regime for onshore management of offshore funds thereby neutralising the impact of constitution of business connection/ permanent establishment/ tax residence for the offshore funds in India."

Why does it need to be revisited?

Capital-market experts give various reasons.

For one, there is a threshold set for individual investors' holding in the fund.

It reads: "The aggregate participation or investment in the fund, directly or indirectly, by persons resident in India does not exceed five percent of the corpus of the fund".

Also read: SC ruling on comparability in transfer pricing might necessitate a review of safe harbour rules

Fund managers say that it is difficult to monitor if this threshold is being breached on a continuous basis, especially if an Indian entity is participating indirectly through separately set up entities. They are also demanding that the threshold be raised from 5 percent to 10 percent.
Secondly, funds want the timeline set for raising the minimum corpus— of a monthly average of Rs 100-crore corpus—extended.
Currently, funds have a year to raise this amount. The clause reads: "The monthly average of the corpus of the fund shall not be less than one hundred crore rupees: Provided that if the fund has been established or incorporated in the previous year, the corpus of fund shall not be less than one hundred crore rupees at the end of such previous year."
The funds want this time period to be extended to three or five years.
Thirdly, they want the threshold of profit sharing with fund managers to be revised. Fund managers and connected entities cannot take more than 20 percent of the profits made by the fund through transactions done through the fund manager.
Experts pointed out that some of the provisions under the 9A IT Act do not apply to funds set up in Singapore and therefore funds set up through the International Financial Services Centre (IFSC) in GIFT City are at a disadvantage.