KPMG IN INDIA
Budget 2008 Highlights Financial Services Sector TA X
Table of Contents Tax proposals relevant to Financial Services sector
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Direct Tax
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Indirect Tax
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Policy initiative in the Financial Services sector announced in the Budget
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Recent policy changes in the financial services sector
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Banking
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Insurance
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Mutual Funds
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Real Estate Investment Trusts
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Non-banking Financial Companies
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Portfolio Manager
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Venture Capital Funds
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Securitisation
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Foreign Exchange Management
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Glossary
30
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F I N A N C I A L S E RV I C E S
Tax proposals relevant to Financial Services sector The summary that follows highlights the salient features of the Finance Bill 2008, in terms of direct and indirect taxes relevant to Financial Services sector. Unless otherwise indicated, the proposed amendments relating to direct taxes will apply from assessment year 2009-10 and the amendments relating to service-tax will apply from a date to be notified after the enactment of the Finance Bill 2008.
Direct Tax • Short-term Capital Gains tax (STCG) on equity shares or units of an equity oriented fund, where Securities Transaction Tax (STT) is applicable, is proposed to be increased to 15 percent from 10 percent. After the levy of applicable surcharge and education cess, the effective rate of tax on STCG for domestic companies would be 16.995 percent and 15.836 percent for foreign companies • It is proposed that a domestic parent company (not being a subsidiary of another company) would now be allowed to set off the dividend received from its subsidiary company against dividend distributed by the parent company for calculation of dividend distribution tax. For this purpose, a company is considered to be a subsidiary of another company if the other company holds half the nominal capital therein • It is proposed that a transaction of reverse mortgage shall not amount to a ‘transfer’ and income therefrom will not be taxable as ‘income’ in the hands of the recipient • The Government had recently permitted Indian companies to issue Foreign Currency Exchangeable Bonds (FCEB). It is proposed that the conversion of FCEB shall not be regarded as ‘transfer’. Also, the cost of acquisition of the shares received upon conversion of the FCEB shall be the price at which the corresponding FCEB is acquired • It is proposed that withholding tax would not be applicable on interest payable on corporate bonds/debts instruments issued in the dematerialised form and listed on the recognised stock exchange. This proposal will come into effect from 1 June 2008 • A Commodities Transaction Tax (CTT) is proposed to be levied on taxable commodities transactions undertaken by the seller or the purchaser as indicated below:
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Taxable commodities transaction
Sale of an option in goods/commodity derivative, where the option is not exercised Sale of an option in goods/commodity derivative, where the option is exercised
Rate
Payable by
0.017 percent on option premium
Seller
0.125 percent on the settlement price of the option
Purchaser
0.017 percent of the Sale of any other commodity price at which the commodity derivative is derivative sold.
Seller
• CTT will be allowed as a deduction, provided the income earned from the taxable commodities transactions is included under the head ‘profits and gains of business or profession’ • Currently, the STT is levied on derivative sale transactions entered into in a recognised stock exchange at the rate of 0.017 percent and was payable by the seller. It is now proposed to levy STT (with effect from 1 June, 2008) as under: Taxable securities transaction
Sale of an option in securities
Sale of an option in securities, where option is exercised Sale of a futures in securities
Rate 0.017 percent on option premium
Payable by Seller
0.125 percent on the settlement price of the option
Purchaser
0.017 percent
Seller
• The earlier provision for allowance of rebate in respect of STT paid from income-tax payable on business income is proposed to be deleted. Going forward, it is proposed that the STT paid by a taxpayer during the year with respect to taxable securities transactions shall be allowed as a deduction from the taxpayer’s business income • Dematerialisation of Tax Deduction at Source (TDS) / Tax Collection at Source (TCS) certificates (i.e. non-requirement of furnishing TDS / TCS certificates) has been deferred till 1 April 2010 • Authority has been granted to the Central Board of Direct Taxes (CBDT) to frame rules detailing the procedure for giving credit to taxpayers for any TDS / TCS
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• Clarificatory amendment introduced to provide that a person failing to deduct tax would also be deemed to be a taxpayer in default. Currently, the taxpayer is treated to be in default where on withholding, he does not deposit the tax in time. The amendment to be effective retrospectively from 1 June 2003 • Payments made to non-residents require furnishing of a chartered accountant certificate and an undertaking by the payer confirming appropriate withholding of taxes for remittance. The payer would now also be required to file necessary information relating to such payments in a manner and form to be prescribed by CBDT. The amendment is to be effective from 1 April 2008 • Due date for filing of corporate tax returns and income-tax returns of persons either whose accounts are required to be audited or is a working partner of a firm whose accounts are required to be audited, has been advanced to 30 September instead of 31 October. • Consequently, the relevant due date for filing a wealth tax return, FBT return, transfer pricing report and other supporting documents would also stand advanced to 30 September. The amendment is to be effective from 1 April 2008 • Two-stage assessment of returns re-introduced. Initial stage assessment would require computerised processing (without any human interface) which would make adjustments for any arithmetical error or incorrect claims based on information apparent in the return. The amendment is to be effective from 1 April 2008 • The tax officer can reopen an assessment with respect to income chargeable to tax which is not a subject matter of any appeal, reference or revision but believed to have escaped assessment. The amendment is to be effective from 1 April 2008 • The tax officer has been empowered to extend the period of furnishing of special audit report under Section 142(2A) on his own. The amendment is to be effective from 1 April 2008 • Non-service of notice or service of notice in an inappropriate manner, would not be considered as valid grounds for objecting to any proceedings of assessment or reassessment if the taxpayer appears in such proceedings or co-operated in any enquiry related to such proceedings. The amendment is to be effective from 1 April 2008 • Notice for scrutiny assessment to be served on the taxpayer within a period of 6 months from the end of the financial year in which the return is furnished instead of 12 months from the end of the month of filing return under the existing provision. The amendment is to be effective from 1 April 2008
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• Retrospective amendment introduced with effect from 1 April, 1989 stating that a direction in the assessment order initiating penalty proceedings would tantamount to satisfaction of the tax officer for initiating such proceedings • Where any notice or other document is required to be issued, served or given by the revenue authorities, it shall be deemed to have been authenticated if the name and office of a designated revenue authority is printed, stamped or otherwise written thereon. The amendment is to be effective from 1 June 2008 • Amendments have been made to provide that if revenue authorities do not file an appeal in a given case, then on the similar issue of law for another taxpayer or another assessment year, the appeal of revenue cannot be dismissed on the basis that the issue in dispute is not challenged in some previous judgment. The amendment is to be effective retrospectively from 1 April 1999 • Clarificatory explanation introduced to provide that in case of a re-assessment proceeding, the Joint Commissioner, Commissioner or the Chief Commissioner, as the case may be, is only required to be satisfied with respect to the reasons for re-opening and not required to issue such notice. The amendment is to be effective retrospectively from 1 October 1998 • Entities established for charitable purposes are generally exempt from tax. Entities were considered as established for charitable purposes if they provided relief to the poor, education, medical relief or was engaged in advancement of any other object of general public utility. Entities engaged in the advancement of any other object of general public utility will not be considered as charitable if it undertakes any trade or business or services in such relation for a consideration • The Income-tax Appellate Tribunal (ITAT) cannot grant stay of demand for a period exceeding 365 days in aggregate, even if the delay in disposing of the substantive appeal pending before the ITAT is not attributable to the taxpayer. This provision is proposed to be effective from 1 October 2008 • Banking Cash Transaction Tax levied at 0.1 percent on ’taxable banking transaction’ is withdrawn. The provision would be effective from 1 April 2009.
Fringe Benefit Tax (FBT) • Any expenditure incurred on or payment through non-transferable pre-paid electronic meal card usable only at eating joints or outlets is excluded from levy of FBT
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• Any expenditure incurred on or payment made for following purposes to be excluded from the category of ’employee welfare’ for the purpose of valuation of fringe benefits: - crèche facility for the children of the employee - sponsoring a sportsman being an employee; and - organising sports events for employees. • Any expenditure on or payment made for maintenance of any accommodation in the nature of a guest house shall be excluded from the levy of FBT • The valuation of expenditure on or payment for festival celebrations to be reduced from 50 percent to 20 percent • It has been clarified that fringe benefits will include securities offered under an employee stock option plan or scheme where the employee stock options have been granted. This amendment will apply from assessment year 2008-09 • FBT recovered by the employer from the employees with respect to allotment/ transfer of specified security or sweat equity shares shall be deemed to be tax paid by such an employee. The deeming provisions shall apply only to the extent to which the amount of recovery relates to the value of fringe benefits provided to such employee. The employee shall not be entitled to any refund or credit out of such deemed payment of tax against tax on any other income or any other tax liability in India. The said amendments will apply from assessment year 2008-09.
Key indirect tax proposals • Service tax has been proposed to be levied on the following services: - Services provided in relation to management of investments under unit linked insurance plans - Services provided by stock exchanges in relation to securities - Services provided by commodity exchanges in relation to sale or purchase of any goods or forward contracts - Services provided by a processing and clearing house in relation to processing, clearing and settlement of transactions in securities, goods or forward contracts - Services provided by money changers. These proposals will come into effect from a date to be notified after the enactment of the Finance Bill, 2008. Also, a new scheme for claiming credit on taxable and exempt services has been introduced. The service provider may either reverse the credit attributable to the inputs and input services used for providing exempted services or pay 8 percent of the value of the exempted services.
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Policy initiatives in the Financial Services sector announced in the Budget Some of the key policy initiatives in the Financial Services sector announced by the Hon. Finance Minister in the budget speech are summarised below –
Capital markets Measures to expand the corporate bonds market The Hon. Finance Minister in the Budget 2006 had announced the setting up of an exchange traded market for corporate bonds. A single unified exchange traded market for corporate bonds would result in the development of infrastructure to support the secondary debt market trading system, which allows efficient price discovery and reliable clearing and settlement. Further to these provisions, the following policy measures have been proposed in the Budget 2008 • The development of the bond, currency and derivatives markets, which will include launching of exchange-traded currency and interest rate futures, and developing a transparent credit derivatives market with appropriate safeguards • Enhancing the tradability of domestic convertible bonds by putting a mechanism in place that will enable investors to separate the embedded equity option from the convertible bond and trade it separately and • Encouraging the development of a market-based system for classifying financial instruments based on their complexity and implicit risks.
National market for securities It is proposed that the Empowered Committee of state Finance Ministers would work with the Central Government to create a pan Indian Market for securities that will expand the market base and enhance the revenues of the State Governments.
Permanent Account Number (PAN) In the Budget 2007, it was announced that a PAN would be the sole identification number for all participants in the securities market. It is now proposed that a PAN would be required for all the transactions in the financial market, subject to suitable threshold exemption limits.
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Waiver of farm loans by banks A scheme of debt waiver and debt relief for farmers has been placed before Parliament wherein: 1) All agricultural loans disbursed by scheduled commercial banks, regional rural banks (RRBs) and cooperative credit institutions up to 31 March, 2007 and overdue as on 31 December, 2007 will be covered under the scheme 2) For marginal farmers (i.e., holding upto 1 hectare) and small farmers (1-2 hectare), there will be a complete waiver of all loans that were overdue on 31 December, 2007 and which remained unpaid until 29 February, 2008. For the other farmers, there will be a one time settlement (OTS) scheme for all loans that were overdue on 31 December, 2007 and which remained unpaid until 29 February, 2008. Under the OTS, a rebate of 25 percent will be given against payment of the balance of 75 percent 3) Agricultural loans were restructured and rescheduled by banks in 2004 and 2006 through special packages. These rescheduled loans, and other loans rescheduled in the normal course as per RBI guidelines, will also be eligible either for a waiver or an OTS on the same pattern. The implementation of the debt waiver and debt relief scheme will be completed by June 30, 2008. Upon being granted the debt waiver or signing an agreement for debt relief under the OTS, the farmer would be entitled to fresh agricultural loans from the banks, in accordance with normal rules. The total value of overdue loans being waived is estimated at INR 50,000 crore and the OTS relief on the overdue loans is estimated at INR 10,000 crore. Other policy announcements •
Commercial banks, including RRBs are advised to add at least 250 rural household accounts every year at each of their rural and semi-urban branches
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Individuals such as retired bank officers, ex-servicemen etc. are allowed to be appointed as business facilitators or business correspondents or credit counsellors.
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Recent policy changes in the Financial Services sector Keeping in view the changing landscape in the financial sector, Regulatory authorities have been suitably focusing its regulatory and supervisory framework to promote a stable and efficient financial sector. Some of the significant developments in the financial services sector during the period from March 2007 to February 2008 have been summarised hereunder:
Banking Fair Practices Code for Lenders With a view to achieving greater transparency, the RBI vide its Circular dated 6 March 2007 has made it mandatory for all SCB excluding Regional Rural Banks that all loan application forms relating to priority sector advances (in respect of all categories of loans and irrespective of the amount of loan sought by the borrower) should include certain minimum information. This information would cover details about the fees / charges, if any payable for processing, the amount of such fees refundable in the case of non-acceptance of application, pre-payment options, etc. Further the banks have been advised that lenders should convey in writing, within stipulated time, the main reason / reasons which, in the opinion of the banks has led to rejection of the loan applications.
Enhancement of disclosures (Under Accounting Standard 17) In terms of extant instructions, SCB were required to adopt the three business segments viz. “Treasury”, ‘Other Banking Business” and “Residual” as the uniform business segments and “Domestic” and “International” as the uniform geographic segments for the purpose of segment reporting under Accounting Standard 17. RBI vide its circular dated 18 April 2007 has enhanced the disclosures to be made by the banks under the “Other Banking Business” Segment. This segment has now been divided in the following three, viz, Corporate / Wholesale Banking, Retail Banking and Other Banking operations. Accordingly, banks have to adopt the following business segments for public reporting purposes, from 31 March 2008: (a) Treasury (b) Corporate / Wholesale Banking (new) (c) Retails Banking (new) (d) Other Banking Business The geographical segments remain unchanged as ‘domestic; and ‘international.’
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Comprehensive Guidelines on Derivatives RBI has issued comprehensive guidelines on derivatives (excluding foreign exchange derivatives) by banks vide its circular dated 20 April 2007. The Circular lists the requirements re: the eligible participants, eligibility criteria, broad principles for undertaking derivative transactions, permissible derivative instruments, risk management and corporate governance aspects, risk management, etc.
Maintenance of Cash Reserve Ratio (CRR) on exempted categories RBI vide its Circular dated 20 April 2007 has advised all SCB (excluding Regional Rural Banks) that they would be exempted from maintaining average CRR with effect from 1 April 2007, on (i) Liabilities to the banking system in India as computed under Clause (d) of the Explanation to Section 42 (1) of the RBI Act, 1934 (ii) Credit Balances in ACU (US$) Accounts (iii) Transactions in Collateralized Borrowing and Lending Obligations (CBLO) with Clearing Corporation of India (CCIL) and (iv) Demand and Time Liabilities in respect of their Offshore Banking Units.
Prudential Guidelines on Capital Adequacy and Market Discipline RBI vide its Circular dated 27 April 2007, has issued guidelines for implementation of the New Capital Adequacy Framework. The revised framework consists of three-mutually reinforcing pillars, viz. minimum capital requirements, supervisory review of capital adequacy, and market discipline. Foreign banks operating in India and Indian banks having operational presence outside India should migrate to the above selected approached under the Revised Framework with effect from 31 March 2008. All other commercial banks (except Local Area Banks and Regional Rural Banks) are encouraged to migrate to these approaches under the Revised Framework in alignment with them but in any case not later than 31 March 2009.
Risk Weight on Residential Housing Loans reduced RBI vide its Circular dated 3 May 2007, has advised that the risk weight in respect of housing loans upto INR 2 million to individuals against the mortgage of residential housing properties would be reduced from 75 percent to 50 percent. Similarly, the risk weight for banks investment in mortgage backed securities, which were backed by housing loans and were issued by the housing finance companies regulated by the National Housing Bank would also be reduced from 75 percent to 50 percent.
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Doorstep Banking RBI vide its Circular dated 24 May 2007 has permitted all SCB (excluding Regional Rural Banks) to (i) deliver cash / draft at the doorstep of the individual customers (in addition) to corporate customers / Government Department / PSUs etc). either against cheques received at the counter or requests received through any secure convenient channel such as phone banking / internet banking and (ii) deliver cash / draft at the doorstep of Corporate Customers / Government Departments / PSUs etc. against cheques received at the counter or requests received through any secure convenient channel such as phone banking / internet banking, subject to the banks adopting technology and security standards and including those specifically relating to authenticating users and taking adequate safeguards / precautions in undertaking the above transactions.
Holding Companies With a view to assess the globally prevalent Bank Holding Companies (BHCs) and Financial Holding Companies and their suitability for India (given the Indian legal, regulatory and accounting framework), RBI came out with a discussion paper dated 27 August 2007. The key points emanating from the discussion paper are as under: • Currently, banks aggregate investment in the financial services companies including subsidiaries is limited to 20% of the paid up capital and reserves of the bank. In a BHC / FHC structure, this restriction would not apply as the investment in subsidiaries and associates would be made directly by the BHC / FHC. • The paper highlights the major motivation for such structures and the key legal and regulatory constraints that may be encountered while implementing such structures in India. • The paper also expresses the supervisory concerns emanating from the FHC structures and the need for an appropriate regulator in the case of such structures. • The concept of intermediate holding companies within the FHC structures and the India specific concerns have also been dealt with in the paper.
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Guidelines for issuing preference shares as part of regulatory capital With a view to providing a wider choice of instruments to Indian banks for raising Tier I and Upper Tier II capital, RBI vide its Circular dated 29 October 2007 has decided to allow the banks to issue the following types of preference shares in Indian Rupees. (i) Tier I Capital – Perpetual Non-cumulative Preference Shares (PCNPs) (ii) Upper Tier II Capital (a) Perpetual Cumulative Preference Shares (PCPs) (b) Redeemable Non-cumulative Preference Shares (RNCPs) (c) Redeemable Cumulative Preference Shares PCNPs are to be treated on par with equity, and hence, the coupon payable on these instruments will be treated as dividend (an appropriation of Profit and Loss Account). All other types of preference shares mentioned above will be treated as liabilities and the coupon payable thereon will be treated as interest (charged to profit and loss account).
Scope of Infrastructure Lending Expanded The RBI issued a Circular dated 30 November 2007 expanded the definition of the term “infrastructure lending” (defined under Circular dated 16 June, 2004) to cover within the expanded definition, any credit facility granted by lenders (i.e. banks, FIS or NBFCs) to companies engaged in laying down and/ or maintenance of gas, crude oil and petroleum pipelines.
Prudential Norms for Investments widened Earlier, SCB were allowed to invest in unlisted non-SLR securities up to 10 percent of their total investment in non-SLR securities as on 31 March of the previous year. In order to encourage the banks to increase the flow of credit to infrastructure sector, the RBI vide Circular dated 06 December 2007 has decided to allow banks to also invest in unrated bonds of companies engaged in infrastructure activities within the ceiling of 10% for unlisted non-SLR securities.
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Loans / Advances to Mutual Funds to be included in Bank’s Capital Market Exposure RBI vide its Circular dated 14 December 2007 has notified the SCB that exposure to Mutual Funds would form part of Capital market exposure of the bank. Further, the Irrevocable Payment Commitments (IPCs) in favour of Stock Exchanges on behalf of Mutual Funds are to be treated at par with guarantees issued for purpose of capital market operations. Such exposure of banks will, therefore, form part of their Capital Market exposure.
Bank Finance to Factoring Companies RBI vide its Circular dated 12 February 2008 has allowed SCB to extend financial assistance to support the factoring business of Factoring Companies which comply with specified criteria.
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Insurance Advertisement, Promotion and Publicity With the intent to protect the interest of the insuring public, enhance their level of confidence in the nature of sales material used and ultimately encourage fair business practice, in May 2007, the IRDA issued a Circular giving out the guidelines on advertisement, promotion & publicity of insurance companies, and insurance intermediaries. The Circular is effective from 1 July 2007. The Circular classifies the advertisement in two categories, viz. Institutional advertisements (advertisements for promoting the brand image of the company) and Insurance advertisements (advertisements with the specific purpose of soliciting insurance business). Also, the Circular gives out the general do and don’ts for all advertisements. The advertisements should comply with the general requirements, specific requirements, and mandatory disclosure as specified in the circulars.
Definition - Infrastructure In February 2008, the IRDA issued a notification whereby the definition of the term ‘infrastructure’ has been amended in the IRDA (Registration of Indian Insurance Companies) Regulations, 2000. Every insurance company is required to invest a part of its assets in the ‘infrastructure’ sector. The definition of the term ‘infrastructure’ has now been amended to bring in line with the Reserve Bank of India definition which is as follows, “Infrastructure covers roads, highways, port, airport, inland waterway/port, water supply and sanitation, telecom services, industrial park or SEZ, power generation, transmission and distribution. Besides, as per the central bank’s norm, public activities of similar nature, which the Central Board of Direct Taxes will notify in due course, would also be treated as infrastructure.”
Declaration of Bonus – Relaxation for Life Insurance Companies In April 2007, the IRDA issued a Circular whereby it has extended the relief granted to Life Insurance Companies for declaring bonus in case the Life Fund is in a deficit. As per the existing regulations, a life insurance company can declare bonus within a period of five years even in case it has a deficit, which has now been extended by another two years thereby making it to seven financial years, commencing from the year in which the life insurance business operations are started.
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Appointment of a C.E.O. / M.D. The Insurance Act, 1938 provides that no appointment, re-appointment or termination of CEO, Whole-time Director or Managing Director of an insurance company is valid unless the previous approval of the IRDA is sought. In August 2007, the IRDA advised that the application for such an approval should be made at least 30 days prior to the commencement of the appointment so as to allow sufficient time to IRDA to examine such proposals. The application needs to be made in the specified format as prescribed by the IRDA. The application also enquires as to whether the insurance company has complied with the relevant provisions of the Companies Act, 1956.
Reporting of Maintenance of Solvency Margin Post relaxation of controls on the tariffs for the non-life insurance industry, in November 2007, the IRDA issued a Circular making it mandatory for all non-life insurance companies to file their solvency position as at the end of each quarter. This stipulation was already effective for life insurance companies and now the same has also been made applicable to non-life and reinsurance companies. Quarterly submission of Financial statements In November 2007, the IRDA issued a Circular whereby it has made mandatory for all insurers to submit un-audited segment-wise financial statements on a quarterly basis. The manner of preparing the un-audited financial statements shall be as per the instructions contained in the IRDA (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2002 and various circulars / instructions issued there under.
Amendment to IRDA (Obligations of Insurers to Rural or Social Sector) Regulations, 2008 The Insurance Act, 1938 makes it mandatory for an insurer to undertake a particular percentage of life and general insurance business in the rural or social sector. These percentages were notified in the IRDA (Obligations of Insurers to Rural or Social Sector) Regulations, 2002. The regulations specified the percentage of obligations to be undertaken by the insurers in the first six years after the implementation of these regulations. The IRDA has now amended these regulations and specified the obligations of insurers to rural or social sectors for the 7th, 8th, 9th and 10th financial year and also clarified that the obligations of the insurers towards the rural and social sectors for the 10th financial year shall also be applicable in respect of the financial years thereafter. The regulations also specify the obligations for the existing insurers as on the date of the commencement of the IRDA Act, 1999 towards the rural and social sector from financial year 2007-08 to financial year 2009-10.
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Mutual Funds Investments in ADRs/ GDRs/ Foreign Securities and overseas Exchange Traded Fund (‘ETF’) The Securities and Exchange Board of India (‘SEBI’) has vide its circular in May 2007 made the following changes pertaining to investments in ADRs/ GDRs and Foreign Securities by mutual funds : • The aggregate ceiling for the mutual fund to invest in ADRs/GDRs issued by Indian companies, equity of overseas companies listed on recognized stock exchanges overseas, and rated debt securities raised from USD 3 billion to USD 4 billion. The investment is permitted with a sub-ceiling for individual mutual funds which should not exceed 10 percent of the net assets managed by them as on March 31 of each relevant year, subject to a maximum of USD 200 million per mutual fund. The SEBI has further vide its circular in September 2007 made the following changes pertaining to investments in ADRs/ GDRs and Foreign Securities by mutual funds: • The aggregate ceiling for the mutual fund to invest in ADRs/GDRs issued by Indian or foreign companies, equity of overseas companies listed on recognized stock exchanges overseas, rated debt securities and derivatives traded on overseas recognized stock exchange raised from USD 4 billion to USD 5 billion. The investment is permitted with a sub-ceiling for individual mutual funds to a maximum of USD 300 million. The other conditions with respect to the investments in ADRs/GDRs/Foreign Securities and overseas ETF remain the same.
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Parking of Funds in Short-Term Deposits of Schedule Commercial Banks by Mutual Funds- Pending deployment The SEBI has vide its circular in April 2007/October 2007, issued the following guidelines for parking of funds in short-term deposits (short-term shall be treated as a period not exceeding 91 days/raised to 182 days in case deposits are placed as margin for trading in derivatives) of scheduled commercial banks pending deployment. The guidelines provide that, no mutual fund shall park more than• 15 percent of the net assets in short-term deposit(s) of all the scheduled commercial banks put together. It may be raised to 20 percent with prior approval of the trustees. • 20 percent of total deployment by it in short term deposits. of associate and sponsor scheduled commercial banks • 10 percent of the net assets of its scheme in short term deposit(s), with any one scheduled commercial bank, including the banks subsidiaries Also, no funds can be parked by a scheme in a bank which has invested in that scheme.
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Real Estate InvestmentTrusts (REITs) SEBI has issued the draft regulations on Real Estate Investment Trusts (REITs) in December 2007, yet to be enacted. The draft regulation lays the procedures for administering REITS and the compliance requirements of the Trustee, AMC, etc REITs means a trust registered under the Indian Trusts Act, 1882 and registered with SEBI under these regulations, whose object is to organize, operate and manage real estate collective investment. REIT’s needs to float schemes which are close ended schemes and which are appraised by an appraising authority. Further, the schemes are prohibited from investing in vacant land or property development activities. It has also been proposed that the schemes would be required to distribute atleast 90 percent of its net income after tax as dividends each year to unit holders. Click here for more details.
Short Selling SEBI has vide its circular in November 2007 provided that a mutual fund can engage in short selling of securities as well as lending and borrowing of securities as per framework to be specified by the SEBI.
Index Fund Scheme SEBI has introduced Index Fund schemes vide its circular in November 2007. ‘Index fund scheme’ means a mutual fund scheme that invests in securities in the same proportion as an index of securities;”
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Waiver of entry load for direct applications Effective 4 January 2008, investors who apply directly for schemes of mutual funds, without routing the application through any distributor/agent/broker, via Internet to the AMC or collection centre/Investor Service Centre would avoid entry load. Also, they will forgo an entry load if they transact directly for additional purchases under the same folio and switch-in to a scheme for other schemes.
Removal of charging of initial issue expenses by close ended schemes to the investors SEBI has vide its circular in January 2008 provided that close-ended schemes of mutual fund launched after 31 January 2008 will have to meet the sales, marketing and other such expenses connected with sales and distribution of schemes from the entry load. These schemes can neither charge nor amortise the initial issue expenses. Investors will now find such schemes more cheaper and will probably have more clarity and transparency on expenses charged to them.
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NBFCs Ceiling on rate of interest In April 2007, the RBI revised the rate of interest payable on public deposits by NBFCs (including chit fund companies, other than residuary non-banking financial companies) to12.5 percent from the existing 11 percent per annum taking into account the market developments. This is the maximum permissible rate an NBFC can pay on its public deposits and they may offer lower rates. This new rate of interest applies to fresh public deposits and renewals of matured public deposits.
Corporate Governance In May 2007, the RBI issued proposed guidelines on corporate governance in order to enable NBFCs to adopt best practices and greater transparency in their operations. Emphasis had been placed on formation of an audit committee, constitution of risk management committee and compliance with the instructions on connected lending relationships. Further, in July 2007, the RBI issued a notification stating that the guidelines on ‘connected lending’ were being reevaluated. Apart from these, all other instructions issued earlier had to be complied with.
Declaration of Net Asset Value of Security Receipts In May 2007, the RBI issued guidelines on declaration of net asset value of security receipts issued by securitisation companies / reconstruction companies at periodical intervals in order to enable the Qualified Institutional Buyers to know the value of their investment.
Overseas Presence NBFCs will now need to also meet additional conditions before they are allowed to set-up subsidiary/JV/representative office abroad or invest abroad. In this regard, the banking regulator, Reserve Bank of India has issued draft guidelines on 24 January 2008 to be complied by an NBFC besides the extant ones. An NBFC that intends overseas presence could adopt any of the following four options i.e. Subsidiary, Joint Venture, other Investments and Representative office. As a general policy, NBFCs would not be allowed to set up branches abroad. Overseas existing branches of NBFCs would need to comply with the proposed guidelines. Click here for the flash news
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Mortgage Guarantee Companies (‘MGC’) Based on the proposals for the Union Budget 2007-08, the RBI had issued draft guidelines in January 2008 and notified a Mortgage Guarantee Companies (‘MGC’) as a NBFC. Further in January 2008, the RBI also issued draft guidelines on the registration and operation of a MGC, which were to be complied by every NBFC carrying on mortgage guarantee business. In February 2008, RBI issued the final guidelines on the registration and operation of a MGC. Along with the final guidelines, the RBI also issued prudential norms for MGCs on: - Income recognition - Asset classification - Accounting standards - Provisioning requirements The RBI has also issued Mortgage Guarantee Companies Investment (Reserve Bank) Directions in February 2008, basically covering directions in relation to: - Investment policy of MGC and pattern of investment - Income recognition - Accounting of investments Click here for the flash news
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Portfolio Manager Renewal of Certificate of Registration A portfolio manager can function only under a Certificate of Registration issued by SEBI which is valid for three years from the date of its issue. Renewal application has to be made three months before the expiry of the validity of the certificate. In May 2007, SEBI clarified that where the renewal application is not received by the expiry date of the registration certificate, the portfolio manager will cease to be as such and will immediately stop carrying on portfolio manager activities from the date of such expiry. The portfolio manager can either transfer the business to another SEBI registered portfolio manager or allow the client to withdraw the securities and funds in its custody at the option granted to each client separately. Similar treatment would be in case SEBI refuses to grant renewal. Renewal application made after expiry of registration will be considered as fresh application for registration. Portfolio manager will stop taking any fresh business/clients from the date of expiry of registration if renewal application is made less than three months before the expiry and SEBI has not advised otherwise by the date of expiry of registration. A portfolio manager can surrender the registration voluntarily before its expiry by intimating the existing clients about the same at least one month in advance before requesting for surrender of certificate to SEBI.
Draft SEBI (Investment Advisers) Regulations, 2007 There was always an ambiguity on whether an Investment Advisory Company, establishing itself in India, was required to register under SEBI (Portfolio Managers) Regulations, 1993. To resolve this ambiguity, in October 2007, SEBI released draft “Investment Adviser Regulations”, under which an Investment Adviser will be required to obtain a Certificate of Registration from SEBI to commence or continue the said business. Click here for the key features of the draft regulations
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Venture Capital Funds Overseas Investments by Venture Capital Funds In August 2007, the SEBI allowed registered Venture Capital Fund (VCFs) to invest in equity and equity-linked instruments only of off-shore venture capital undertakings (‘off-shore VCUs’) subject to an overall limit of USD 500 million. The key provisions are: • VCFs, desirous of making investments in off-shore VCUs need to apply in the specified format to the SEBI for its prior approval. No separate permission from the RBI is necessary in this regard. • Such investments would be made only in those VCUs who have an Indian connection (i.e. company which has a front office overseas, while back office operations are in India) and up to 10 percent of the investible funds of a VCF. • The SEBI would allocate investment limits on ‘first come- first serve’ basis, depending on the availability in the overall limit of USD 500 million. This allowance is subject to the Foreign Exchange Management (Transfer or issue of any foreign security), regulations, 2004 being amended. The amendment to these regulations is yet to be made.
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Securitisation Declaration of Net Asset Value For enabling the Qualified Institutional Buyers to know the value of their investment in the Security Receipts, the RBI has issued guidelines to registered Securitisation Company / Reconstruction Company (‘SC / RC’) requiring them to declare Net Asset Value of the Security Receipts issued by them at periodical intervals.
Guidelines to Securitisation Companies and Reconstruction Companies In July 2007, the RBI has issued guidelines and directions to SC / RC relating to registration, owned fund, permissible business, operational structure for giving effect to the business of securitisation and asset reconstruction, deployment of surplus funds, internal control system, prudential norms, disclosure requirements, etc.
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Foreign Exchange Management External Commercial Borrowing (ECB) Modification of ECB policy Effective 7 August 2007, ECB in excess of USD 20 million is allowed only for meeting foreign currency expenditure. ECB up to USD 20 million is allowed for meeting rupee and foreign currency expenditure. Click here for more details. All-in-cost ceilings Effective 21 May 2007, the revised the all-in-cost ceilings for ECB are:
Average Maturity Period
All in cost ceiling over 6 months LIBOR Existing
Revised
3-5 years
200 basis points
150 basis points
More than 5 years
350 basis points
250 basis points
Prepayment of ECB Effective 26 September 2007, ECBs upto USD 500 million can be prepaid without prior approval of the RBI, subject to conditions. The earlier limit, effective 30 April 2007, was USD 400 million. End use restriction Effective 21 May 2007, ECB cannot be used also for development of integrated township.
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Overseas investments Liberalisation Overseas Direct Investments (ODI) were further liberalised and rationalised as under: i. Enhancement of limit for ODI: • effective 14 June 2007 - from 200 to 300 percent of networth of the investing company; and • effective 26 September 2007 - from 300 to 400 percent of networth of the investing company. ii. Enhancement of limit for portfolio investment by listed Indian companies: • effective 14 June 2007 from 25 to 35 percent of networth; and • effective 26 September 2007 from 35 percent to 50 percent of networth. Further, the requirement of a reciprocal 10 percent share holding in Indian companies has been done away with effect from 26 September 2007. iii.Guarantees issued by an Indian party to or on behalf of the JV/WOS are to be reckoned at 100 percent of the amount of guarantees effective 14 June 2007 (limit enhanced from 50 percent). Click here for more details. Liberalisation in the hedging of ODI by residents Resident entities having ODI are permitted to hedge the consequent exchange risks by entering into forwards and options with banks. Earlier, one could only deliver or roll over such contracts on the due date. Effective 19 June 2007, one could also cancel such forward contracts. Further, 50 percent of the cancelled contracts may be allowed to be rebooked. Shares acquired in exchange Acquisition of shares in a foreign company by an Indian party in exchange of issue of ADRs/GDRs, will be considered as ODI and be subsumed under the limit stipulated for such ODI.
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Pledge of shares Indian parties can also transfer shares held in overseas joint venture/ wholly owned subsidiary (JV/ WOS) by way of pledge to an overseas lender for availing overseas fund based and non-based facilities. This is subject to the condition the overseas lender is regulated and supervised as a bank and the total commitments of the Indian party are within the stipulated limits.
Convertible instruments The Ministry of Finance issued revised guidelines to the effect that from 1 May 2007, investment by way of only fully convertible preference shares would be treated as part of share capital. Foreign investment by way of any other type of preference shares (nonconvertible, optionally convertible or partially convertible) would be considered as debt and would be in conformity with ECB guidelines and caps. Click here for further details It has also been clarified that effective 8 June 2007, debentures that are fully and mandatorily convertible into equity within specified time would be reckoned as a part of equity under foreign direct investment (FDI) scheme of the Government of India.
Acquisition under open offers etc. Effective 24 May 2007 non-resident corporates can open escrow accounts without prior approval of RBI for acquisition/transfer of shares/convertible debentures via open offers/delisting/exit offers, subject to applicable guidelines.
Issue of shares Effective 29 November 2007, Indian companies are required to issue shares/convertible debentures within 180 days from the date of receipt of the inward remittance or date of debit to NRE/FCNR(B) account. If shares are not issued within such period, the funds will have remitted back to the concerned person, unless RBI specifically permits a longer tenure.
Rupee loans for share purchase under ESOP Effective 22 August 2007, non-resident Indian (NRI) employees of Indian companies can avail rupee loan for acquiring shares of companies issued under employee stock option plans (ESOP), subject to certain terms and conditions.
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Purchase of securities Foreign Central Banks are permitted to purchase securities, other than shares or convertible debentures, of an Indian company and government securities in secondary market, subject to stipulated terms and conditions.
Investment in stock/ commodity exchanges Effective 30 January 2008, foreign investment in Indian stock / commodity exchange is allowed up to 49 percent, which includes 26 percent in the form of FDI and 23 percent in the form of foreign institutional investment (FII) / portfolio investment. The cap for holding by a single investor is 5 percent.
Exporters Effective 6 October 2007, it is possible for exporters to earn interest on EEFC accounts to the extent of outstanding balances of US $ 1 million per exporter. RBI has allowed this as purely a temporary measure and valid upto 31 October 2008 and would be subject to further review. Exporters are thus allowed to maintain outstanding balances to the extent of US $ 1 million in the form of term deposits up to one year maturing on or before 31 October 2008. The rate of interest payable on such deposits has been left to the discretion of the banks.
Enhancement of corporate remittance limits Effective 30 April 2007, an Indian company can remit, without prior approval: • up to 5 percent of the investment made or USD 100,000, whichever is higher as reimbursement of pre-incorporation expenses incurred in India (limit enhanced from USD 100,000). • in respect of infrastructure projects executed by the company, any sum up to USD 10 million per project (limit enhanced from USD 1 million).
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Surrender of foreign exchange Effective 14 November 2007, individual Indian residents are obliged to surrender received/ realised/ unspent/ unused foreign exchange to the authorised person within 180 days from such receipt/ realization / purchase/ acquisition or date of his return to India.
Limit for overseas remittance for resident individuals enhanced Existing limit for resident individuals for making overseas remittances have been enhanced as under: • Effective 8 May 2007 – from USD 50,000 to USD 100,000 per financial year (April - March). • Effective 26 September 2007 - from USD 100,000 to USD 200,000 per financial year The limit applies to any permitted current or capital account transaction or a combination of both.
Operation of non-resident ordinary (NRO) accounts Effective 25 May 2007, a non resident individual account holder can authorize any resident individual to operate (i.e, for making local payments and remittance outside India to account holder) his/ her NRO account by executing a power of attorney.
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Glossary American Depository Receipt
ADR
Asset Management Company
AMC
Bank Holding Companies
BHC
Cash Reserve Ratio
CRR
Central Board of Direct Taxes
CBDT
Chief Executive Officer
CEO
Clearing Corporation of India
CCI
Collateralised Borrowing and Lending Obligations
CBLO
Commodities Transaction Tax
CTT
Employee Stock Option Plans
ESOP
Exchange Traded Fund
ETF
Export Earners Foreign Currency
EEFC
External Commercial Borrowing
ECB
Financial Holding Companies
FHC
Financial Institution
FI
Foreign Currency Exchangeable Bonds
FCEB
Foreign Direct Investment
FDI
Foreign Institutional Investment
FII
Global Depository Receipt
GDR
Insurance Regulatory Development Authority
IRDA
Irrevocable Payment Commitments
IPC
Managing Director
MD
Mortgage Guarantee Companies
MGC
Non-banking Financial Company
NBFC
One time settlement
OTS
Overseas Direct Investment
ODI
Permanent Account Number
PAN
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Perpetual Cumulative Preference Shares
PCPS
Perpetual Non-cumulative Preference Shares
PNPS
Public Sector Undertaking
PSU
Qualified Institutional Buyers
QIB
Real Estate Investment Trust
REIT
Reconstruction Company
RC
Redeemable Non-cumulative Preference Shares
RNPS
Regional Rural Banks
RRB
Scheduled Commercial Bank
SCB
Securities Transaction Tax
STT
Securitisation Company
SC
Short Term Capital Gains
STCG
Statutory Liquid Ratio
SLR
Tax Collection at Source
TCS
Tax Deduction at Source
TDS
The Reserve Bank of India
RBI
The Securities and Exchange Board of India
SEBI
Venture Capital Fund
VCF
Venture Capital Undertaking
VCU
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