I GENERAL OVERVIEW

After a remarkable overall surge in 2018, the private equity (PE) landscape in India witnessed a mixed bag of trends and challenges in 2019. While the value of PE deals skyrocketed, the number of deals showed a downward trend, fundraising activity was rather subdued and exits declined sharply in terms of volume and value.

2018 had ended on a high note, leaving room for hope on account of the impending general elections. However, 2019 proved to be a slow year for the Indian economy. After the general election results in May, the economy recorded a decline in growth to 5 per cent for the second quarter of 2019 against the impressive 8 per cent in the same period in 2018. The third quarter witnessed further decline in economic growth to a six-year low of 4.5 per cent. At the same time, India jumped 14 places to the 63rd position out of 190 countries in the World Bank's annual global Ease of Doing Business rankings, a 'tremendous achievement, especially for an economy that is as large and complex as India'.2

Despite this slowdown, certain trends from 2018 continued in 2019. For instance, global PE and M&A investors continued to gravitate towards India and investment values continued to surge. The interest shown by global pension funds and sovereign wealth funds (SWFs) in India continued on an upward trajectory, with SWFs from Abu Dhabi, Canada and Singapore having made some of the largest PE investments. Investors' focus remained fixed on control and governance. As a result, consolidation and deleveraging continued to be the key drivers and buyouts increased drastically, surpassing the total value of buyouts by 30 per cent compared to that in 2018. In terms of sectors, the technology sector continued to attract investors and there was an increased interest in the infrastructure sector.3 Due to the introduction of the amended Insolvency and Bankruptcy Code and the continuing crisis relating to non-banking financial companies, the Indian stressed assets market continued to present a host of opportunities for PE investors.4

2019 also witnessed certain unique trends. The launch of India's first real estate investment trust (REIT),5 Embassy Office Parks REIT, by Blackstone and the Embassy Group not only offers hope for the liquidity crunch-ridden real estate sector but is also expected to be a game changer and pave the way for more investment vehicles of a similar nature.6 Platform deals are gaining momentum across multiple sectors owing to buyouts reaching an all-time high primarily due to private equity investments, and investors are increasingly tending towards a more concise and focused investment approach; therefore, adopting a buy-and-build approach.7 Domestic financial services groups such as Kotak and Edelweiss raised substantial amounts of capital for their specialised distressed asset arms with the aim of investing in companies that are already bankrupt or on the brink of bankruptcy. It is likely that debt will drive opportunities in 2020.8 Lastly, late-stage start-ups garnered attention from SWFs, which provided growth funding to e-commerce start-ups in various sectors such as logistics and pharmaceuticals. This is indicative of SWFs' growing interest in India as well as their growing risk appetite.9

i 2019 v. 2018

2019 started on a high note with fundraisings worth US$2.5 billion recorded in January, the highest monthly fundraising ever.10 The first quarter of 2019 recorded a total fundraising of US$2.8 billion, which was more than twice the value of funds raised in the same period of 2018.11 In fact, the first half of 2019, with total fundraising of US$5.5 billion, witnessed an 85 per cent increase in fundraising compared to that in the first half of 2018.12 However, the third quarter of 2019 recorded fundraisings worth US$2.3 billion, an 11.5 per cent decline compared to the amount of fundraising recorded in the third quarter of 2018.13 Even though the aggregate of funds raised in November 2019 (US$172 million) declined by nearly 50 per cent in comparison to November 2018 (US$398 million), large India-dedicated fundraising plans worth US$2.3 billion were announced, which continued to inspire hope for the Indian PE landscape among investors.14

Unlike 2018, which recorded the highest-ever annual fundraising total of US$8.1 billion, 2019 witnessed PE firms struggling to hit the final fundraising milestone, with only five Indian funds hitting the final close in 2019. The sector-agnostic True North and Multiples, which have been trying to reach final close for nearly two years, are yet to achieve their target. This sluggishness in PE fundraising is in stark contrast to the trend in the venture capital (VC) sector where global and domestic limited partners (LPs) pumped a substantial amount of money into India-focused VC funds in 2019.15

Some of the significant fundraisings in 2019 were in the structured credit and debt sector. The private credit fund Edelweiss Alternative Asset Advisors Ltd (through Edelweiss India Special Asset Fund II (EISAF II)) has raised US$1.3 billion for investments in non-performing assets (NPAs), making it the largest fundraising in the private-debt strategy space in India.16 Edelweiss Global Wealth and Asset Management looks to raise nearly US$1 billion through its third fund, Edelweiss Special Opportunities Fund III, for investments in growth-seeking holding and operating firms.17 India Resurgence Fund is eyeing a final close of its first India-focused fund at US$750 million for investment in distressed assets in India18 and has received a commitment of US$225 million from Canada Pension Plan Investment Board (CPPIB).19 Kotak Special Situations Fund, a sector-agnostic fund launched in February 2019, has reached a total commitment of US$1 billion (with a commitment of US$500 million from the Abu Dhabi Investment Authority) for tapping distressed debt opportunities in India.20 Another significant fundraising in 2019 was the US$850 million fund raised by the India-focused private equity fund, ChrysCapital. This fundraising is ChrysCapital's eighth fund, was the fastest ever fund raise and made ChrysCapital the largest India-focused private equity investor.21

Significant fundraising announcements include the platform created by the National Investment and Infrastructure Fund (NIIF) and CPPIB's highway operator Roadis for investment (in equal proportions) up to US$2 billion in toll-operate-transfer models, acquisition of existing road concessions and other investment opportunities.22 Warburg Pincus LLC plans to raise up to US$1.5 billion pursuant to its plans to launch its first India-focused private equity fund for investments in the financial, manufacturing and consumer sectors.23 The Department for Promotion of Industry and Internal Trade (DPIIT) has prepared a vision document, Startup India Vision 2024, for facilitating the setting up of the following, in India, by 2024:

  1. 50,000 new start-ups;
  2. 500 incubators and accelerators;
  3. 100 innovation zones in urban local bodies;
  4. deployment of the entire 100 billion rupee corpus of the Fund of Funds;
  5. expansion of corporate social responsibility funding to incubators;
  6. an 'India start-up fund' worth 10 billion rupees;
  7. 10 billion rupees of seed funding; and
  8. seven research parks.

In addition, the vision document contemplates tax incentives for investments in start-ups, exemption of angel tax on all investments by alternate investment funds (AIFs) and setting up a regulatory sandbox for testing innovative financial products. This government initiative is expected to strengthen the start-up ecosystem in India.24 Temasek Holdings Pte and EQT Infrastructure IV have set up O2 Power, a US$500 million renewable energy platform, in India, which aims to achieve more than four gigawatts of installed capacity in solar and wind projects, through mergers and acquisitions. This would be EQT Infrastructure IV's first investment in India with an approximate 65 per cent contribution in the platform.25 Global Infrastructure Partners, through its Indian business unit, Vector Green Energy, is set to acquire the 300-megawatt solar generation capacity of Rattan India for an estimated value of US$10 billion.26

ii Industry sector trends

In continuation of the trends in 2018, sector-agnostic funds did not dominate fundraising activity in 2019, and the real estate, consumer technology and financial services sectors continued to witness a substantial amount of fundraising activity. In the real estate sector in particular, commercial real estate saw an increase in investments, while the residential segment struggled.27 The infrastructure sector dominated the fundraising landscape and reinforced the increasing investor interest in investment platforms. The highlight of 2019 was India's first ever REIT, raised by Embassy Office Parks, a Bangalore-based real estate developer, and backed by Blackstone Group LP.28

iii Infrastructure

The NIIF and Roadis (a highway concessions company) announced a platform that will invest up to US$2 billion in highway projects in India to create a large roads platform by targeting toll-operate-transfer models and acquiring existing road concessions and investment opportunities in the roads sector.29 The New York-based Global Infrastructure Partners has initiated a soft launch of its India-focused infrastructure fund that has a target corpus of US$1 billion and will focus on the acquisition of operating assets in areas such as roads, renewables and transmission.30 CPPIB has committed US$600 million to the NIIF by committing US$150 million to the NIIF Master Fund and agreeing to co-investment rights of up to US$450 million in future opportunities to invest alongside the NIIF Master Fund. As a result of CPPIB's investment, the NIIF Master Fund has reached US$2.1 billion in commitments and has achieved its initial targeted fund size.31 The Piramal Group and Lone Star Funds are in the process of setting up an investment platform of a US$600 million to US$700 million fund for the purpose of acquiring operating road assets.32 In addition, APG Asset Management and Piramal Enterprises are looking to raise a second fund of US$500 million to invest in infrastructure projects in India.33

iv Stressed assets, NPAs and structured debt

The most significant fundraising in 2019 was EISAF II, a US$1.3 billion fund set up by Edelweiss Financial Services for the purpose of investment in distressed assets.34 Edelweiss Financial Services also announced its intention to raise US$1 billion in funds for its third AIF, Edelweiss Special Opportunities Fund III, which will focus on structured credit and investments in the performing credit space.35 Similarly, AION Capital Ltd has started raising funds for its second fund, which has a targeted corpus of US$1 billion for investment in structured credit.36 The US$1 billion Kotak Special Situations Fund,37 Lone Star's announced US$1 billion fund38 and CPPIB's commitment of US$225 million to the India Resurgence Fund39 are some of the other significant PE fundraisings in the Indian debt market. Taking note of the impact of the liquidity crisis on micro, small and medium-sized enterprises (MSMEs), a Reserve Bank of India (RBI) panel has recommended the creation of a government-sponsored distressed assets fund of US$719 million to support crowdfunding from VC and PE firms focused on investment in MSMEs.40

v Consumer, technology and financial services

A91 Partners closed one of the largest consumer-focused funds at US$350 million for the purpose of investment across consumer, healthcare, financial services and technology companies.41 Lighthouse Funds closed its third consumer-focused fund at US$230 million, which aims to assist companies with operational enhancement, marketing and sales optimisation, mergers and acquisitions and human capital enhancement.42 Investcorp raised a US$142 million fund for the purpose of investment in the consumer, financial services and healthcare sectors.43 IIFL Asset Management Co Ltd raised US$134 million for its first PE fund, which will focus on the financial, consumer, healthcare and technology sectors with the aim of backing professional entrepreneurs and investing across the multiple life stages of a business.44 DSG Consumer Partners raised a US$65 million fund for the purpose of early stage investment in the consumer sector.45

vi Early stage

Nexus Venture Partners raised a US$350 million fund focused on the consumer-retail sector.46 Lightbox Ventures closed its third India-focused fund at US$209 million, taking the total capital raised by the firm to over US$400 million.47 The other significant fundraisings in the early stage sector include the US$60 million raised by Fireside Ventures for its second fund, which has a target corpus of US$100 million;48 DSG Consumer Partners' third fund, which closed at US$65 million and will be focusing on investing in seed and Series A rounds;49 and the US$50 million fund raised by Tanglin Venture Partners for investing in technology start-ups in India and South East Asia.50 Binny Bansal (the former CEO of India's e-commerce major, Flipkart) has announced his plans to launch a US$400 million fund to invest in start-ups in India that are in need of growth capital.51

vii Real estate

Xander Investment Management raised a US$250 million fund for investment in industrial real estate in India.52 Motilal Oswal Real Estate hit the second close of its fourth fund (which has a target corpus of US$211 million) at US$128 million and will use this fund for investment in mid-income and affordable housing projects across the top six Indian cities and in selective commercial projects.53 SmartOwner announced the launch of a real estate fund with a target corpus of US$70 million, which will focus on investment in real estate such as co-working and commercial spaces.54 Investcorp, which acquired the PE and real estate funds businesses of IDFC Alternatives Ltd in 2019, which marked its entry into the Indian market, announced its maiden India-focused fund of US$300 million.55

viii Healthcare

InvAscent raised US$250 million for its third fund, India Life Sciences Fund, for early stage investments in the healthcare and pharmaceutical sectors.56 A91 Partners' US$350 million fund, focused on investments across sectors such as healthcare and technology, will be one of the largest maiden domestic funds raised by Indian general partners (GPs).57 Quadria Capital announced a US$400 million fund for investment in healthcare, life sciences and associated areas.58

ix Sector agnostic

The most significant sector-agnostic fundraising was the close of ChrysCapital's (one of India's largest home-grown private equity firms) eighth fund at US$850 million. The close of this fund has increased the size of ChrysCapital's assets under management to US$4 billion.59 Other significant fundraisings include the US$406 million fund raised by B Capital (Facebook co-founder Eduardo Saverin's global VC firm)60 and the US$60 million fund raised by Fireside Ventures.61

x Investments and exits

The total value of PE deals at US$38 billion surpassed 2018's total of US$35.1 billion and hit a new high in 2019. As the total value rose while deal volume fell, the average ticket size for PE deals surged nearly 50 per cent and the number of billion-dollar deals doubled. This is in sharp contrast to the trend in 2018 when the ticket size of the deals remained flat due to a marginal fall in both volume and value.62 Despite the overwhelming increase in the value of deals, the number of deals declined from 1,362 in 2018 to 1,307 in 2019,63 presumably because the highways and renewable energy sectors are where the Indian market is highly concentrated and other sectors (e.g., aviation, ports and telecoms) have few meaningful assets that hold potential for investments.64

2019 witnessed the largest ever private equity deal in India, in the acquisition of the telecoms tower business of Reliance Infrastructure Limited by Brookfield Asset Management Inc (a Canadian investment firm) for US$3.7 billion.65 In addition, Brookfield, through its infrastructure investment trust, acquired a 1,480-km gas pipeline by acquisition of East West Pipeline Limited (a Reliance group company) for US$1.9 billion.66 Other significant PE investments in 2019 include the US$1.6 billion investment in the airports unit of GMR Infrastructure by a consortium of investors comprising of Tata Group, SSG Capital Management and GIC (a Singapore sovereign wealth fund);67 the US$1.1 billion investment in GVK Airports by the Abu Dhabi Investment Authority, Canada's Public Sector Pension Investment Board and the Indian government-backed NIIF;68 and the US$1 billion investment in India's leading digital payments company, Paytm, by a group of investors led by T Rowe Price (a US-based asset manager) and comprising of existing shareholders of Paytm (Alibaba, Softbank and Discovery Capital).69

In terms of sectors, the infrastructure sector received the most attention from investors. While the number of deals in the real estate sector dropped, other sectors that continued to draw investors include the energy, technology and financial services sectors.70 The hospitality sector witnessed a leap in investor interest on the back of investments worth US$1.2 billion across two deals:71 the US$500 million investment by Brookfield in the debt-ridden Hotel Leela72 and the US$600 million investment by GIC in an Indian Hotels Company special purpose vehicle (SPV).73

2019 witnessed a decline in exits in terms of both value and volume due to the volatility of the market. There were 185 exits with a combined value of approximately US$9.5 billion, which is a 63 per cent decline in terms of value from 2018, which saw 262 exits worth US$25.9 billion, including Walmart's US$16 billion acquisition of Flipkart from multiple investors.74 The majority of exits were by way of public market deals (up 45 per cent compared with 2018) and initial public offerings (down 67 per cent on 2018), followed by mergers and acquisitions and secondary deals.75

Two of the most significant exits of 2019 generated substantial return within only a few years of investment.

Warburg Pincus struck two exits in 2019:

  1. the sale of its entire stake in ICICI Lombard for approximately US$200 million (which is also the company's quickest exit in India, resulting in approximately 40 per cent of annualised return within two years of investment);76 and
  2. the sale of its 13-year-old investment in the Lemon Tree Hotels Limited hotel chain, for US$40 million, resulting in a sub-par return on its investment.77

Another exit that demonstrated a quick churn of investment was the buyout of the majority stake in India and South Asia-focused cancer treatment provider, Cancer Treatment Services International, of TPG Growth by New York-listed Varian Medical Systems Inc for US$283 million only three years after making the investment.78 The other significant exits in 2019 include the sale of a minority stake in SBI Life Insurance Company Limited by Carlyle for US$393 million, resulting in a spectacular 120 per cent return on investment;79 and the exit of Sixth Sense from Hindustan Foods Ltd at a vale of US$8 million, earning a nine-fold return on its investment in the contract manufacturer for fast-moving consumer goods companies, which is one of the highest ever returns earned by a firm in India.80

xi Reception by LPs and fund managers

According to a market survey conducted by the Emerging Markets Private Equity Association, while India has slid from second to third position in its perceived attractiveness to LPs and GPs, it has continued to hold steady since 2015. LPs' past concerns in relation to the exit environment and the uncertain political environment seem to have been allayed with recent changes and the conclusion of the general elections in 2019. In fact, of all the emerging markets, India attracts the highest percentage of LPs because of the favourable exit opportunities available to technology-enabled companies, with 63 per cent of all LPs currently investing or planning to invest in technology opportunities in India.81 The fact that most of the significant fundraisings of 2019 were by home-grown funds is a step in a positive direction to resolve the long-standing issue of lack of local participation in funds and fund management. In terms of disadvantages, investors have cited oversupply of funds and high-entry multiples as deterrents to investment in India, while many have already achieved their recommended levels of exposure to the Indian market.82

While 2019 was an excellent year in terms of PE investment and a year of steady and consistent performance in terms of fundraising and exit activity, the slowdown of the Indian economy, the decline in exports and the rise in international crude oil prices are factors that are likely to impact PE activity in India. However, given that investors hold a long-term perspective towards India, they may remain unfazed by the current market slowdown. With a turbulent and uncertain 2020 ahead, the need of the hour is a more favourable deal environment coupled with effective economic measures and governance reforms that will boost investor sentiments and increase the attractiveness of the Indian market.

II LEGAL FRAMEWORK FOR FUNDRAISING

i Offshore structures

Foreign investors have always opted for a jurisdiction that provided tax neutrality to them with respect to their investments in India. Under the Indian tax regime, a non-resident investor is subject to tax in India if it receives or is deemed to receive income in India; or income accrues or arises or is deemed to accrue or arise in India. However, if the non-resident is based out of a jurisdiction that has entered into a double-taxation avoidance treaty (DTA) with India, the taxation implications are nullified and the Indian income tax laws apply only to the extent they are more beneficial than the tax treaties. Accordingly, most India-focused funds are based out of either Singapore or Mauritius as a limited liability partnership (LLP) or a corporate entity. Further, the GP and the investment manager, who set up and operate the investment vehicle, are located outside India.

ii Tax risks re offshore structures

To curb tax avoidance, the government introduced the General Anti-Avoidance Rule (GAAR), with effect from the financial year beginning on 1 April 2017. The introduction of the GAAR has provided the tax authorities with the ammunition to recharacterise a transaction or an arrangement such that it gets taxed on the basis of substance, rather than on its form. The consequences include investment vehicles being denied DTA benefits or reclassification of capital gains as any other income, or a combination of these. In addition, the government amended the criteria for determining the tax residence of offshore companies by introducing the place-of-effective-management (POEM) guidelines, with effect from 1 April 2017. According to the POEM guidelines, if the key management and commercial decisions that are necessary to conduct the business of any entity as a whole are, in substance, made in India, an offshore entity could be construed as being tax resident in India.

The past two years also witnessed India renegotiating its DTA agreements with Singapore and Mauritius, making these less attractive as fund jurisdictions. The details of these changes along with an analysis on the future of these countries as viable fund jurisdictions is set out in detail in Section II.vi.

iii Rise of unified structures with direct investment by LPs

The fear of tax exposure owing to the various changes set out above has led to investors exploring unified structures or co-investment structures. Under the unified structure, both domestic and foreign investors make their investments into a domestic pooling vehicle. These unified structures received a huge impetus in 2015.

Until 2015, these investment vehicles were heavily funded by domestic investors since prior permission from the Foreign Investment Promotion Board was required if the overseas funds intended to directly invest in a privately pooled vehicle in India. To increase the participation of offshore funds in these investment vehicles, since November 2015, the RBI has permitted such investment vehicles to receive investments from non-resident Indian investors and foreign investors through the automatic route, as long as control of the investment vehicles vests in the hands of sponsors and managers, or investment managers, that are considered Indian-owned and controlled under the extant foreign regulations; investments by Indian-controlled AIFs with foreign investment are thus deemed to be domestic investments.

iv Legal framework of domestic funds

ALTERNATIVE INVESTMENT FUNDS

Prior to private equity capital gaining popularity, entrepreneurs relied heavily on loan capital raised from banks and financial institutions, public issuances and private placements. Realising the potential role of PE funds and the value addition they would contribute to the growth of corporate entities, the Securities and Exchange Board of India (SEBI) introduced a set of regulations governing investments by VC companies. This was followed by an overhaul in the regulations in 2012 with the introduction of the SEBI (Alternative Investment Funds) Regulations 2012 (the AIF Regulations) to regulate privately pooled investment vehicles that collect funds from investors on a private placement basis. The AIF Regulations replace the earlier regulatory framework of the SEBI (Venture Capital Funds) Regulations 1996, which covered funds that primarily invested in unlisted VC undertakings.

Under the AIF Regulations, an AIF is a privately pooled investment vehicle incorporated in the form of an LLP, trust or body corporate, which collects funds from Indian and foreign investors for investments in accordance with a defined investment policy for the benefit of its investors.

Based on the nature of the funds and their investment focus, the AIF Regulations categorise funds into Category I AIF,83 Category II AIF84 and Category III AIF.85 These categories of funds must also comply with distinct investment conditions and restrictions during their life.

The AIF Regulations prescribe, inter alia, a cap of 1,000 on the number of investors pooling into the AIF, conditionality on the minimum corpus for the fund and a minimum amount to be invested by an investor. To align the interests of the investors and the promoters or sponsors of the fund, the sponsor or manager of the AIF is required to have a continuing interest in the AIF throughout the life of the AIF. Further, investment by the sponsor or manager of a Category I AIF or Category II AIF has to be at least 2.5 per cent of the corpus (at any given point) of the AIF or 50 million rupees, whichever is lower. The continuing interest in the case of a Category III AIF has to be at least 5 per cent of the corpus or 100 million rupees, whichever is lower.

Before commencing operations, AIFs should register with SEBI, which takes about four to six weeks. An AIF can be set up in the form of a trust, a company, an LLP or a body corporate. Most funds in India opt for the trust structure. The entities involved in the structure are a settlor, a trustee and a contributor. The settlor settles the trust with a small amount as an initial settlement. The trustee is appointed to administer the trust and is paid a fee in lieu of such services. The investor signs up to a contribution agreement or a subscription agreement to make a capital commitment to the fund.

SECTOR-FOCUSED FUND STRUCTURES

REITs and infrastructure investment trusts

In 2014, SEBI notified the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations 2014 (the REIT Regulations) and the SEBI (Infrastructure Investment Trusts) Regulations 2014 (the Infrastructure Regulations) to regulate investments in the real estate and infrastructure sectors respectively. An infrastructure investment trust (InvIT) and a REIT must register with SEBI to conduct their business.

A REIT is a trust formed under the Indian Trust Act 1882 (the Trust Act) and registered under the Registration Act 1908 with the primary objective of undertaking the business of real estate investment in accordance with the REIT Regulations and has separate persons designated as sponsor, manager and trustee. The REIT is created by the sponsor of the trust, the trustee oversees the entire REIT and ensures all rules are complied with, and the beneficiaries are the unitholders of the REIT. The parties involved in the establishment of the REIT are: (1) the sponsor; (2) the trustee; (3) the investment manager and (4) the valuer. Each REIT is allowed to have a maximum of three sponsors, with each of these having a net worth of not less than 200 million rupees and a collective net worth of not less than 1 billion rupees. The sponsor should have not less than five years' experience in the development of the real estate sector. The trustee is the owner of the REIT assets, which it holds for the benefit of the unitholders, and it oversees the activities of the manager. The investment manager enters into an investment management agreement with the trustee and makes the investment decisions for the REIT. The responsibility of the valuer is to conduct half-yearly and annual valuations of the REIT's assets. The REIT Regulations impose a restriction on a REIT to invest only in SPVs or properties or transfer development rights in India or mortgage-backed securities. A REIT is allowed to make an initial offer of its units only through a public issue. No such offer can be made unless the offer size is at least 2.5 billion rupees and the value of the assets is not less than 5 billion rupees.

Akin to a REIT, an InvIT is a trust formed under the Trust Act and registered under the Registration Act. The InvIT is created by the sponsor of the trust, the ownership of the property vests in the trustee and the beneficiaries are the unitholders of the InvIT. It should be ensured that no unitholder of an InvIT enjoys superior voting rights or any other rights over another unitholder. Further, the Infrastructure Regulations prohibit multiple classes of units of InvITs. The Infrastructure Regulations require that an InvIT must hold not less than 51 per cent of the equity share capital or interest in the project SPVs. The parties involved in the establishment of the InvIT are: (1) the sponsor, (2) the trustee, (3) the investment manager, and (4) the project manager. The sponsor is responsible for the creation of the trust. The trustee is the owner of the InvIT assets, which it holds for the benefit of the unitholders. While the investment manager makes the investment decisions for the InvIT, the project manager is responsible for achieving the execution or management of the project in accordance with the Infrastructure Regulations. The Infrastructure Regulations further require that the investment manager, in consultation with the trustee, is required to appoint the majority of the board of directors or governing board of the holding company and SPVs.

Both the Infrastructure Regulations and the REIT Regulations include conditions on investment and borrowing powers, the process for listing and trading of units, net worth and experience requirements, rights and obligations of different entities involved and the valuation of assets and the distribution policy. The distinguishing feature is that the Infrastructure Regulations exclude projects that generate revenue or profit from rental or leasehold income.

In 2017, the RBI permitted banks to participate in REITs and InvITs within the overall ceiling of 20 per cent of their net owned funds for direct investments in shares, convertible bonds or debentures, units of equity-oriented mutual funds and exposure to venture capital funds (VCFs) both registered and unregistered, subject to the following conditions: (1) the banks must have put in place a board-approved policy on exposure to REITs or InvITs specifying the internal limit on such investments within the overall exposure limits in respect of the real estate sector and infrastructure sector; (2) not more than 10 per cent of the unit capital of a REIT or InvIT can be invested by the banks; and (3) the banks must adhere to the prudential guidelines of the RBI, as applicable. In October 2019, the RBI further permitted banks to lend funds and extend credit facilities to InvITs subject to certain conditions, including: (1) the banks must have adopted a board-approved policy on exposures to InvITs specifying, inter alia, the appraisal mechanism, sanctioning conditions, internal limits and monitoring mechanism; (2) the banks can only lend to such InvITs where none of the underlying SPVs, having existing bank loans, is facing a 'financial difficulty'; (3) bank finance to InvITs for acquiring equity in other entities will be subject to the RBI guidelines, as applicable; and (4) the banks must undertake an assessment of all critical parameters to ensure timely debt servicing. Such availability of credit to InvITs is a welcome move as it will encourage investments into and by InvITs.

In November 2018, SEBI amended the guidelines for public issues of REIT and InvIT units with a view to further rationalising and easing the issue process. 2019 witnessed further amendments to the REIT Regulations and Infrastructure Regulations, details of which are set out in Section VII.iii.

At present, there are two public InvITs, three privately placed InvITs and one listed REIT. According to SEBI, investors infused 6.7 billion rupees in REITs and 113.47 billion rupees in InvITs aggregating to 120 billion rupees in 2019. In particular, mutual funds increased their investment in REITs by 10 times from 70 million rupees in January 2019 to 725 million rupees in December 2019. While InvITs are expected to benefit from the RBI's decision to allow banks to lend them funds, REITs offer a potential avenue for investors due to declining interest of investors in the residential segment for limited appreciation in property prices and inability to monetise assets.86

v Steps to popularise domestic funds as fund structures

Over the past year, the government has taken steps for mobilising domestic capital from banks, mutual funds and insurance companies. In fact, the Alternative Investment Policy Advisory Committee in its report submitted on 19 January 2018 recommended the use of domestic funds as they currently constitute only a minor percentage of the total funds invested annually. Under a domestic fund structure, the fund vehicle (typically a trust entity registered with SEBI as an AIF) is not to be taxed on any income that is earned from investments. The income earned is taxable in the hands of the investors when the VCF or AIF distributes this to investors. Further, the characterisation of income in their hands is the same as that realised or distributed by the investee company to the fund. On 3 July 2018, SEBI raised the cap for overseas investments in AIFs and VCFs from US$500 million to US$750 million. Investments in AIFs in 2019 rose 53 per cent over 2018, to 1.4 trillion rupees.87 Further, a restriction on allocating foreign portfolio investors (FPIs) to more than 50 per cent of the securities in a single debt issuance prompted FPIs to use the AIF route to make debt investments into India.

vi Preferred jurisdictions for offshore funds

BACKGROUND

The primary driver that determines the choice of jurisdiction for setting up India-focused funds is a domicile that has executed a DTA with India. Currently, India has separate DTA agreements with various countries, such as Ireland, Mauritius, the Netherlands and Singapore. The Netherlands has been a popular jurisdiction primarily with portfolio investors. This is because the capital gains tax benefit is available to Dutch entities as long as they hold less than 10 per cent of the shares of an Indian company.

Over the years, Mauritius has been one of the most favoured destinations to set up India-focused funds and accounts for more than 30 per cent of the foreign investment into India. This is because India has a DTA with Mauritius that provides various benefits, such as tax exemption on capital gains, a robust dispute resolution network and the right to repatriate capital and returns.

The benefits under the India–Singapore DTA are available only to entities that reside, or are domiciled, in Singapore. Further, the treaty benefits are linked to satisfaction of certain conditionalities, popularly known as the limitation-of-benefits clause. Unlike the treaty between India and Mauritius, the capital gains exemption under the India–Singapore DTA is linked to satisfaction of the limitation-of-benefits clause, which requires that the affairs of the Singapore entity should not be arranged with the primary purpose of availing itself of the capital gains exemption. In addition, the entity should not be a shell or conduit company.

RECENT TREATY CHANGES

The bilateral investment treaty between India and Mauritius was amended on 10 May 2016 pursuant to a protocol signed between the respective governments (the Mauritius Protocol). Pursuant to the Mauritius Protocol, the capital gains tax exemption is being phased out and any capital gains arising from sale of shares (acquired after 1 April 2017 and transferred after 31 March 2019) will be taxable in India at the full domestic rate of 15 to 20 per cent. Further, shares transferred before 31 March 2019, will be taxed at 50 per cent of the domestic tax rate of India subject to certain conditions. This phasing out of the capital gains exemption is only applicable to sales of shares and not sales of debentures. Accordingly, sales of debentures continue to enjoy tax benefits under the India–Mauritius DTA, making Mauritius a preferred destination for debt investments.

Further, prior to the Mauritius Protocol, India did not have the right to tax any residuary income of a Mauritian tax resident arising in India. The Mauritius Protocol has now enabled India to tax 'other income' arising from a Mauritian tax resident in India. In addition, the Financial Services Commission of Mauritius has introduced domestic substance rules to determine whether Mauritius-based entities are managed and controlled in Mauritius. India and Mauritius have also agreed to assist each other to collect revenue claims, upon a request from each other's revenue authorities. All such measures, viewed cumulatively, signal India's serious resolve to curb tax avoidance. From the investor or fund's perspective, the phased withdrawal of capital gains tax exemption will give investors time to reassess their investment structures in relation to India.

The amendments to the India–Mauritius DTA have made it a significantly less popular destination for making investments. In addition, the announcement made by the Prime Minister of Mauritius in the country's budget in June 2018 indicates a potential 3 per cent tax liability on Mauritian FPIs earning dividend income from Indian shares.

The capital gains exemption under the India–Singapore DTA was coterminous with the capital gains exemption under the India–Mauritius DTA. Thus, taking its cue from the Mauritius Protocol, the respective governments of India and Singapore signed a protocol amending the India–Singapore DTA, introducing source-based taxation for capital gains arising upon transfer of shares (acquired on or after 1 April 2017) and enabling the application of domestic laws to curb tax avoidance or tax evasion. This language allows the Indian government to apply the GAAR even in situations where a specific anti-avoidance provision exists in the DTA.

SINGAPORE OR MAURITIUS

Although Singapore is no longer a relevant jurisdiction for investors seeking to take advantage of tax arbitrage, Singapore is taking various steps to attract foreign investors, including by introducing the concept of a Singapore variable capital company (SVCC) to be used as a vehicle for investment. The SVCC is expected to simplify the process of redemption of open-ended funds. Currently, the redemption of open-ended funds is a long-drawn-out process involving drawing up of accounts, audit and issuance of a solvency certificate. Singapore also enjoys an edge over Mauritius because of its outstanding banking facilities, access to financial products and better talent, thus causing a shift of funds from Mauritius to Singapore.

The choice of jurisdiction assumes more importance for FPIs since the securities held by an FPI are considered capital assets and the gains derived from their transfer are considered capital gains. Therefore, funds that have so far taken the position that this kind of income qualifies as business income may have to revisit their structures to ensure that they operate from jurisdictions that allow them to obtain relief on paying the applicable tax in India.

vii Investment route for offshore funds

FOREIGN DIRECT INVESTMENT ROUTE

Investors typically route their investments in an Indian portfolio company through a foreign direct investment (FDI) vehicle if the strategy is to play an active part in the business of the company. FDI investments are made by way of subscription or purchase of securities, subject to compliance with the pricing guidelines, sectoral caps and certain industry-specific conditions. Such investments are governed by the rules and regulations set out under the FDI consolidated policy (the FDI Policy), which is issued every year by the DPIIT of the Ministry of Commerce and Industry, and the Foreign Exchange Management (Non-Debt Instruments) Rules 2019 (the Non-Debt Rules). The Non-Debt Rules supersede the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations 2017. While the changes introduced in the Non-Debt Rules were originally not substantial, many changes have been pushed through individual amendments since its notification. Under the Non-Debt Rules, in line with the erstwhile regulations, any investment of 10 per cent or more of the post-issue paid-up equity capital on a fully diluted basis of a listed company will be reclassified as an FDI. In addition, the Non-Debt Rules stipulate that the pricing of convertible equity instruments is to be determined upfront and the price at the time of conversion should not be lower than the fair value at the time of issue of such instruments.

The Non-Debt Rules have been aligned with the SEBI (Foreign Portfolio Investors) Regulations 2019 (the FPI Regulations) to provide that an FPI may purchase or sell equity instruments of an Indian company that is listed or to be listed subject to the individual limit of 10 per cent (for each FPI or an investor group) of the total paid-up equity capital on a fully diluted basis or the paid-up value of each series of debentures, preference shares or share warrants issued by an Indian company. The aggregate holdings of all FPIs put together (including any other permitted direct and indirect foreign investments in the Indian company) are subject to a cap of 24 per cent of the paid-up equity capital on a fully diluted basis or the paid-up value of each series of debentures, preference shares or share warrants. Such aggregate limit of 24 per cent can be increased by the concerned Indian company to up to the sectoral cap or statutory ceiling (as applicable) by way of a board resolution and a shareholders' resolution (passed by 75 per cent of the shareholders).

Previously, any investment in excess of the sectoral caps or not in compliance with the sectoral conditions required prior approval of the Foreign Investment Promotion Board (FIPB). In furtherance of its announcement in 2017, the government abolished the FIPB in 2017. In place of the FIPB, the government has introduced an online single-point interface for facilitating decisions that would previously have been taken by the FIPB. Upon receipt of an FDI application, the administrative ministry or department concerned will process the application in accordance with a standard operating procedure (SOP) to be followed by investors and various government departments to approve foreign investment proposals. As a part of its initiative to ease business further, the SOP also sets out a time limit of four to six weeks within which different government departments are required to respond to a proposal. More than two years on, there is very little information in the public domain about the proposals processed by the SOP.

FPI ROUTE

Foreign investors who have a short investment horizon and are not keen on engaging in the day-to-day operations of the target may opt for this route after prior registration with a designated depository participant (DDP) as an FPI under the FPI Regulations. The FPI Regulations supersede the erstwhile SEBI (Foreign Portfolio Investors) Regulations 2014 (the 2014 Regulations). The process of registration is fairly simple and ordinarily it does not take more than 30 days to obtain the certificate.

In 2014, to rationalise different routes for foreign portfolio investments and create a unified and single-window framework for foreign institutional investors, qualified institutional investors and sub-accounts, SEBI, the security watchdog, introduced the regulations on FPIs. In December 2017, SEBI, with the intention of providing ease of access to FPIs, approved certain changes to the FPI Regulations, which included: (1) rationalisation of fit-and-proper criteria for FPIs; (2) simplification of the broad-based requirement for FPIs; (3) discontinuation of requirements for seeking prior approval from SEBI in the event of a change of local custodian or FPI DDP; and (4) permitting reliance on due diligence carried out by the erstwhile DDP at the time of the change of custodian or FPI DDP. In addition, with a view to improve ease of doing business in India, a common application form has been introduced for registration, the opening of a demat account and the issue of a permanent account number for the FPIs.

In 2019, SEBI introduced the FPI Regulations, with certain important changes from the 2014 Regulations, including:

  1. the re-categorisation of FPIs into two FPI categories (rather than the three FPI categories under the 2014 Regulations). This will be done by the National Securities Depository Limited in consultation with the respective FPI DDPs;
  2. for investment in securities in India by offshore funds floated by an asset management company that has received a no-objection certificate under the SEBI (Mutual Funds) Regulations 1996, registration as an FPI will have to be obtained within 180 days of the date of the FPI Regulations;
  3. the broad-based requirement (where the fund was required to be established by at least 20 investors) for certain categories of FPIs has been done away with;
  4. the concept of opaque structure has now been removed from the FPI Regulations such that the entities that are incorporated as protected cell companies, segregated cell companies or equivalent structures, for ring-fencing of assets and liabilities, can now seek registration as FPIs under the FPI Regulations. Having said that, under the 2014 Regulations, where the identity of the ultimate beneficial owner was accessible, such entities could fall outside the scope of opaque structures and, hence, obtain registration as an FPI. Similarly, while the concept of opaque structures has been removed under the FPI Regulations, FPIs need to mandatorily comply with the requirement of disclosure of beneficial owners to the SEBI; and
  5. the total investment by a single FPI, including its investor group, must be below 10 per cent of a company's paid-up equity capital on a fully diluted basis. If this threshold is exceeded, the FPI needs to divest the excess holding within five trading days of the date of settlement of trades resulting in the breach. The window of five trading days allows FPIs to avoid any change in the nature of their investments. However, upon failure to divest the excess holding, the entire investment in the company by the FPI (including its investor group) will be treated as an FDI, and the FPI (including its investor group) will be restricted from making further portfolio investments in terms of the FPI Regulations.

The clubbing of investment limits for FPIs is done on the basis of common ownership of more than 50 per cent or on common control. As regards the common-control criteria, clubbing shall not be done for FPIs that are: (1) appropriately regulated public retail funds; (2) public retail funds that are majority owned by appropriately regulated public retail funds on a look-through basis; or (3) public retail funds whose investment managers are appropriately regulated. The term 'control' is understood to include the right to appoint a majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of shareholding or management rights, by shareholders' or voting agreements, or in any other manner.

Under the original FPI regime, Category I FPIs were restricted to those who were residents of a country whose securities market regulator was either a signatory to the International Organization of Securities Commission's Multilateral Memorandum or had a bilateral memorandum of understanding with SEBI. Hence, Category I FPIs were essentially governments and related entities or multilateral agencies and were perceived to be the highest-quality and lowest-risk investors.

Pursuant to the reclassification of FPIs, the entities that have been added to Category I, inter alia, are:

  1. pension funds and university funds;
  2. appropriately regulated entities, such as insurance or reinsurance entities, banks, asset management companies, investment managers, investment advisers, portfolio managers, broker dealers and swap dealers;
  3. appropriately regulated funds from Financial Action Task Force member countries;
  4. unregulated funds whose investment manager is appropriately regulated and registered as a Category I FPI; and
  5. university-related endowments of universities that have been in existence for more than five years.

In addition, the Category II FPI is the new residual category, which includes all the investors not eligible under Category I, such as individuals, appropriately regulated funds not eligible as Category I FPIs and unregulated funds in the form of limited partnerships and trusts. An applicant incorporated or established in an international financial services centre (IFSC) is deemed to be appropriately regulated under the FPI Regulations.

Market participants have welcomed all these changes as pragmatic steps by SEBI to enhance the flow of institutional capital into India.

FOREIGN VENTURE CAPITAL INVESTOR ROUTE

The foreign venture capital investor (FVCI) route was introduced with the objective of allowing foreign investors to make investments in VC undertakings. Investment by such entities into listed Indian companies is also permitted subject to certain limits or conditions. Investment through the FVCI route requires prior registration with SEBI under SEBI (Foreign Venture Capital Investors) Regulations 2000 (the FVCI Regulations). Investment companies, investment trusts, investment partnerships, pension funds, mutual funds, endowment funds, university funds, charitable institutions, asset management companies, investment managers and other entities incorporated outside India are eligible for registration as FVCIs. One of the primary benefits of investing through the FVCI route is that FVCI investments are not subject to the RBI's pricing regulations or the lock-in period prescribed by the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018.

Pursuant to the FVCI Regulations, FVCIs must register with SEBI before making investments. The process typically takes 20 to 30 days from the date of application. To promote job creation and innovation, the RBI allowed for 100 per cent FVCI investment in start-ups. In this regard, the Non-Debt Rules also allow FVCIs to purchase equity, equity-linked instruments or debt instruments issued by an Indian start-up, irrespective of the sector in which it is engaged, subject to compliance with the sector-specific conditions (as applicable). Previously, only investment in the following sectors did not require prior approval of the securities regulator:

  1. biotechnology;
  2. information technology;
  3. nanotechnology;
  4. seed research and development;
  5. pharmaceuticals (specifically in terms of discovery of new chemical entities);
  6. dairy;
  7. poultry;
  8. biofuel production;
  9. hotels and convention centres with a seating capacity of over 3,000; and
  10. infrastructure.

III THE INSOLVENCY CODE

2019 has been an epochal year for the Insolvency and Bankruptcy Code 2016 (the Insolvency Code). In the three years to November 2019, the Insolvency Code recorded resolution of an aggregate 167 cases, out of which 81 cases were resolved during 2019 itself. The Insolvency Code helped recover 1.57 trillion rupees of unpaid bank loans or money due to vendors, amounting to 42 per cent of the total amount due. These figures comprise cases that were actually brought before the adjudicating authorities. Considering the number of successful resolutions under the Insolvency Code prior to their admission by the adjudicating authority, the Insolvency Code might have helped the recovery of about 5 trillion rupees of unpaid dues. In 2019, the Insolvency Code saw one of the biggest resolutions, and one of the largest FDI inflows, involving an amount of 420 billion rupees for the acquisition of Essar Steel by ArcelorMittal.88

During 2018, a reduction in the voting threshold from 75 per cent to 66 per cent of the committee of creditors (CoC) with respect to key decisions was introduced, which enabled quick decision-making, allowing for approvals of viable resolution plans. In addition, the scope of 'connected persons' who were barred from bidding for companies under the Insolvency Code was reduced such that the entities (such as financial entities having connected persons through investee companies in India or abroad) could participate in the bidding process so long as they are not related parties.

Following the trend for changes and clarifications, 2019 also witnessed a number of amendments to the Insolvency Code and the Insolvency and Bankruptcy Board of India (IBBI) (Insolvency Resolution Process for Corporate Persons) Regulations 2016 (the CIRP Regulations) thereunder. One of the key amendments to the Insolvency Code included the grant of immunity to an insolvent company and its assets from prosecution for offences committed prior to the insolvency process, provided that such insolvent company has been acquired by a person who is not connected with the management or such offences. In addition, the time period for resolution of cases under the Insolvency Code, including litigations and other judicial process, has been increased from 270 days to 330 days. One of the amendments also provides that a resolution plan could distinguish between financial creditors on the basis of their priority and value of security interest.

Key amendments to the CIRP Regulations in 2019 include:

  1. the resolution applicant must furnish the CoC with a performance security pertaining to the nature of the resolution plan and the business of the corporate debtor;
  2. an authorised representative of a financial creditor will be entitled to cast his or her vote in respect of all financial creditors represented by him or her. Accordingly, the waterfall for payments under the resolution plan has been modified to the effect that the dissenting financial creditors will be paid in priority to the financial creditors who voted in favour of the resolution plan;
  3. corporate restructuring of the corporate debtor (by way of merger, amalgamation and demerger) can now be included in the resolution plan; and
  4. the insolvency professionals and insolvency professional agencies must electronically furnish certain forms to ensure transparency in the corporate insolvency resolution process. Any failure, delay or furnishing of incomplete or incorrect information or records with the form by the insolvency professionals will make them liable for an action under the Insolvency Code by the IBBI.

In addition, the IBBI has notified separate regulations for insolvency resolution processes and bankruptcy proceedings for personal guarantors to the corporate debtors, with effect from 1 December 2019. The regulations on the insolvency resolution process, inter alia, set out the eligibility criteria of the resolution professional, the manner of receipt and verification of claims of creditors, the contents of the repayment plan and the procedure for filing an application for the issuance of a discharge order. Akin to the regulations on the insolvency process, the regulations on the bankruptcy process provide for, inter alia, the eligibility to act as a bankruptcy trustee for the bankruptcy process, the manner of preparation of reports and timeline for submission by the bankruptcy trustee and the manner of realisation of assets of the bankrupt and its distribution. In March 2019, the IBBI also issued an indicative charter of responsibilities of the CoC and resolution professionals for the purpose of clarifying the roles and responsibilities to be discharged by them respectively during the insolvency process.

Apart from the legislative amendments, the Insolvency Code was significantly shaped by verdicts passed by the Supreme Court of India. One of the key developments in the Insolvency Code is the Supreme Court's decision to uphold the constitutional validity of the Insolvency Code. The Insolvency Code has faced challenges of unconstitutionality on the basis that it, inter alia, provides primacy to financial creditors over operational creditors. In this context, operational creditors will need to calculate ways in which to secure themselves in the eventuality of default of payments by corporate debtors.

The immediate impact of the Insolvency Code is evident from the improvement in India's ranking by the World Bank on the country's ability to handle insolvency cases, moving up 33 places to 103rd position. Also in 2018, the National Company Law Tribunal resolved insolvency cases amounting to more than 800 billion rupees, a figure that was predicted to hit the trillion-rupee mark as there were several high-profile deals pending. The trillion-rupee mark was finally hit during 2019, which illustrates the success of the Insolvency Code in India. However, the most significant change is that promoters are behaving better in relation to lenders and no longer enjoying an upper hand when negotiating deals with lenders.

IV SOLICITATION, DISCLOSURE REQUIREMENTS AND FIDUCIARY DUTIES

Typically, investment vehicles issue a private placement memorandum (PPM) or an offer document to raise funds from prospective investors. The PPM sets out all material information to enable the investors to make an informed decision, including fund structure, summary of key terms, background of the key investment team, risk factors, disciplinary history and risk management tools in Category III AIFs.

A lesson learned by the industry in 2019, from SEBI's interpretation of the AIF Regulations, was for investment managers to pay careful attention while drafting the investment objectives in the PPM.

SEBI reprimanded SREI Multiple Asset Investment Trust and SREI Alternative Investment Managers for not making investments within the specified limits set out in their PPM. Industry experts have criticised the reprimand as misplaced, stating that managers should be afforded the flexibility of conducting their business within the broad framework contained in the marketing document, and the terms contained therein should not be subject to a strict interpretation. Having said that, in accordance with the AIF Regulations, managers and sponsors are beginning to set out the risk of their investments in relation to the minimum amount required to be invested. Since a PPM in India acts as both a marketing and a disclosure document, careful attention has to be paid while drafting the PPM to ensure a fine balance between regulatory requirements prescribed by SEBI and the marketing leverage that they want from their commitments to the fund.

With respect to offshore India-focused funds, the disclosure requirements, marketing guidelines and limits on solicitation are governed by the laws of the fund's domicile or jurisdiction. While there is no regulatory framework governing the marketing documents of offshore India-focused funds, under the AIF Regulations, AIFs are required to disclose certain financial information, including sharing valuation reports and filing the PPM with SEBI, for domestic funds. Further, there are limitations on the number of investors that an investment vehicle can attract. For instance, no AIF scheme (other than an angel fund) can have more than 1,000 investors.

Recognised as fiduciaries, directors of an investment vehicle are exposed to liabilities, arising out of breach of their duties towards the fund and its stakeholders. Accordingly, directors should be mindful of their duties and exercise a supervisory role, during the entire cycle of a fund. For instance, at the time of fund formation, a director should ensure that the structure of the fund is tax-compliant, and that the information set out in the offer documents is not untrue or misleading. During the life of the fund, the directors should ensure policies regarding conflicts of interest are in place and adhered to.

Similar principles are built into the AIF Regulations and the REIT Regulations, which require the sponsor and the manager to act in a fiduciary capacity towards their investors and disclose any potential conflicts of interest.

V TAXATION

i Taxation of foreign funds

Following the adoption of the GAAR on 1 April 2017, the Indian tax authorities have the ability to treat arrangements outside India as an 'impermissible avoidance arrangement' if the main purpose of the arrangement is to obtain a tax benefit and the arrangement has no 'commercial substance'. Mere location of the entity in a tax-efficient jurisdiction will not invoke the GAAR. Accordingly, it is critical for a fund to demonstrate commercial reasons for setting up a fund in a particular jurisdiction. The steps that a fund may undertake to demonstrate commercial reasons include the renting of office space, and employment of personnel in that jurisdiction.

The other potential taxation risk in India for offshore funds is the risk of being perceived to have a permanent establishment in India on account of the fund's relationship with the investment advisory team based in India, in which case it would be liable to tax in India. As stated earlier, when determining POEM and actual residency status of an entity, the key guiding principle is whether the entity is engaged in 'active business outside India'. To protect itself from any exposure to charges of having a permanent establishment, a fund must, inter alia, demonstrate that decision-making for the fund is being undertaken at the offshore fund level and not in India. To encourage fund management in India, the Finance Act 2015 provided for safe-harbour rules, where fund management activity carried out through an eligible fund manager in India by an eligible investment fund shall not constitute a business connection in India, subject to the fund and fund manager satisfying various restrictions, such as participation or investment by persons resident in India to be limited to 5 per cent, and a prohibition on the fund making any investment in its associate entity and carrying on or controlling and managing any business in India or from India.

ii Taxation of domestic funds

The Finance Act 2015 conferred tax pass-through status upon Category I and Category II AIFs. Accordingly, the income from investment is not taxed in the hands of such funds but is taxed in the hands of the unitholders. The taxation of Category III AIFs depends on the legal status of the fund (i.e., company, limited liability partnership or trust). Accordingly, investment fund income, other than the business income, is exempt from tax and income received by or accrued to Category I and Category II AIF unitholders is chargeable to tax in the same nature and in the same proportion as if it were income received by or accrued to the unitholder had the investment been made directly by the unitholder. This amendment has provided long-awaited clarity to AIFs given that, prior to this amendment, AIFs were subject to trust taxation provisions that posed several tax uncertainties.

On similar lines, amendments were made to provide pass-through status to REITs and InvITs. Taxes are imposed on these in the manner set out below.

Particulars SPVs REITs Sponsor/investor
Dividend Exempt subject to conditions Exempt Exempt
Interest No withholding Exempt Taxable
Rental income (only applicable for REITs, not InvITs) No withholding Exempt Taxable
Capital gains N/A Taxable Exempt
Other income N/A Taxable Exempt

Further, tax implications for different streams of income in the hands of the investors are set out below.

DIVIDENDS

Dividends declared by Indian companies are exempt from tax in the hands of the investors. The investee companies are liable to pay dividend distribution tax on the net dividend distributed in the hands of the investee companies at the rate of 20.55 per cent of the dividend imposed on the distributing company.

INTEREST

Interest income is subject to tax in the hands of Indian resident investors at the rate that would otherwise apply to the investors on their ordinary income. Income from interest on debt ranges from 5.46 per cent to 43.68 per cent, depending on the regulatory regime, currency of debt and rate of interest.

CAPITAL GAINS

Any short-term capital gain arising on the transfer of listed shares on any recognised stock exchange in India, where securities transaction tax is payable, is subject to tax at the rate of 15 per cent (plus applicable surcharge and cess) subject to any tax benefit under the relevant tax treaty in the case of both residents and non-residents. Sales off the market that result in short-term gain are subject to tax at the rate of 40 per cent (plus applicable surcharge and cess) subject to any tax benefit under the relevant tax treaty in the case of non-residents and at the rate of 30 per cent (plus applicable surcharge and cess) in the case of residents.

Any long-term gain exceeding 10,000 rupees on transfer of listed shares by both residents and non-residents on any recognised stock exchange in India, where securities transaction tax is payable, is subject to tax at the rate of 10 per cent (without the benefits of indexation and neutralisation of foreign exchange fluctuation) and where the transfer is made after 1 April 2018 and off the market, it is subject to a tax of 10 per cent (without the benefits of indexation and neutralisation of foreign exchange fluctuation).

In addition, the government has revised Section 56(2)(viib) of the Income Tax Act 1961 to exempt investments received from Category II AIFs from the applicability of angel tax with effect from 1 April 2020. Previously, this exemption was limited to investments received from Category I AIFs. This amendment is expected to encourage investments by Category II AIFs; this category includes the majority of AIFs in India.

LOSSES

With effect from 1 April 2020, any accumulated losses (in the nature of business loss) incurred by Category I or Category II AIFs will be passed to the investors who will be able to set these off against their income, provided that they have held units in the AIF for longer than 12 months. In addition, with effect from 1 April 2020, any accumulated losses (not in the nature of business losses) incurred by Category I or Category II AIFs prior to 31 March 2019 will be passed to the investors, subject to the condition that they held units in the AIF on 31 March 2019. Accordingly, such losses can be carried forward and set off by the investors against their income from the year in which the loss had first occurred, taking that year as the first year in accordance with Chapter VI of the Income Tax Act. However, such pass-through benefit of losses will not be available to investors who acquired units of AIFs on or after 1 April 2019.

OFFSHORE INVESTMENTS

By way of a circular dated 3 July 2019, the Central Board of Direct Taxes has clarified that any income in the hands of a non-resident investor from offshore investments routed through a Category I or Category II AIF that is deemed a direct investment outside India is not taxable in India under Section 5(2) of the Income Tax Act. The circular further clarified that any exempt loss arising from the offshore investment by a non-resident investor may not be set off or carried forward against the income of the Category I or Category II AIF. This clarification essentially prevents double taxation of the non-resident investor's income in India and in its country of residence.

IFSC

The Finance Act 2019 exempts taxation of income arising from the transfer of global depository receipts, rupee-denominated bonds and derivatives on a stock exchange in an IFSC, for non-resident investors of Category III AIFs, provided that the income is solely in the form of convertible foreign exchange and all units of the AIFs are held by non-residents (except for units held by the sponsor or manager). This exemption is a positive step to boost offshore funding raising by Category III AIFs in an IFSC.

In addition, the Finance Act 2019 provides an exemption to a unit (as defined under the Special Economic Zones Act 2005) operating from an IFSC from dividend distribution tax in respect of dividends distributed from income accumulated by such unit from its operations in the IFSC from 1 April 2017. Similarly, the distributions made by mutual funds located in IFSCs, which derive income solely in the form of convertible foreign exchange and all units of which are being held by non-residents, are exempted from the levy of dividend distribution tax. Unlike Category III AIFs located at IFSCs, the manner of non-resident holding in such mutual funds has not been provided.

VI KEY INVESTMENT TERMS

As the alternative investment market in India continues to mature through the involvement of more sophisticated LPs, reporting requirements have become more complex and demanding. Each LP is looking to closely monitor the ways in which the GP is putting the capital to work. Consequently, LPs now include back-office management and reporting as key items on their due diligence checklist when determining which funds to invest in. In addition, reporting requirements have become robust enough to ensure complete visibility of the operating status of portfolio investments.

Over the years, LPs have become much more vocal in their demands for transparency in investment decision-making as well. Accordingly, the nature of the rights of the investment and advisory committees, and seeking a seat on these committees, have become key points of negotiation between LPs and GPs. LPs are also demanding a veto with respect to each investment decision made by the investment committee. In addition, any transaction involving a potential conflict of interest is expected to be referred for resolution to an advisory board consisting of representatives from the LPs.

LPs are also demanding a veto right with respect to critical decisions such as capital deployment, appointment of key personnel, conflicts of interest and sector focus. A positive trend witnessed has been LPs getting involved with the day-to-day operations of the portfolio companies and sharing sectoral expertise to expand the businesses. With many development finance institutions acting as LPs, funds are being compelled to follow international benchmarks with respect to governance, anti-corruption, and environmental and social norms. This increased involvement of LPs in the decision-making process is being driven by a number of factors, such as an unprecedented run-up in sizes, persistent under-performance and unexpected liquidity pressures on LPs.

To attract more LPs, GPs in India are amenable to moving away from the classic '2 and 20' fee–carry model. Since management fees have no bearing on the performance of the portfolio investments, LPs are unwilling to take risks with respect to the percentage of the management fee. When it comes to the amount on which the management fee is being calculated, LPs are demanding that during the commitment period, fees be calculated as a percentage of the capital commitments made to a fund. After the commitment period, the fee should be calculated as a percentage of the capital contribution that has not been returned to the LPs. Further, LPs are opting for co-investment structures, which results in an overall reduction in the fees that LPs pay to GPs. To diversify an LP's risk, waterfalls are being structured to allow LPs to invest on a deal-by-deal basis or on a blind-pool basis. In addition, at the time of formation of the fund itself, GPs are asked to provide a fee model to act as a guide, to assess and set management fees. Further, distribution of carried interest is being structured on a staggered basis such that allocation of carry is proportionate to the returns achieved by the fund.

Owing to the administrative hassle of managing too many GP relationships, powerful and large LPs are cherry-picking the GPs they want to deal with. LPs are willing to bet their money on decently sized GPs who have a consistent track record. The operational due diligence on GPs has become highly detailed, with meticulous data analysis being conducted as a part of the GP selection process. Other than the standard performance metrics, such as internal rate of return, detailed past-performance figures are being taken into account when conducting due diligence checks.

LPs are also expressing concerns about the expenses that are charged to a fund, and are always looking to cap the expenses incurred by GPs, either as a fixed amount or a percentage of the total size of the fund. In the event that the LPs and GPs agree to an annual cap on operating expenses, LPs want the right to be consulted before GPs set the annual cap.

With increased scrutiny of the fund structures by tax authorities, GPs have successfully negotiated for clawback clauses from LPs to cover future tax liabilities. While LPs fight to limit the scope of such clauses to a certain fixed period, this may not be acceptable in the Indian context given the long limitation period available to the tax authorities to proceed against funds.

The changing dynamics between LPs and GPs has given both parties an opportunity to remould the Indian private equity space into a more sophisticated market. Practically speaking, perfect alignment of the LPs' and GPs' interests is close to impossible. However, if Indian GPs have to keep the funds flowing from LPs, GPs must get into the habit of making adjustments to the agreed fund terms and conditions.

VII REGULATORY DEVELOPMENTS

i Amendments to FDI Policy

The DPIIT made certain noteworthy changes to the FDI Policy during 2019 in its attempt to make India an attractive destination for FDI flows. Such changes include the following:

  1. 100 per cent FDI is now permitted under an automatic route in entities that are engaged in the sale of coal and coal mining activities including coal washing, crushing, handling and separation (magnetic and non-magnetic);
  2. 100 per cent FDI is now permitted under an automatic route for contract manufacturing and, accordingly, the entity with the FDI can undertake the manufacturing activities itself or through contract manufacturing, on either a principal-to-principal basis or a principal-to-agent basis. It has been clarified by the DPIIT that the investee entity will be deemed to be a manufacturing entity itself even if the manufacturing is done by a third-party contractor, provided that it is done under a legally tenable contract. In addition, the entity that has outsourced the manufacturing to the third-party contractor will be eligible to sell the manufactured product through wholesale, retail or e-commerce on the same footing as an entity that manufactures directly; and
  3. 26 per cent FDI has been permitted under the approval route in entities that are engaged in uploading or streaming news and current affairs through digital media.

ii National Guidelines on Responsible Business Conduct 2019

The Ministry of Corporate Affairs (MCA) has revised and updated the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business of 2011 and issued the National Guidelines on Responsible Business Conduct 2019 (NGRBC). The revised guidelines have been aligned with the United Nations (UN) Sustainable Development Goals, the UN Guiding Principles for Business and Human Rights, the Paris Agreement on Climate Change, International Labour Organization core conventions Nos. 138 and 182 on child labour, and annual business responsibility reports mandated by SEBI and the Companies Act 2013, including recent amendments with respect to corporate social responsibility.

As with the earlier guidelines, the NGRBC is designed to assist businesses to perform above and beyond the requirements of regulatory compliance. The NGRBC applies to all businesses irrespective of their ownership, size, structure or location, including foreign multinational corporations investing or operating in India. They are also a guide for Indian multinational companies in their overseas operations. They encourage businesses to not only follow these guidelines in the context of business over which they have direct control and influence but also for their suppliers, vendors, distributors and collaborators. A committee on business responsibility reporting constituted by the MCA will develop formats for listed and unlisted companies to report on their business responsibilities. This is expected to boost investor confidence and increase their creditworthiness.

iii REITs and InvITs

The MCA has amended the Companies (Acceptance of Deposits) Rules 2014 (the Deposit Rules) to exclude any amount received by a company from a REIT from the purview of 'deposit' under Rule 2(1)(c)(xviii) of the Deposit Rules. This follows the previous amendments, which excluded amounts received from AIFs, domestic VCFs, InvITs and mutual funds registered with SEBI.

In April 2019, SEBI notified amendments to the REIT Regulations and the Infrastructure Regulations. Some of the key changes include a reduction in the minimum subscription from any investor in any publicly issued InvIT from 1 million rupees to 100,000 rupees. In the case of a publicly listed REIT, the minimum subscription amount has been reduced from 200,000 rupees to 50,000 rupees. In addition, the minimum trading lot has been reduced from 500,000 rupees to 100,000 rupees. This is expected to increase the reach of retail investors to real estate and infrastructure projects, which was earlier limited due to high minimum investment requirements involved in investments through AIFs. Prior to the 2019 amendments, the aggregate consolidated borrowings and deferred payments of a listed InvIT, its holding company and SPVs were capped at 49 per cent of the value of InvIT assets, which restricted the ability of InvITs to make further acquisitions and provided for limited returns as compared to AIFs. Such limit has now been increased to 70 per cent of the value of InvIT assets subject to certain conditions such as obtaining a prior approval of 75 per cent of the unitholders and utilisation of funds only for the purpose of acquisition or development of the infrastructure projects or real estate projects. Unlisted private InvITs have received a much-anticipated relaxation of the rules in terms of the minimum number of investors, which is now at the discretion of the InvITs (capped at 20 members). The leverage limit of these private InvITs is to be specified under the trust deed (in consultation with the investors).

SEBI has also issued certain clarifications in relation to InvITs that issue units on a private placement basis, which are proposed to be listed. With effect from 15 January 2020, a draft placement memorandum is to be filed with SEBI and recognised stock exchanges through a SEBI-registered merchant banker, at least 30 days prior to the opening of the issue. The memorandum must contain disclosures as specified in the Infrastructure Regulations and should be submitted along with a due diligence certificate issued by the merchant banker. Upon perusal of the placement memorandum, SEBI may issue observations (if any) on such placement memorandum within 15 days of the later of: (1) receipt of the draft memorandum, (2) receipt of additional information or clarification from the issuer or the regulatory authority, (3) receipt of an in-principle approval from the stock exchanges, or (4) receipt of clarification or information from any regulator or agency, where SEBI has sought any clarification or information from such regulator or agency. It is the merchant banker's responsibility to ensure that all such comments are suitably incorporated in the draft placement memorandum and provide a due diligence certificate as per the prescribed format.

iv Harmonisation of IFSC-incorporated AIF investment provisions

In August 2019, SEBI harmonised the provisions governing investments by AIFs incorporated in IFSCs with the provisions governing investments applicable to domestic AIFs such that the AIFs incorporated in IFSCs are permitted to make investments in accordance with the provisions of the AIF Regulations. This is in furtherance of SEBI's endeavour to encourage fund managers to incorporate AIFs in an IFSC. In November 2018, SEBI prescribed detailed operating guidelines to regulate AIFs in India's first IFSC set up under Section 18(1) of the Special Economic Zones Act 2005 in Gujarat International Finance Tec-City. These actions are in furtherance of the guidelines prescribed in 2015 to facilitate and regulate the securities market at the IFSC. The operating guidelines allow AIFs in the IFSC to invest through the FVCI, FDI or FPI route. Previously, AIFs in the IFSC were allowed to invest only through the FPI route. In addition, the caps applicable to AIFs (see Section II.iv) will not be applicable to an AIF set up in the IFSC. The guidelines provide global investors a more viable option to set up global funds in the IFSC in the form of an AIF.

v Amendments in the Significant Beneficial Owners Rules

The MCA has notified amendments to the Companies (Significant Beneficial Ownership) Rules 2018 (the SBO Rules). The amendments, inter alia, pertain to widening the definition and scope of significant beneficial owners (SBO) and include stringent provisions on disclosure of such ownership by a company. However, the SBO Rules do not apply to SEBI-registered investment vehicles such as mutual funds, AIF, REITs or InvITs. In addition, the SBO Rules do not apply to holding companies that have filed a declaration with the registrar of companies (RoC) in the prescribed form.

The SBO Rules define SBO to mean an individual who, acting alone or together, or through one or more persons or trust, possesses one or more of the following rights or entitlements in the reporting company: (1) holds indirectly, or together with any direct holdings, not less than 10 per cent of the shares; (2) holds indirectly, or together with any direct holdings, not less than 10 per cent of the voting rights in the shares; or (3) has right to receive or participate in not less than 10 per cent of the total distributable dividend, or any other distribution, in a financial year through indirect holdings alone, or together with any direct holdings. Any individual who does not hold any right or entitlement indirectly as per (1), (2) or (3) shall not be considered to be an SBO under the SBO Rules.

In addition, the SBO Rules specify the criteria as to when an individual shall be considered to directly hold a right or entitlement in a company: (1) the shares in the reporting company representing such right or entitlement are held in the name of the individual; or (2) the individual holds or acquires a beneficial interest in a company and has made a declaration in this regard to the company. An individual is deemed to indirectly hold a right or entitlement in a company where the member of the company is a body corporate (whether incorporated or registered in India or abroad), other than a limited liability partnership, and the individual holds the majority stake in that member or holds the majority stake in the ultimate holding company (whether incorporated or registered in India or abroad) of that member. The term 'majority stake' means holding more than 50 per cent of the equity share capital or voting rights in the body corporate or having the right to receive or participate in more than 50 per cent of the distributable dividend or any other distribution by the body corporate.

A new provision has been inserted into the SBO Rules, which requires every company to identify its SBO and ensure he or she files a declaration with the RoC. Every reporting company needs to, in all cases where a member (other than an individual) holds not less than 10 per cent of its (1) shares; (2) voting rights; or (3) right to receive or participate in the dividend or any other distribution payable in a financial year, give notice to such member to provide information in prescribed form.

vi Clarification on the appointed date

In view of differing judgements on whether the 'appointed date' in schemes of mergers and amalgamations filed under Section 232 of the Companies Act 2013 should be a specified date preceding the sanctioning of the scheme or filing of the certified copy with the RoC, or thereafter, once the MCA has issued a clarification on the interpretation of appointed date clarifying that companies may choose the appointed date of the merger or amalgamation based on occurrence of an event, which allows such companies to function independently until such event actually materialises. However, in the case of an event-based date being a date subsequent to the date of filing the order with the RoC under Section 232(5), the company shall file an intimation of the same with the Registrar within 30 days of such scheme coming into force. Such appointed date identified under the scheme shall also be deemed to be the acquisition date and date of transfer of control for the purpose of conforming to accounting standards (including Indian Accounting Standard 103, Business Combinations).

vii Integrated online reporting of foreign investments and filing of annual returns

To simplify the reporting process of foreign investments, the RBI released the single master form (SMF) with effect from 1 September 2018. With the implementation of the SMF, the reporting of FDI (which is presently a two-step procedure, namely the submission of an advance remittance form (ARF) and a foreign collaboration – general permission route (FC-GPR) form), has been merged into a single revised FC-GPR. Five forms (FC-GPR, FC-TRS, LLP-I, LLP-II and CN) were available for filing using the SMF. Since 1 September 2018, all new filings for these five form categories must be done using the SMF only. In addition, the RBI has introduced the Foreign Liabilities and Assets Information Reporting System, a web-based reporting portal, via a circular dated 28 June 2019, for the purpose of replacing email-based reporting of foreign liabilities and assets of Indian companies, FDI received by Indian companies, and inward and outward foreign affiliate trade statistics.

viii Class action under the Companies Act 2013

The MCA has revised the requisite number of members for filing an application for a class action on the ground that the management or affairs of the company are being conducted in a manner that is prejudicial to the interests of the company in the following manner: (1) the lower of at least 5 per cent of the total members of the company or 100 members, in the case of a company having a share capital; (2) members holding not less than 5 per cent of the issued share capital of the company, for an unlisted company; or (3) members holding not less than 2 per cent of the issued share capital of the company, for a listed company.

ix Draft National e-Commerce Policy

In February 2019, the DPIIT issued the Draft National e-Commerce Policy, which primarily aims to create a conducive regulatory framework for development of the e-commerce sector, empowering domestic entrepreneurs, leveraging access to data, ensuring infrastructure development and stimulating the participation of MSMEs, start-ups and traders in the digital economy. It provides for regulating cross-border data flows while enabling sharing of anonymised community data. Any data not collected in India, any business-to-business data shared between business entities, data flow through software having no personal or community implications and data (excluding data generated by users in India from e-commerce, social media activities or search engines) shared internally by multinational corporations are exempted from cross-border data flow restrictions. In addition, it recognises the 'network effect' (greater access to data sources resulting in greater likelihoods of success) in M&A transactions by which e-commerce players such as social medial platforms take over potential competitors early and avoid emergence of competition later. An inter-ministerial panel under the DPIIT will be constituted to address stakeholders' concerns and provide necessary clarifications on issues related to FDI in e-commerce. The policy is expected to come into effect during 2020 and sufficient time will be provided to stakeholders to adapt the policy prospectively.89

x SEBI framework for issue of depository receipts

In October 2019, SEBI introduced a framework for the issue of depository receipts (DRs) pursuant to Section 41 of the Companies Act 2013, the Companies (Global Depository Receipt) Rules 2014 and the Depository Receipts Scheme 2014. In light of the recent RBI and central government notifications amending the definition of permissible jurisdiction and amendments to the Prevention of Money Laundering Act (Maintenance of Records) Rules 2005, it has been clarified that only a company incorporated in India and listed on a recognised stock exchange in India may issue permissible securities and their holders may transfer such securities for the purpose of issuing DRs subject to the compliance of the requirements in relation to the eligibility, permissible jurisdictions and international exchanges, compliance with extant laws, permissible holder requirements, voting rights and pricing and obligations of the Indian depository, foreign depository and the domestic custodian.

xi Key tax proposals under the Finance Bill 2020

The Finance Bill 2020, presented on 1 February 2020, seeks to give effect to the financial proposals of the central government for the financial year 2020–2021. Some of the key tax proposals announced in the Finance Bill are summarised below.

Any income of a sovereign wealth fund in the nature of dividend, interest or long-term capital gains arising from an investment made by it in India on or before 31 March 2024 and held for at least three years, whether in the form of debt or equity in a company or enterprise carrying on the business of developing or operating and maintaining, or developing, operating and maintaining any infrastructure facility or any other notified business, are proposed to be exempted from tax under the Finance Bill. Such exemption is granted to sovereign wealth funds that fulfil certain conditions, inter alia: (1) the fund is wholly owned and controlled (directly or indirectly) by the government of a foreign country; (2) the fund does not undertake any commercial activity whether within or outside India; (3) the fund is set up and regulated under the law of such foreign country; and (4) assets of the fund vest in the government of such foreign country upon dissolution.

To incentivise offshore funds to set-up their management arm in India, these have been granted exemption from the purview of business connection (so as to avail exemption from income tax in India), subject to fulfilment of certain conditions, inter alia: (1) the aggregate participation or investment in the fund, directly or indirectly, by persons resident in India should not exceed 5 per cent of the corpus of the fund; and (2) if the fund has been established or incorporated in the financial year under review, the corpus of the fund should not be less than 1 billion rupees at the end of a six-month period from the last day of the month of its establishment or incorporation, or at the end of such financial year, whichever is later. Following certain practical difficulties in achieving the objective of such exemptions, the Finance Bill relaxes the aforesaid conditions to the extent that any contribution by an eligible fund manager during the first three years, up to 250 million rupees, will not be included for calculation of aggregate participation or investment in the fund. In addition, if the offshore fund has been established or incorporated in the previous year, the corpus of the fund should not be less than 1 billion rupees at the end of a 12-month period from the last day of the month of its establishment or incorporation.

Another important development proposed by the Finance Bill is to abolish the levy of dividend distribution tax (currently at the rate of 20.56 per cent) on the distribution of dividend. It is proposed to shift the tax burden from the company, mutual fund or business trust to the shareholders or unitholders, through tax deduction at source. To remove the cascading effect on taxation of dividend, income from dividends received from a domestic company by another domestic company will be deducted from the total income of such recipient company, to the extent of dividend distributed by such recipient company one month prior to the return filing date. However, business trusts will continue to enjoy tax-free receipt of dividend from investee companies. Moreover, the Finance Bill proposes to do away with the requirement of listing units of business trusts (i.e., InvITs and REITs) on a recognised stock exchange for the purpose of availing tax incentives.

In an attempt to adopt the principal purpose test90 outlined in the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI),91 the Finance Bill proposes to amend the Income Tax Act to empower the Indian government to enter into a double taxation avoidance agreement (DTAA) with another country (for, inter alia, avoidance of double taxation) without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in a DTAA for the indirect benefit of residents of any third country or territory). Upon such amendment, the benefits that can be availed by a taxpayer under a DTAA will be subject to the principle purpose test.

VIII OUTLOOK

Despite the Indian economy facing a slowdown, PE/VC investment continued to see a steady rise in 2019. A growth of 28 per cent in PE/VC investment was recorded in 2019, primarily in the infrastructure sector, comprising about 30 per cent of total investment (by value) in 2019 in comparison with only 12 per cent in 2018. The number of deals increased from 769 deals in 2018 to 1,037 deals in 2019, of which 60 per cent were attracted by start-ups. Buyouts emerged as the primary deal type for the PE/VC industry in 2019, accounting for 34 per cent of total PE/VC investment. Such growth in the number of buyouts during 2019 illustrates a shift of Indian PE/VC deals towards the global norm of buyouts being the largest PE/VC deal type. With an approximate value of US$48 million, the Indian PE/VC industry contributed about 1.7 per cent of India's GDP.92

As we progress into 2020, PE investments are expected to grow by 15 to 20 per cent as a result of India's growth potential owing to government initiatives, a conducive regulatory framework, enhancement in ease of doing business and encouragement to new avenues of investment (such as REITs and InvITs). Pursuant to such an encouraging trend, PE/VC fundraising is likely to continue to retain investors' interest during 2020 and the global signs of economic slowdown or deceleration must only be a temporary consideration.

This article is an extract from The Private Equity Review, 9th Edition. Click here for the full guide. 

Footnotes

1 Raghubir Menon and Ekta Gupta are partners, Deepa Rekha is a principal associate, Srishti Maheshwari is a senior associate and Rooha Khurshid is an associate at Shardul Amarchand Mangaldas & Co.

2 https://www.worldbank.org/en/news/press-release/2019/10/24/doing-business-india-top-10-improver-business-climate-ranking.

3 https://www.pwc.in/assets/pdfs/publications/2018/deals-in-india.pdf.

4 https://www.vccircle.com/flashback-2019-pe-firms-scoop-up-assets-of-distressed-firms-in-pre-bankruptcy-stage.

5 An investment vehicle that owns and operates real estate-related assets and allows individual investors to earn income produced through ownership of commercial real estate without actually having to buy any assets.

6 https://www.wsj.com/articles/global-investors-flock-to-indias-first-reit-after-launch-by-blackstone-11559041201.

7 See footnote 4.

8 ibid.

9 See footnote 3.

10 https://ivca.in/wp-content/uploads/reports/2019/EY_PE_Monthly_Deal_Roundup_January_2019.pdf.

11 https://ivca.in/wp-content/uploads/2019/05/PE_Roundup_for_March_2019.pdf.

12 https://ivca.in/wp-content/uploads/2019/11/IVCA-EY-Deal-Tracker-H1-2019.pdf.

13 https://ivca.in/wp-content/uploads/2019/10/IVCA-EY-Monthly-Deal-PE-VC-Roundup-Sep-2019.pdf.

14 https://ivca.in/wp-content/uploads/2020/01/IVCA-EY-PEVC-roundup-for-November-2019.pdf.

15 https://www.vccircle.com/flashback-2019-vcs-snag-record-sum-as-pe-firms-toil-hard-to-cross-finish-line.

16 https://www.vccircle.com/edelweiss-private-credit-fund-raises-1-3-bn-for-investment-in-stressed-assets/.

17 https://www.livemint.com/companies/news/edelweiss-eyes-1-billion-corpus-for-latest-fund-1553542141658.html.

18 https://www.livemint.com/companies/news/piramal-bain-likely-to-lower-maiden-india-fund-target-to-750-mn-1560446624991.html.

19 https://timesofindia.indiatimes.com/business/india-business/cppib-commits-usd-225-mn-to-india-resurgence-fund/articleshow/72864772.cms.

20 https://www.livemint.com/industry/banking/kotak-special-situations-fund-gets-commitments-worth-1-billion-1565602811437.html.

21 https://timesofindia.indiatimes.com/business/india-business/chryscap-raises-850m-in-record-4-mths/articleshow/67425776.cms.

22 https://niifindia.in/national-investment-and-infrastructure-fund/.

23 https://www.livemint.com/companies/news/warburg-pincus-to-raise-up-to-1-5-billion-for-first-india-focused-fund-11574927308025.html.

24 https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/dpiit-proposes-startup-india-vision-2024-proposes-tax-sops-for-new-ventures/articleshow/69043102.cms?from=mdr.

25 https://www.livemint.com/companies/news/eqt-temasek-launch-500-million-renewable-energy-platform-in-india-11579697683545.html.

26 https://www.financialexpress.com/industry/global-infrastructure-partners-india-arm-close-to-buying-rattan-india-solar/1771851/.

27 https://www.livemint.com/industry/infrastructure/commercial-real-estate-continues-to-attract-private-equity-investments-11572079594320.html.

28 https://www.livemint.com/money/personal-finance/india-s-first-reit-is-finally-here-should-you-invest-1552826505402.html.

29 https://www.bloombergquint.com/business/niif-roadis-partner-to-create-platform-to-invest-up-to-usd-2-bn-in-highways-projects.

30 https://www.livemint.com/industry/infrastructure/gip-eyes-up-to-1-billion-corpus-for-india-focused-infra-fund-1566149747595.html.

31 https://economictimes.indiatimes.com/markets/stocks/news/canadas-cppib-to-invest-600-million-in-niif-master-fund/articleshow/72388737.cms?from=mdr.

32 https://www.livemint.com/companies/news/piramal-lone-star-in-talks-to-set-up-road-asset-platform-1559664266691.html.

33 https://www.business-standard.com/article/companies/apg-piramal-look-to-raise-second-fund-to-invest-in-infra-projects-in-india-119031400047_1.html.

34 https://www.business-standard.com/article/companies/edelweiss-financial-services-ties-up-1-3-billion-to-buy-india-debt-assets-119011701244_1.html.

35 https://www.vccircle.com/edelweiss-targets-1-bn-corpus-for-structured-credit-fund/.

36 https://www.livemint.com/Companies/sbNBhD1cXeoovKW0hvEncL/AION-Cap-targets-1-billion-corpus-for-new-fund.html.

37 See footnote 20.

38 https://economictimes.indiatimes.com/industry/banking/finance/lone-star-funds-looks-to-acquire-distress-assets-in-india/articleshow/54351245.cms?from=mdr.

39 https://www.bloombergquint.com/economy-finance/piramal-backed-india-resurgence-fund-gets-dollar225-million-from-canadas-cppib.

40 https://www.deccanchronicle.com/business/in-other-news/260619/panel-for-rs-5000-crore-stressed-asset-fund-for-msmes.html.

41 https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/a91-partners-acquires-350-million-one-of-the-largest-maiden-funds-so-fa/articleshow/69316701.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst.

42 https://www.livemint.com/companies/news/pe-fund-lighthouse-closes-third-fund-at-230-million-1557226072675.html.

43 https://economictimes.indiatimes.com/industry/banking/finance/investcorp-raises-rs-1000-cr-for-india/articleshow/70322993.cms?from=mdr.

44 https://www.livemint.com/Companies/OdSFQcz4TRzzWQUxh0qUFO/IIFL-AMC-raises-950-crore-Category-II-AIF.html.

45 https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/dsg-consumer-partners-makes-final-close-of-third-fund-at-65m/articleshow/70868299.cms?from=mdr.

46 https://www.vccircle.com/nexus-venture-partners-inches-towards-final-close-of-fifth-fund.

47 https://www.techcircle.in/2019/09/17/rebel-foods-backer-lightbox-closes-third-fund-at-209-mn.

48 https://www.livemint.com/companies/start-ups/fireside-ventures-secures-60-mn-for-second-fund-to-raise-40-mn-more-11574163885539.html.

49 https://www.livemint.com/market/mark-to-market/dsg-consumer-partners-closes-65-million-third-fund-1566964611512.html.

50 https://tech.economictimes.indiatimes.com/news/startups/ex-tiger-executives-fund-gets-backing-from-internet-entrepreneurs-flipkart-ceo/67949373.

51 https://www.businessex.com/article/binny-bansal-to-establish-400-million-fund-vc-fund-to-focus-on-startups-in-india-and-southeast-asia/492.

52 https://economictimes.indiatimes.com/industry/services/property-/-cstruction/xander-sets-up-250-mn-industrial-real-estate-platform-for-india/articleshow/71597266.cms?from=mdr.

53 https://www.vccircle.com/motilal-oswal-real-estate-hits-second-close-of-fourth-fund/.

54 https://www.vccircle.com/real-estate-marketplace-smartowner-launches-private-equity-fund/.

55 https://www.livemint.com/companies/news/investcorp-raising-up-to-300-mn-for-maiden-india-fund-1560358240744.html.

56 https://economictimes.indiatimes.com/industry/healthcare/biotech/healthcare/invascent-led-india-life-sciences-fund-raises-250-million/articleshow/67765969.cms?from=mdr.

57 https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/a91-partners-acquires-350-million-one-of-the-largest-maiden-funds-so-fa/articleshow/69316701.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst.

58 https://www.business-standard.com/article/companies/pe-investor-quadria-capital-plans-new-400-million-health-care-fund-119082500815_1.html; www.business-standard.com/article/companies/pe-investor-quadria-capital-plans-new-400-million-health-care-fund-119082500815_1.html.

59 https://www.livemint.com/Companies/n2gPqbjnVzHMGyo6YTygbI/ChrysCapital-closes-8th-private-equity-fund-at-850-million.html.

60 https://www.financialexpress.com/industry/sme/facebooks-co-founder-backer-of-indian-startups-eduardo-saverin-raises-406-million-for-new-fund/1540086/.

61 See footnote 48.

62 https://www.vccircle.com/flashback-2019-how-the-contours-of-pe-vc-m-a-dealmaking-changed-this-year.

63 ibid.

64 https://www.vccircle.com/flashback-2019-brookfield-strikes-a-double-in-this-year-s-top-pe-deals.

65 https://www.business-standard.com/article/companies/reliance-jio-tower-assets-sold-to-canada-s-brookfield-for-rs-25-000-crore-119121601488_1.html.

66 https://www.vccircle.com/brookfield-s-mega-india-pe-deal-to-buy-reliance-gas-pipeline-has-a-buyback-clause/.

67 https://www.vccircle.com/tata-gic-ssg-capital-to-invest-1-15-bn-in-gmr-airports/.

68 https://www.vccircle.com/gvk-gets-1-1-bn-from-adia-psp-investments-niif-to-up-stake-in-mumbai-airport/.

69 https://tech.economictimes.indiatimes.com/news/internet/paytm-gets-1-billion-topup-led-by-t-rowe-price-in-latest-financing-round/72215868.

70 https://www.vccircle.com/flashback-2019-how-the-contours-of-pe-vc-m-a-dealmaking-changed-this-year.

71 https://www.pwc.in/assets/pdfs/research-insights/2019/deals-in-india-mid-year-review-and-outlook-for-2019.pdf.

72 https://www.businesstoday.in/current/economy-politics/brookfield-checks-in-at-hotel-leelaventure-industry-experts-cheer/story/386389.html.

73 https://www.vccircle.com/gic-forms-600-mn-platform-with-indian-hotels-to-acquire-hotels/.

74 https://www.pwc.in/assets/pdfs/services/deals/deals-in-india-annual-review-and-outlook-for-2020.pdf.

75 https://www.vccircle.com/flashback-2019-pe-vc-exits-drop-but-these-investors-minted-money.

76 https://www.vccircle.com/warburg-pincus-spins-high-returns-from-quick-india-exit.

77 https://www.vccircle.com/warburg-pincus-checks-out-of-hospitality-firm-with-dull-returns/.

78 https://www.vccircle.com/tpg-growth-buys-majority-stake-cancer-treatment-services/.

79 https://www.vccircle.com/carlyle-clocks-stellar-returns-from-partial-exit-in-sbi-life/.

80 https://www.sixth-sense.in/sixth-sense-scores-one-of-the-best-vc-exits-in-india-in-recent-times/.

81 https://www.empea.org/app/uploads/2019/05/2019-lp-survey-final-web.pdf.

82 ibid.

83 An AIF that invests in start-up or early stage ventures, social ventures, small and medium-sized enterprises, in infrastructure or other sectors or areas that the government or regulators consider socially or economically desirable (including VC funds, SME funds, social venture funds, infrastructure funds, angel funds and such other AIFs as may be specified).

84 An AIF that does not fall into Category I and III and does not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted under the AIF Regulations will be a Category II AIF.

85 An AIF that employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives will be a Category III AIF. AIFs such as hedge funds or funds that trade with a view to making short-term returns or other open-ended funds can be included.

86 https://economictimes.indiatimes.com/markets/stocks/news/reits-invits-pick-up-steam-mutual-funds-pour-in-rs-12000-crore-in-2019/articleshow/73211059.cms?from=mdr.

87 https://www.business-standard.com/article/pti-stories/aif-investment-rises-to-rs-1-4-lakh-cr-in-dec-quarter-120021301028_1.html.

88 https://www.businesstoday.in/current/corporate/how-path-breaking-verdicts-crucial-amendments-shaped-insolvency-laws-in-2019/story/392738.html.

89 https://economictimes.indiatimes.com/news/economy/policy/government-to-come-out-with-national-e-commerce-policy-within-12-months/articleshow/69942932.cms.

90 The principal purpose test is a test to be used by tax authorities to determine if the primary purpose of making an investment through a jurisdiction has been to obtain a tax benefit, and, if so, establishes that a taxpayer would be denied the benefit of the double taxation avoidance agreement (DTAA).

91 India has signed and ratified the MLI, which came into force in India on 1 October 2019. The provisions of the MLI will be applicable to more than 30 of the covered DTAAs and will be applied alongside the existing DTAAs, thereby modifying their application to implement the anti-base erosion regime.

92 https://www.businesstoday.in/current/economy-politics/infra-drives-pe-vc-investments-to-an-all-time-high-in-2019/story/394497.html.