India offers tax breaks to offshore funds managed by local professionals

India has unveiled proposed amendments to its tax laws aimed at making it easier for offshore investment funds to operate through India-based fund managers without incurring additional tax liabilities, according to a recently published draft bill. The planned changes come as the government seeks to curb significant foreign capital outflows in recent months and make the country's financial sector more attractive to overseas investors, addressing longstanding complaints about India's complex and sometimes aggressive tax regime.

Under the current law, offshore funds wishing to work with Indian fund managers are required to satisfy strict conditions to avoid being taxed in India. These include maintaining a minimum corpus of 1 billion Indian rupees (approximately $10.49 million), having at least 20 investors, and restricting any single investor’s contribution to no more than 25% of the fund’s capital. Failure to comply with each of these requirements risks subjecting the fund’s India-linked profits to domestic taxation at rates that can reach as high as 38%.

The Finance Ministry’s newly proposed bill seeks to eliminate these minimum size and diversification requirements under its “safe harbour” rules. If passed by parliament, the reforms would allow offshore funds regardless of their size or investor concentration to utilise Indian-based fund managers without automatically incurring a business connection in India or related tax exposure. The government says the changes are designed “in order to promote fund management activity and provide tax certainty.”

According to Girish Vanvari, founding partner of the tax advisory firm Transaction Square, the revised approach marks a significant simplification for global investors. “By replacing a highly prescriptive regime with a far simpler substance-based framework, the government has substantially reduced the risk of offshore funds being regarded as having a ‘business connection’ in India - and thus taxable - merely because their investment manager is located here,” he said.

Some safeguards will remain under the updated proposal. Offshore funds will still need to ensure that no more than 5% of their assets are sourced from domestic Indian investors and that they do not assume control over businesses operating within India if they wish to maintain exemption from taxation.

Industry experts have welcomed the move. Nehal Sampat, a partner at PricewaterhouseCoopers, noted that the previous rules had made it difficult for offshore funds to appoint onshore fund managers without running afoul of tax authorities. “This is a significant ease-of-doing-business measure, and it will provide a fillip to offshore funds to hire onshore managers,” he said.

The Finance Ministry has not responded to queries for additional comment. The proposed amendments will now move forward for consideration in the Indian parliament, and if enacted, are expected to create a more investor-friendly environment for global funds choosing to operate via India.