Budget 2024: How tax-free retail funds will benefit NRIs

The answer is yes as long as the money is not directly invested in equities.

The Union Budget 2024-25 proposed that “retail schemes and exchange-traded funds (ETFs) set up in Gujarat International Finance Tec-City, or GIFT City, will now enjoy tax exemptions along similar lines as available to specified funds”.

“Now retail funds in GIFT will get the same tax benefit like category III Alternative Investment Funds (AIFs),” said Suresh Swamy, partner, Price Waterhouse & Co. Llp-Gift IFSC Branch.

AIFs are high-risk investment vehicles meant for high-net-worth individuals. Category III AIFs invest in securities of listed and unlisted investee companies, derivatives, complex or structured products, or other AIF units.

 

Before the budget announcement, non-residents (including foreigners) could save tax through category III AIFs. However, the minimum ticket size for investing in those funds is $150,000.

For the new funds, the minimum ticket size can be as low as $100.

There are 68 category-III AIFs at GIFT City, but no retail fund or ETF has been approved yet.

DSP Asset Managers Pvt. Ltd is finalizing the proposals for a first-of-its-kind fund for foreign investors. Mirae Asset Mutual Fund and HDFC Asset Management Co. Ltd also have the retail fund management licence to launch such funds. Meanwhile, smaller entities without the licence observe from the sidelines as the entry bar is not very high.

An uphill task for AMCs

The executive of an asset manager with a GIFT City retail licence said setting up such funds presents practical challenges. At some point, regulators from foreign jurisdictions will ask AMCs to register with them if they want to distribute funds to foreign retail investors with low ticket sizes.

“They are still okay if we take money from accredited investors or family offices because regulators believe they have good acumen. The moment we start pitching to retail investors, they will start having problems,” said the executive, whose AMC may apply for a retail fund next week with the International Financial Services Centres Authority(IFSCA).

The other challenge is to integrate the payment system with foreign banks. If a systematic investment plan or investment gets rejected, it would be operationally more difficult for the AMCs to deal with foreign banks than domestic banks, said the executive on the condition of anonymity.

To be sure, a new provision allows NRIs to maintain a dollar account with a domestic bank in GIFT City.

It might also be more cost-effective for AMCs to take money from foreign retail investors in an overseas fund, which feeds into a domestic fund. For instance, instead of Mirae’s India wing directly doing KYC for each investor and taking investments, it can tell its South Korean parent to get funds in an ETF or fund in South Korea. That fund can then, in turn, invest in the scheme that has underlying domestic securities.

Non-resident Indians (NRIs) are easy targets for AMCs in GIFT City. They are more familiar with India, and banks can sell to them more easily than to foreign nationals and institutions. Also, instead of opening a new bank account in India to invest, non-residents can use their foreign bank accounts and invest through GIFT City. Yet, with this announcement, more NRIs may opt for the tax-free route.

Interestingly, it might encourage even smaller players who don’t have a domestic mutual fund licence to launch retail funds and ETFs in GIFT City. The ₹100 crore net worth requirement, among others, makes it difficult for smaller players to register with the Securities and Exchange Fund of India as a mutual fund. The IFSCA, on the other hand, only asks for a $1 million net worth (around ₹8.3 crore).

Benefits for NRIs

Under India’s Double Taxation Avoidance Agreement (DTAA) with the US, an NRI has to pay capital gains tax on mutual funds or equities—12.5% for long-term investments and 20% for short-term investments—as per Indian tax laws.

Swamy told  that if US NRIs invest through a GIFT City fund, which feeds into a mutual fund (not equities), India will not levy any tax on them. “This makes the investments in India very tax efficient,” he added. However, US citizens might still be subjected to taxation in their home country.

HDFC AMC and Mirae Asset already offer such products, but they are structured as Category III AIFs with a mMintinimum ticket size of $150,000. The retail funds and ETFs can have a ticket size of as low as $100. “This will make the product appeal to a mass audience. “An ETF can’t be run if they have a ticket size of $150,000.”

The new funds will also benefit investors from other countries that have similar DTAAs with India, including the UK, Australia and Hong Kong.