[Deepansh and Sahil are students at Government Law College.]
The Government of India has recently allowed setting up of Family Investment Funds (FIF) at GIFT International Financial Services Centre (GIFT IFSC). FIF is a type of family office which is primarily created to look after the assets of a single family. This comes as a move to make India a more favorable jurisdiction for wealthy families to set up their family offices vis-à-vis Singapore, Dubai, and Hong Kong.
Recently, there has been news that some tech billionaires are planning to set up FIFs. This will end the long wait of the first FIF being set up at GIFT IFSC. However, there are still some clarifications on material issues which must be released by the regulators to instill trust and clarity amongst prospective participants.
What are Family Offices?
Family offices are entities which allow the members of a family to pool resources and then invest the funds of the family across various asset classes and jurisdictions. A family office provides a wide range of services tailored to meet the needs of family.
The primary purpose of setting up a family office is to manage the wealth of a family and to allow intergenerational transfer of wealth. However, the concept of family offices has evolved to provide services other than investment and wealth management which goes on to include lifestyle management, educational planning, healthcare planning, etc. for the members of the family.
Nature of FIF
FIFs, simply put, are a type of family office permitted to be set up at GIFT IFSC. The International Financial Services Authority (Fund Management Regulations) 2022 (FM Regulations) introduced the concept of an FIF. As per the FM Regulations a ‘family investment fund’ has been defined as “a self-managed fund pooling money only from a single family and has been set up in terms of these regulations.” In essence, FIFs are investment vehicles which can be set up at the GIFT IFSC for the purpose of investing the money of a single family globally.
FIFs are self-managed funds and are required to be registered as authorized fund management entities (FMEs) as per the FM Regulations. They are permitted to pool money only from a ‘single family.’ The definition of a single family has been expanded recently. Earlier single family meant the group of individuals who are lineal descendants of a common ancestor and included their spouses and children. This essentially meant that only individuals were allowed to make contributions.
Subsequently, International Financial Services Centres Authority through its circular dated 1 March 2023, expanded the ambit of single family to encourage contributions even from entities such as sole proprietorship firm, partnership firm, company, limited liability partnership, trust or a body corporate, in which an individual or a group of individuals of a single family exercises control and directly or indirectly holds ‘substantial economic interest’ which, as per the circular, means at least 90% economic interest in the entity.
Further, the FIF is also allowed to pool investments from its employees, directors, FME or other persons providing services to it, in lieu of grant in FIF’s economic interest. However, the aggregate investments by the above-mentioned employees shall not exceed an aggregate of 20% of FIF’s profits.
Thus, in effect, a single family can now remit funds to the FIF via the above-mentioned individuals and entities.
Analysing the Regulatory Conundrums
In order to pool money in FIF, funds need to be remitted to it, around which revolves the regulatory conundrums that are dealt with in the ensuing paragraphs.
Remittance route
From an investment perspective, FIF is considered as a ‘foreign entity’ according to the exchange control norms specifically the Foreign Exchange Management (Overseas Investment) Rules 2022 (OI Rules). Therefore, any investment being made by the residents or Indian entities (IE) in the FIF have to necessarily comply with the OI Rules.
However, within the exchange control norms lies an ambiguity with respect to whether the remittances made in the FIF by the IEs are to be considered as overseas portfolio investment (OPI) or overseas direct investment (ODI).
View to treat remittance as OPI
The essence of setting up an FIF is to make portfolio investments in order to manage the wealth of the family. Further, Direction 24(1) of Foreign Exchange Management (Overseas Investment) Directions 2022 (OI Directions) expressly lays down that an investment may be made by an ‘Indian person’ (both individuals and IE) into an IFSC fund by way of an OPI. Moreover, as per the prevalent market practice, ODI is made with the intention of carrying out ‘business activity’ which in FIF’s case does not seem to be the objective of the single family.
View to treat remittance as ODI
ODI as defined under the OI Rules means investment by way of acquisition of unlisted equity capital of a foreign entity, or subscription as a part of the memorandum of association of a foreign entity, or investment in 10%, or more of the paid-up equity capital of a listed foreign entity or investment with control where investment is less than 10% of the paid-up equity capital of a listed foreign entity. Any outbound investment which is made in a manner resulting in control to the remitting IE should be classified as an ODI. Since, the IE will have control over the FIF, such remittances could fall within the definition of ODI.
The present ambiguity on whether the remittance to an FIF from an Indian person can be classified as an ODI has far reaching practical implications. This is because the amount of investment permissible by an IE as per the Schedule I of the OI Rules is 400% of the net-worth of the IE. In comparison, the permissible investment via the OPI route is 50% of the net-worth of the IE. The OI Directions, as stated above, use the word ‘may’ to treat investment into GIFT IFSC as OPI and do not mandate that such investments are exclusively in the nature of OPI.
Nonetheless, a clarification from the regulator i.e. Reserve Bank of India is quite essential in the current scenario, since there is a substantial difference in the cap of remittances made by the above-mentioned routes.
Remittance via trust
A trust is now included in the ambit of an eligible entity to remit funds to FIF. However, a trust cannot remit money to an FIF because (a) it does not form a part of IEs under the OI Rules, and (b) no trust apart from a registered trust being engaged either in educational sector or setting up of hospitals in India is eligible to make overseas remittances and that too in a similar sector.
Since an FIF is not a part of these two sectors, a clarification needs to be issued by the regulators with respect to mode of remittance to an FIF from a trust set up in India.
Round tripping
Another pressing ambiguity is with respect to round-tripping. Round-tripping is when money is first remitted from a host jurisdiction to be invested in a foreign jurisdiction, and which subsequently is reinvested in the host jurisdiction. Regulators do not like such transactions as they are used to evade tax. Prior to the introduction of the new overseas investment laws in 2022, round tripping was prohibited in India. However, Rule 19(3) of the OI Rules permits round tripping structures up to two levels of foreign subsidiaries.
In the case of an FIF, ideally an Indian family would want to invest money in an FIF only for the purpose of making global investments. The frequently asked questions (FAQ) released by the GIFT SEZ demonstrate permission for remittance to GIFT IFSC by ‘Indian residents’ only on the condition that such money is not again invested in India. However, these FAQs predate the FM Regulations and there is no clarity on whether the FIFs that receive money from Indian families are prohibited on making investments in India. Further, the FM Regulations cover Indian securities in their permissible asset list. However, the availability of such investments to Indian families is yet to be clarified. This has crucial commercial implications as prospective investors would want clarity on their permissible investment universe before setting up such structures.
Concluding Remarks
The introduction of the FIF is a welcome move and aligns well with the aim of the Indian Government to make GIFT IFSC a financial powerhouse and to increase the ease of doing business. Further, this move puts GIFT IFSC at par with other favourable IFSCs, at least for setting up a family office. It is the hope of stakeholders that Indian families will now consider FIFs at GIFT rather than other alternatives. However, clarifications on material aspects are required as investors would wish to avoid any potential conflicts with the regulators.
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