Mumbai: The tax department is snooping after foreign institutional investors (FPIs) for Indians.

In a series of unusual and probing questions, the tax authorities have asked several offshore funds to explain how they go about raising money, what proportion of Indian investments make up the fund pools and which top investors in a fund they know. At least a dozen FPIs have received notices from the Income Tax (IT) department in the last few weeks seeking information about who is managing the funds and from where, two people familiar with the queries told ET.

Resident Indians can only invest in FPIs whose exposure to India is less than 50%, while total subscription by Non-Resident Indians (NRIs) cannot exceed 50% of a fund corpus.

While the tax department has from time to time conducted inquiries to find out whether FPIs are evading taxes by taking advantage of favorable tax treaties between India and other countries or to ascertain the place of effective control (POEM) of a fund, the interference has caught many by surprise the most recent round of questions.

Some of the information requested by the IT department may require FPIs to go even beyond the strict disclosure limits set by capital markets regulator Securities & Exchange Board of India (Sebi).

Here are some questions from two such communications dated October 16 and 30: “Please explain how you approach investors with supporting documents for subscription to your FPI fund”; “Can Indians also invest in the fund? If yes, please segregate the number of participants/AUM (assets under management) as originating from India”; “Please prove the authenticity of your source of funds with the following details: names and addresses of the top 20 parties from which transfers were received.” “Where are the trading terminals located, where are the orders placed from,” etc.

More demanding than Sebi
As regulators, tax and law enforcement agencies look closer to spot Indian faces behind FPIs and foreign private equity and venture capital funds following U.S. short-seller Hindenburg’s allegations against Adani Group in January, the questions facing IT offices are ahead of key state elections and the planned assessment of India (after more than a decade) this month by the Financial Action Task Force, a global anti-money laundering organization.

As part of a stricter disclosure regime, starting this year, FPIs will disclose the identity of the last natural persons standing behind the fund investors who have 10% or more beneficial ownership (BO). “But the tax authorities apparently require the disclosure of the top 20 investors without an ownership threshold filter. This is in addition to examining aspects related to the decision-making process followed by FPI, the location of trading terminals, order placement and trade settlement processes followed, etc. Such an examination now makes it even more complex to find the right FPI investment structure said Richie Sancheti, founder of the law firm Richie Sancheti Associates.

Looking for more details
Other details requested from FPIs (which have received the recent notices) include: how and from where the fund will be managed, the team size to manage the fund, details of the name, address, qualifications of the fund managers, how the trades are confirmed etc settled, the tax liability is in the hands of the fund participants and copies of various submissions made to Sebi about the fund participants.

“There is case law and departmental circulars stating that TRCs (tax residency certificates) should be sufficient evidence of claiming treaty benefits, but tax authorities are looking for control and management information as well as the source of funds to determine whether there is round-tripping Comes Make sure that the company claiming a tax treaty/other tax benefits is actually substantive. With the advent of the POEM and GAAR (general anti-avoidance rules), tax benefit claims are coming under greater scrutiny day by day and increasingly sharper questions are being raised in these current questionnaires aim to take this forward,” said Ashish Mehta, Partner at Khaitan & Co.

Questions around POEM arise when tax officials suspect that while a fund is set up in a treaty territory such as Mauritius, Singapore or the Netherlands to claim certain tax benefits, its key decision-makers are located elsewhere, perhaps even in India.

The notices served under Section 142(1) of the IT Act also require the FPIs to produce their certificate of incorporation under specific laws abroad and copies of bank statements for the relevant year (for which the IT department is conducting a re-audit) for tax disbursements of the funds), a mock statement for short-term and long-term capital gains, an account statement summary and a sample contract statement for each stock broker.

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