India Looks To Shift Offshore Derivatives Market To GIFT City

Finance Minister Nirmala Sitharaman announced plans to shift the entire offshore derivatives market to Gujarat International Finance Tech-City when she announced the recognition of offshore derivative instruments in international financial hub.

The move will require all major financial generators of offshore derivatives to register with the International Financial Services Centre at GIFT City.

At the end of December, the notional value of ODIs on equity, debt, hybrid securities, and derivatives stood at Rs 96,292 crore, including Rs 86,351 crore in equity.

The move ties in with the push to move offshore derivatives back home. India has succeeded in shift Nifty derivatives trading from Singapore to the IFSC. It's expected to fully transition by the middle of this year as all traders are moved to GIFT City through the India-Singapore Connect.

What Has Been Proposed?

According to the Finance Bill, the income of non-residents on the transfer of ODIs entered with an IFSC banking unit is exempt under Section 10(4E) of the Income Tax Act.

Under the ODI contract, the IFSC banking unit or IBU—in this case foreign banks—makes investments in permissible Indian securities. Income earned by the IBU on such investments is taxed as capital gains, interest, and dividends under Section 115AD of the Act.

After the payment of tax, the IBU passes such income to the ODI holders.

As of now, the exemption is provided only on the transfer of ODIs and not on the distribution of income to the non-resident ODI holders. Hence, this distributed income is taxed twice in India—first when received by the IBU and then when the same income is distributed to non-resident ODI holders.

The budget has removed the double taxation by proposing exemption to any income distributed on the offshore derivative instruments entered with an offshore banking unit of an IFSC.

The budget has also proposed to provide for exemption on capital gains under the exempted income for foreign portfolio investors.

What Does It mean? 

India has so far not recognised offshore derivatives instruments used through Mauritius or any other tax haven route to trade in the domestic securities market. The country monitors these instruments via SEBI regulations for various intermediaries, getting access to disclosures on ODIs periodically.

In May 2016, the SEBI board decided that all the foreign portfolio instruments issuing ODIs or participatory notes shall follow the 'know your customer' of ODI subscribers as per the Indian Prevention of Money Laundering Act. The KYC or anti-money laundering norms applicable to ODI issuers will be the same as those for all other domestic investors.

The recognition of ODIs in the IFSC is a major shift towards the recognition of these instruments as market essentials and further nudging trades to a jurisdiction where it has more supervision.

The International Financial Services Centres Authority is the regulator for IFSC, or GIFT City, and it makes market regulations in consultation with SEBI, the RBI, and the Finance Ministry.

So, a IFSC banking unit can create ODIs that can invest in the domestic Indian market. It can also hedge the same with SGX Nifty Futures that would fully move to IFSC by the middle of 2023.

The GIFT City domicile for these ODIs will also remove the sword of frequent income tax harassment for many of the funds.