The economic survey presented by the Government just prior to the Budget had very rightly prescribed that India needs a “virtuous cycle” of savings and investment to fulfill its aspiration to become a USD 5 trillion economy. This “virtuous cycle” cannot be conceived without a robust financial services sector. In this backdrop, Honorable Finance Minister Nirmala Sitharaman faced a gigantic task of providing a boost to the financial services sector which is facing several challenges such as liquidity crisis in the Non-banking Financial Companies (NBFCs) sector and high level of Non-Performing Assets (NPAs) in the banking sector. Hon’ble FM Sitharaman has tried to live up to this challenge and provided the much-needed impetus to the sector by proposing several important reforms, some of which are discussed here.
NBFCs and Banking Sector
FM Sitharaman has recognised the crucial role that NBFCs play in supporting the credit needs of the several sections of the economy. In order to alleviate the liquidity issues faced by the sector, it has been announced that the Government will provide credit guarantee to Public Sector Banks for purchase of high-rated pooled assets from NBFCs. This measure was very much needed and will support the NBFC sector on the liquidity front.
Simultaneously, the Government has also proposed several amendments to the Reserve Bank of India (RBI) Act to strengthen the regulatory framework for NBFCs including an increase in the minimum net owned fund requirement, providing enabling powers for resolution of stressed NBFCs, removal of the requirement to maintain debenture redemption reserve, etc. The regulatory framework for housing finance companies is also being strengthened by returning the regulatory oversight to the RBI from National Housing Bank (NHB). A push to growth has also been provided by the announcement of capitalisation of PSU Banks by Rs 70,000 Crores.
On taxation front as well, an amendment is proposed to be made so that taxation of interest income of deposit-taking NBFCs and NBFC-ND-SI in relation to bad and doubtful loans can be deferred until the actual receipt. This amendment aligns the tax treatment of such interest income for NBFCs with that applicable to scheduled banks and housing finance companies and is a very welcome move. Further, borrowers will face a disallowance of interest payable to specified NBFCs unless actually paid. This will incentivise the borrower to make timely interest payments to avoid disallowance.
The government is considering further opening up of foreign direct investment in insurance companies. Further, it has proposed that 100 percent foreign direct investment will now be permitted in insurance intermediaries such as insurance brokers and third-party administrators. These measures will ramp-up foreign investment in the insurance sector.
Foreign Portfolio Investors (FPIs)/ Alternative Investment Funds (AIFs)
The statutory limit for FPI investment in a company is proposed to be raised to the applicable sectoral limit/ statutory ceiling from the current limit of 24 percent. FPI investment is also proposed to be permitted in debt securities issued by REITs and InvITs. Further, in order to ease compliances to be undertaken by FPIs, it is proposed to simplify Know Your Customer (KYC) norms applicable to FPIs. These are very significant measures and will lead to increased FPI activity in the coming days.
On the taxation front, several crucial measures which were demanded by the industry have come through. These include rationalisation of conditions for safe harbor rules to promote onshore fund management activity for offshore funds, permitting pass-through of losses to investors in Category I and II AIFs, extending the exemption from angel tax for funding received by venture capital undertaking from Category II AIFs (which earlier was restricted to only Category I AIFs).
International Financial Services Centre (IFSC)
To further incentivise the development of IFSC, the government has proposed to grant several tax benefits including widening the tax exemption to a unit located in IFSC to 100 percent of the profits for 10 years instead of the 100 percent exemption for first 5 years and 50 percent for the remaining 5 years. It is also proposed to exempt any dividends declared by a company operating in IFSC out of specified accumulated profits from the dividend distribution tax as against exempting only dividends declared out of the current profits. Further, to encourage mutual funds to locate in IFSC it is also proposed to exempt mutual funds from the income distribution tax on income distributed to unitholders where inter alia, all the unit holders are non-residents. Transactions in securities in IFSC will also get a boost as the government has proposed an exemption for Category III AIFs set-up in IFSC (where all the unit holders are non-resident) from capital gains tax.
The government has also announced that it will set out the relevant regulatory framework to make IFSC a hub for aircraft leasing and financing activity as well as international insurance transactions.
The above measures on policy, regulatory and tax front will go a long way in providing a much-needed boost to the financial services sector and reinvigorate confidence in the Indian economy, especially, the financial services sector.
(Views expressed above are the personal opinion of Punit Shah, Shashidhar Upinkudru, Kushal Parik of Dhruva Advisors.)