India-focused offshore funds under ED scanner for rule violations

Betting on India-focused overseas funds can land locals in trouble. The Enforcement Directorate (ED) is learnt to have questioned such investments by a few well-off investors in the past one month.

These individuals have not put money with any foreign portfolio investors (FPI) that are registered with the Securities & Exchange Board of India (Sebi)-an activity that they are aware would be in direct violation of regulations.

Instead, they have invested in offshore funds which in turn have contributed to the corpus of various FPIs whose predominant investments are in stocks that are listed on Indian exchanges.



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Why would a high net-worth individual (HNI) route investments through an offshore vehicle-which could well be regulated abroad-to indirectly buy into Indian equities when he can do it directly at home? It could be to externalise (or dollarize) a large part of his investments, gain on the currency appreciation, or even be a quiet participant in a stock price manipulation plan.

For law enforcement agencies, this is against the rules. According to Moin Ladha, partner at the law firm Khaitan & Co, "An individual is permitted to invest as an overseas investment or portfolio investment under the Liberalised Remittance Scheme (LRS) of RBI. Portfolio Investment specifically restricts any investments in instruments issued by an Indian issuer. Such investments in India-focussed funds can be construed as an indirect means to invest in instruments issued by Indian issuers."

Under LRS, resident individuals can invest up to $250,000 a year in stocks, listed bonds and properties abroad.

"Some of the ultra-HNIs are getting carried away by presentations made by foreign bank representatives who showcase opportunities and advantages of investment in overseas India-focused funds through LRS route. Little do they realise that the LRS window is for outbound investment and not for routing money back to India through overseas funds having large investments in India. Also, there could be some tax arbitrage in investments in overseas funds compared to direct investments in India. But these individuals may be clueless that it amounts to a violation of rules and regulations (under Foreign Exchange Management Act) for which they can be penalised by ED," said Rajesh P Shah, partner at CA firm Jayantilal Thakkar & Company.

Investors who fail to convince ED and find themselves on the wrong side of regulations would have to fork out three times the amount invested as well as surrender the profits as penalty.

These investors have used other offshore vehicles to do what they cannot do directly (by investing in FPIs). Unlike residents, non-resident Indian (NRIs), however, can invest in FPIs subject to the restrictions that a single NRI cannot have more than 25% share while a group of NRIs cannot exceed 50% share in the FPI fund pool. Though the capital market regulator has relaxed these conditions to allow 100% NRIs from FPIs based in the GIFT City financial centre, this is yet to take off.