Understanding the Key Changes to Rule 21AIA for IFSC Funds

The Central Board of Direct Taxes (CBDT) has recently made significant changes to Rule 21AIA of the Income Tax Rules, 1962. These changes mainly affect funds operating in the International Financial Services Centre (IFSC). They are directly tied to Section 10(4D) of the Income Tax Act, which provides tax exemptions to certain "specified funds."

The main point is a shift towards simplifying compliance and ensuring that tax rules match the regulations set by the IFSC Authority (IFSCA). This avoids the burden of dual regulation.

Understanding Section 10(4D)

Before looking at the changes, it’s important to understand the context. Section 10(4D) of the Income Tax Act offers a tax exemption for income earned by a "specified fund" from specific activities. This section was mainly created to encourage the development of financial hubs in IFSCs, such as GIFT City in Gujarat, by making them more attractive for investment.

This tax benefit applies to income from:

• The transfer of capital assets on a recognized stock exchange in an IFSC.
• The transfer of certain securities.
• Income from securities issued by a non-resident.

To qualify for this exemption, a specified fund must meet certain conditions. Rule 21AIA was originally set up to list these "other conditions" as stated by CBDT.

The Key Changes to Rule 21AIA

CBDT has recently made a major amendment to Rule 21AIA, which can be summarized in two parts:

1. Omission of Sub-rule (4)

The most significant change is the removal of sub-rule (4) of Rule 21AIA. This sub-rule was added in an earlier notification and required specific, additional conditions for retail schemes and Exchange Traded Funds (ETFs) to qualify for the Section 10(4D) tax exemption. These conditions included having a minimum of 20 investors, a cap on individual investor holdings, and limits on investments in associates and unlisted securities.

2. Alignment with IFSCA Regulations

The recent amendment, introduced by a recent Finance Act, eliminated these additional conditions. It clarified that retail schemes and ETFs only need to follow the conditions outlined in the IFSCA (Fund Management) Regulations, 2022. The removal of sub-rule (4) from the Income Tax Rules is a direct result of this legislative change.

The Rationale and Impact of the Changes

This amendment reflects a thoughtful step by the government to simplify the regulatory landscape.

Simplification of Compliance

By eliminating CBDT's specific conditions, the government has created a more streamlined compliance framework. Funds now only need to refer to one set of regulations—the IFSCA's—rather than managing two different sets of rules from separate regulators.

Reduced Regulatory Overlap

The change directly addresses the issue of regulatory overlap. The tax exemption for these funds now depends solely on compliance with the framework set by the sectoral regulator (IFSCA), which is a sensible approach.

Encouraging IFSC Investments

This legislative change makes the IFSC a more appealing destination for fund managers and investors. The removal of a separate set of tax rules decreases complexity and potential non-compliance, encouraging more investment into India's emerging financial hub.

Conclusion

In summary, CBDT's notification is a procedural step to align the Income Tax Rules with the updated legal framework. It shows the government's commitment to fostering a clear and investor-friendly environment in the IFSC by allowing the sectoral regulator to take charge of governance, while tax benefits are granted accordingly.

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