Higher taxes bane for India’s hedge funds

India is killing off the one industry that can bring badly behaving tycoons into line while nudging savers away from an unproductive lust for gold.
That industry is domestic hedge funds, which have taken seven years to reach $6 billion in investment commitments from nothing. By contrast, equity investment in India by overseas financial investors is upward of $400 billion.
Even that measly $6 billion figure for so-called Category 3 Alternative Investment Funds overstates the industry’s development. Some managers of vanilla mutual funds now seek the AiF registration to avoid regulatory restrictions on what they can pay distributors for selling to mom-and-pop investors. Alternatives that are meant for the rich don’t have such restraints. But leave aside the pretenders. Rather than encourage a community of investment vigilantes who target firms falsifying accounts or stealing from investors, the Indian taxman is threatening to disband it.
The increase to 42.7% from 35.9% in the tax rate on annual earnings over 50 million rupees ($730,000), announced in the first annual budget after Prime Minister Narendra Modi’s reelection, has a more vocal victim: overseas funds investing in India. These are seeing red. Often structured as trusts or associations, they too will have to pay the higher levy that applies on all non-corporate income. The head of the tax authority in New Delhi has told them they’re “collateral damage.”
Offshore investors can always find other markets. What will onshore hedge fund managers do, except leave the country perhaps? Singapore doesn’t tax capital gains; in India profits on cash equities bought and sold within a year will be charged at 21%, up from 18%. It gets even more draconian. Alternative funds now have to withhold 42.7% of all income on derivatives trading before they pass on the returns to investors. This is bread and butter business for long-short hedge funds, which frequently use derivatives to mount leveraged bets. Worse, the ultimate investors won’t be able to set off that tax against any other business losses.
The Securities and Exchange Board of India, or SEBI, has always been suspicious of the source of capital for hedge funds investing in India from Singapore or Hong Kong. It believes dirty money – proceeds of crime, corruption or tax evasion – comes back home from offshore financial centers after being laundered. Whatever the rational basis of those fears, the regulator’s efforts to set up from scratch a domestic industry in alternative assets is being torpedoed by the taxman. “They may be unwittingly about to kill off the onshore hedge fund industry that SEBI created, even before it has begun to crawl,” Vijay Krishna-Kumar, head of IDFC Asset Management’s liquid alternatives investment, told me.
—Bloomberg