KPMG IN INDIA

Budget 2008 Highlights

Financial Services Sector

TA X
Table of Contents

Tax proposals relevant to

Financial Services sector 2

Direct Tax 2
Indirect Tax 6

Policy initiative in the Financial

Services sector announced in
the Budget 7

Recent policy changes in the

financial services sector 9

Banking 9
Insurance 14
Mutual Funds 16
Real Estate Investment Trusts 18
Non-banking Financial Companies 20
Portfolio Manager 22
Venture Capital Funds 23
Securitisation 24
Foreign Exchange Management 25

Glossary 30
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F I N A N C I A L S E RV I C E S

Tax proposals relevant to Financial Services

sector
The summary that follows highlights the salient features of the Finance Bill 2008,
in terms of direct and indirect taxes relevant to Financial Services sector. Unless
otherwise indicated, the proposed amendments relating to direct taxes will apply
from assessment year 2009-10 and the amendments relating to service-tax will
apply from a date to be notified after the enactment of the Finance Bill 2008.

Direct Tax
• Short-term Capital Gains tax (STCG) on equity shares or units of an equity
oriented fund, where Securities Transaction Tax (STT) is applicable, is
proposed to be increased to 15 percent from 10 percent. After the levy of
applicable surcharge and education cess, the effective rate of tax on STCG for
domestic companies would be 16.995 percent and 15.836 percent for foreign
companies
• It is proposed that a domestic parent company (not being a subsidiary of
another company) would now be allowed to set off the dividend received
from its subsidiary company against dividend distributed by the parent
company for calculation of dividend distribution tax. For this purpose, a
company is considered to be a subsidiary of another company if the other
company holds half the nominal capital therein
• It is proposed that a transaction of reverse mortgage shall not amount to a
‘transfer’ and income therefrom will not be taxable as ‘income’ in the hands
of the recipient
• The Government had recently permitted Indian companies to issue Foreign
Currency Exchangeable Bonds (FCEB). It is proposed that the conversion of
FCEB shall not be regarded as ‘transfer’. Also, the cost of acquisition of the
shares received upon conversion of the FCEB shall be the price at which the
corresponding FCEB is acquired
• It is proposed that withholding tax would not be applicable on interest payable
on corporate bonds/debts instruments issued in the dematerialised form and
listed on the recognised stock exchange. This proposal will come into effect
from 1 June 2008
• A Commodities Transaction Tax (CTT) is proposed to be levied on taxable
commodities transactions undertaken by the seller or the purchaser as
indicated below:
3

Taxable commodities Rate Payable by

transaction

Sale of an option in
goods/commodity derivative, 0.017 percent on
Seller
where the option is not option premium
exercised

Sale of an option in
0.125 percent on the
goods/commodity derivative,
settlement price of the Purchaser
where the option is
option
exercised

0.017 percent of the

Sale of any other commodity price at which the
Seller
derivative commodity derivative is
sold.

• CTT will be allowed as a deduction, provided the income earned from the
taxable commodities transactions is included under the head ‘profits and
gains of business or profession’
• Currently, the STT is levied on derivative sale transactions entered into in a
recognised stock exchange at the rate of 0.017 percent and was payable by
the seller. It is now proposed to levy STT (with effect from 1 June, 2008) as
under:

Taxable securities
Rate Payable by
transaction

Sale of an option in 0.017 percent on

Seller
securities option premium

Sale of an option in 0.125 percent on the

securities, where option is settlement price of the Purchaser
exercised option

Sale of a futures in
0.017 percent Seller
securities

• The earlier provision for allowance of rebate in respect of STT paid from
income-tax payable on business income is proposed to be deleted. Going
forward, it is proposed that the STT paid by a taxpayer during the year with
respect to taxable securities transactions shall be allowed as a deduction from
the taxpayer’s business income

• Dematerialisation of Tax Deduction at Source (TDS) / Tax Collection at Source

(TCS) certificates (i.e. non-requirement of furnishing TDS / TCS certificates)
has been deferred till 1 April 2010

• Authority has been granted to the Central Board of Direct Taxes (CBDT) to
frame rules detailing the procedure for giving credit to taxpayers for any TDS /
TCS
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• Clarificatory amendment introduced to provide that a person failing to deduct

tax would also be deemed to be a taxpayer in default. Currently, the taxpayer
is treated to be in default where on withholding, he does not deposit the tax
in time. The amendment to be effective retrospectively from 1 June 2003

• Payments made to non-residents require furnishing of a chartered accountant

certificate and an undertaking by the payer confirming appropriate withholding
of taxes for remittance. The payer would now also be required to file
necessary information relating to such payments in a manner and form to be
prescribed by CBDT. The amendment is to be effective from 1 April 2008

• Due date for filing of corporate tax returns and income-tax returns of persons
either whose accounts are required to be audited or is a working partner of a
firm whose accounts are required to be audited, has been advanced to 30
September instead of 31 October.

• Consequently, the relevant due date for filing a wealth tax return, FBT return,
transfer pricing report and other supporting documents would also stand
advanced to 30 September. The amendment is to be effective from 1 April
2008

• Two-stage assessment of returns re-introduced. Initial stage assessment

would require computerised processing (without any human interface) which
would make adjustments for any arithmetical error or incorrect claims based
on information apparent in the return. The amendment is to be effective from
1 April 2008

• The tax officer can reopen an assessment with respect to income chargeable
to tax which is not a subject matter of any appeal, reference or revision but
believed to have escaped assessment. The amendment is to be effective
from 1 April 2008

• The tax officer has been empowered to extend the period of furnishing of
special audit report under Section 142(2A) on his own. The amendment is to
be effective from 1 April 2008

• Non-service of notice or service of notice in an inappropriate manner, would

not be considered as valid grounds for objecting to any proceedings of
assessment or reassessment if the taxpayer appears in such proceedings or
co-operated in any enquiry related to such proceedings. The amendment is to
be effective from 1 April 2008

• Notice for scrutiny assessment to be served on the taxpayer within a period

of 6 months from the end of the financial year in which the return is furnished
instead of 12 months from the end of the month of filing return under the
existing provision. The amendment is to be effective from 1 April 2008
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• Retrospective amendment introduced with effect from 1 April, 1989 stating

that a direction in the assessment order initiating penalty proceedings would
tantamount to satisfaction of the tax officer for initiating such proceedings

• Where any notice or other document is required to be issued, served or given

by the revenue authorities, it shall be deemed to have been authenticated if
the name and office of a designated revenue authority is printed, stamped or
otherwise written thereon. The amendment is to be effective from 1 June
2008

• Amendments have been made to provide that if revenue authorities do not

file an appeal in a given case, then on the similar issue of law for another
taxpayer or another assessment year, the appeal of revenue cannot be
dismissed on the basis that the issue in dispute is not challenged in some
previous judgment. The amendment is to be effective retrospectively from 1
April 1999

• Clarificatory explanation introduced to provide that in case of a re-assessment

proceeding, the Joint Commissioner, Commissioner or the Chief
Commissioner, as the case may be, is only required to be satisfied with
respect to the reasons for re-opening and not required to issue such notice.
The amendment is to be effective retrospectively from 1 October 1998

• Entities established for charitable purposes are generally exempt from tax.
Entities were considered as established for charitable purposes if they
provided relief to the poor, education, medical relief or was engaged in
advancement of any other object of general public utility. Entities engaged in
the advancement of any other object of general public utility will not be
considered as charitable if it undertakes any trade or business or services in
such relation for a consideration

• The Income-tax Appellate Tribunal (ITAT) cannot grant stay of demand for a
period exceeding 365 days in aggregate, even if the delay in disposing of the
substantive appeal pending before the ITAT is not attributable to the taxpayer.
This provision is proposed to be effective from 1 October 2008

• Banking Cash Transaction Tax levied at 0.1 percent on ’taxable banking

transaction’ is withdrawn. The provision would be effective from 1 April 2009.

Fringe Benefit Tax (FBT)

• Any expenditure incurred on or payment through non-transferable pre-paid
electronic meal card usable only at eating joints or outlets is excluded from
levy of FBT
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• Any expenditure incurred on or payment made for following purposes to be

excluded from the category of ’employee welfare’ for the purpose of valuation
of fringe benefits:
- crèche facility for the children of the employee
- sponsoring a sportsman being an employee; and
- organising sports events for employees.

• Any expenditure on or payment made for maintenance of any accommodation

in the nature of a guest house shall be excluded from the levy of FBT

• The valuation of expenditure on or payment for festival celebrations to be

reduced from 50 percent to 20 percent

• It has been clarified that fringe benefits will include securities offered under
an employee stock option plan or scheme where the employee stock options
have been granted. This amendment will apply from assessment year 2008-09

• FBT recovered by the employer from the employees with respect to

allotment/ transfer of specified security or sweat equity shares shall be
deemed to be tax paid by such an employee. The deeming provisions shall
apply only to the extent to which the amount of recovery relates to the value
of fringe benefits provided to such employee.

The employee shall not be entitled to any refund or credit out of such deemed
payment of tax against tax on any other income or any other tax liability in
India.

The said amendments will apply from assessment year 2008-09.

Key indirect tax proposals

• Service tax has been proposed to be levied on the following services:

- Services provided in relation to management of investments under unit

linked insurance plans
- Services provided by stock exchanges in relation to securities
- Services provided by commodity exchanges in relation to sale or purchase
of any goods or forward contracts
- Services provided by a processing and clearing house in relation to
processing, clearing and settlement of transactions in securities, goods or
forward contracts
- Services provided by money changers.

These proposals will come into effect from a date to be notified after the
enactment of the Finance Bill, 2008.

Also, a new scheme for claiming credit on taxable and exempt services has
been introduced. The service provider may either reverse the credit
attributable to the inputs and input services used for providing exempted
services or pay 8 percent of the value of the exempted services.
7

Policy initiatives in the Financial Services

sector announced in the Budget
Some of the key policy initiatives in the Financial Services sector announced by
the Hon. Finance Minister in the budget speech are summarised below –

Capital markets
Measures to expand the corporate bonds market
The Hon. Finance Minister in the Budget 2006 had announced the setting up of
an exchange traded market for corporate bonds. A single unified exchange traded
market for corporate bonds would result in the development of infrastructure to
support the secondary debt market trading system, which allows efficient price
discovery and reliable clearing and settlement.

Further to these provisions, the following policy measures have been proposed in
the Budget 2008
• The development of the bond, currency and derivatives markets, which will
include launching of exchange-traded currency and interest rate futures, and
developing a transparent credit derivatives market with appropriate safeguards
• Enhancing the tradability of domestic convertible bonds by putting a
mechanism in place that will enable investors to separate the embedded
equity option from the convertible bond and trade it separately and
• Encouraging the development of a market-based system for classifying
financial instruments based on their complexity and implicit risks.

National market for securities

It is proposed that the Empowered Committee of state Finance Ministers would
work with the Central Government to create a pan Indian Market for securities
that will expand the market base and enhance the revenues of the State
Governments.

Permanent Account Number (PAN)

In the Budget 2007, it was announced that a PAN would be the sole identification
number for all participants in the securities market. It is now proposed that a PAN
would be required for all the transactions in the financial market, subject to
suitable threshold exemption limits.
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Waiver of farm loans by banks

A scheme of debt waiver and debt relief for farmers has been placed before
Parliament wherein:
1) All agricultural loans disbursed by scheduled commercial banks, regional
rural banks (RRBs) and cooperative credit institutions up to 31 March, 2007
and overdue as on 31 December, 2007 will be covered under the scheme
2) For marginal farmers (i.e., holding upto 1 hectare) and small farmers (1-2
hectare), there will be a complete waiver of all loans that were overdue on
31 December, 2007 and which remained unpaid until 29 February, 2008. For
the other farmers, there will be a one time settlement (OTS) scheme for all
loans that were overdue on 31 December, 2007 and which remained unpaid
until 29 February, 2008. Under the OTS, a rebate of 25 percent will be given
against payment of the balance of 75 percent
3) Agricultural loans were restructured and rescheduled by banks in 2004 and
2006 through special packages. These rescheduled loans, and other loans
rescheduled in the normal course as per RBI guidelines, will also be eligible
either for a waiver or an OTS on the same pattern.

The implementation of the debt waiver and debt relief scheme will be completed
by June 30, 2008. Upon being granted the debt waiver or signing an agreement
for debt relief under the OTS, the farmer would be entitled to fresh agricultural
loans from the banks, in accordance with normal rules.

The total value of overdue loans being waived is estimated at INR 50,000 crore
and the OTS relief on the overdue loans is estimated at INR 10,000 crore.

Other policy announcements

• Commercial banks, including RRBs are advised to add at least 250 rural
household accounts every year at each of their rural and semi-urban
branches
• Individuals such as retired bank officers, ex-servicemen etc. are allowed to
be appointed as business facilitators or business correspondents or credit
counsellors.
9

Recent policy changes in the Financial

Services sector
Keeping in view the changing landscape in the financial sector, Regulatory
authorities have been suitably focusing its regulatory and supervisory framework
to promote a stable and efficient financial sector. Some of the significant
developments in the financial services sector during the period from March 2007
to February 2008 have been summarised hereunder:

Banking

Fair Practices Code for Lenders

With a view to achieving greater transparency, the RBI vide its Circular dated 6
March 2007 has made it mandatory for all SCB excluding Regional Rural Banks
that all loan application forms relating to priority sector advances (in respect of all
categories of loans and irrespective of the amount of loan sought by the borrower)
should include certain minimum information. This information would cover details
about the fees / charges, if any payable for processing, the amount of such fees
refundable in the case of non-acceptance of application, pre-payment options, etc.

Further the banks have been advised that lenders should convey in writing, within
stipulated time, the main reason / reasons which, in the opinion of the banks has
led to rejection of the loan applications.

Enhancement of disclosures (Under Accounting Standard 17)

In terms of extant instructions, SCB were required to adopt the three business
segments viz. “Treasury”, ‘Other Banking Business” and “Residual” as the
uniform business segments and “Domestic” and “International” as the uniform
geographic segments for the purpose of segment reporting under Accounting
Standard 17. RBI vide its circular dated 18 April 2007 has enhanced the disclosures
to be made by the banks under the “Other Banking Business” Segment. This
segment has now been divided in the following three, viz, Corporate / Wholesale
Banking, Retail Banking and Other Banking operations. Accordingly, banks have to
adopt the following business segments for public reporting purposes, from 31
March 2008:

(a) Treasury
(b) Corporate / Wholesale Banking (new)
(c) Retails Banking (new)
(d) Other Banking Business

The geographical segments remain unchanged as ‘domestic; and ‘international.’

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Comprehensive Guidelines on Derivatives

RBI has issued comprehensive guidelines on derivatives (excluding foreign
exchange derivatives) by banks vide its circular dated 20 April 2007. The Circular
lists the requirements re: the eligible participants, eligibility criteria, broad
principles for undertaking derivative transactions, permissible derivative
instruments, risk management and corporate governance aspects, risk
management, etc.

Maintenance of Cash Reserve Ratio (CRR) on exempted

categories
RBI vide its Circular dated 20 April 2007 has advised all SCB (excluding Regional
Rural Banks) that they would be exempted from maintaining average CRR with
effect from 1 April 2007, on (i) Liabilities to the banking system in India as
computed under Clause (d) of the Explanation to Section 42 (1) of the RBI Act,
1934 (ii) Credit Balances in ACU (US$) Accounts (iii) Transactions in Collateralized
Borrowing and Lending Obligations (CBLO) with Clearing Corporation of India
(CCIL) and (iv) Demand and Time Liabilities in respect of their Offshore Banking
Units.

Prudential Guidelines on Capital Adequacy and Market

Discipline
RBI vide its Circular dated 27 April 2007, has issued guidelines for implementation
of the New Capital Adequacy Framework.

The revised framework consists of three-mutually reinforcing pillars, viz. minimum

capital requirements, supervisory review of capital adequacy, and market
discipline.

Foreign banks operating in India and Indian banks having operational presence
outside India should migrate to the above selected approached under the Revised
Framework with effect from 31 March 2008. All other commercial banks (except
Local Area Banks and Regional Rural Banks) are encouraged to migrate to these
approaches under the Revised Framework in alignment with them but in any case
not later than 31 March 2009.

Risk Weight on Residential Housing Loans reduced

RBI vide its Circular dated 3 May 2007, has advised that the risk weight in respect
of housing loans upto INR 2 million to individuals against the mortgage of
residential housing properties would be reduced from 75 percent to 50 percent.
Similarly, the risk weight for banks investment in mortgage backed securities,
which were backed by housing loans and were issued by the housing finance
companies regulated by the National Housing Bank would also be reduced from
75 percent to 50 percent.
11

Doorstep Banking
RBI vide its Circular dated 24 May 2007 has permitted all SCB (excluding Regional
Rural Banks) to (i) deliver cash / draft at the doorstep of the individual customers
(in addition) to corporate customers / Government Department / PSUs etc). either
against cheques received at the counter or requests received through any secure
convenient channel such as phone banking / internet banking and (ii) deliver cash /
draft at the doorstep of Corporate Customers / Government Departments / PSUs
etc. against cheques received at the counter or requests received through any
secure convenient channel such as phone banking / internet banking, subject to
the banks adopting technology and security standards and including those
specifically relating to authenticating users and taking adequate safeguards /
precautions in undertaking the above transactions.

Holding Companies
With a view to assess the globally prevalent Bank Holding Companies (BHCs) and
Financial Holding Companies and their suitability for India (given the Indian legal,
regulatory and accounting framework), RBI came out with a discussion paper
dated 27 August 2007.

The key points emanating from the discussion paper are as under:

• Currently, banks aggregate investment in the financial services companies

including subsidiaries is limited to 20% of the paid up capital and reserves of
the bank. In a BHC / FHC structure, this restriction would not apply as the
investment in subsidiaries and associates would be made directly by the BHC /
FHC.

• The paper highlights the major motivation for such structures and the key legal
and regulatory constraints that may be encountered while implementing such
structures in India.

• The paper also expresses the supervisory concerns emanating from the FHC
structures and the need for an appropriate regulator in the case of such
structures.

• The concept of intermediate holding companies within the FHC structures and
the India specific concerns have also been dealt with in the paper.
12

Guidelines for issuing preference shares as part of regulatory

capital

With a view to providing a wider choice of instruments to Indian banks for raising
Tier I and Upper Tier II capital, RBI vide its Circular dated 29 October 2007 has
decided to allow the banks to issue the following types of preference shares in
Indian Rupees.

(i) Tier I Capital – Perpetual Non-cumulative Preference Shares (PCNPs)

(ii) Upper Tier II Capital
(a) Perpetual Cumulative Preference Shares (PCPs)
(b) Redeemable Non-cumulative Preference Shares (RNCPs)
(c) Redeemable Cumulative Preference Shares

PCNPs are to be treated on par with equity, and hence, the coupon payable on
these instruments will be treated as dividend (an appropriation of Profit and Loss
Account). All other types of preference shares mentioned above will be treated as
liabilities and the coupon payable thereon will be treated as interest (charged to
profit and loss account).

Scope of Infrastructure Lending Expanded

The RBI issued a Circular dated 30 November 2007 expanded the definition of the
term “infrastructure lending” (defined under Circular dated 16 June, 2004) to
cover within the expanded definition, any credit facility granted by lenders (i.e.
banks, FIS or NBFCs) to companies engaged in laying down and/ or maintenance
of gas, crude oil and petroleum pipelines.

Prudential Norms for Investments widened

Earlier, SCB were allowed to invest in unlisted non-SLR securities up to 10 percent
of their total investment in non-SLR securities as on 31 March of the previous
year. In order to encourage the banks to increase the flow of credit to
infrastructure sector, the RBI vide Circular dated 06 December 2007 has decided
to allow banks to also invest in unrated bonds of companies engaged in
infrastructure activities within the ceiling of 10% for unlisted non-SLR securities.
13

Loans / Advances to Mutual Funds to be included in Bank’s

Capital Market Exposure
RBI vide its Circular dated 14 December 2007 has notified the SCB that exposure
to Mutual Funds would form part of Capital market exposure of the bank. Further,
the Irrevocable Payment Commitments (IPCs) in favour of Stock Exchanges on
behalf of Mutual Funds are to be treated at par with guarantees issued for
purpose of capital market operations. Such exposure of banks will, therefore, form
part of their Capital Market exposure.

Bank Finance to Factoring Companies

RBI vide its Circular dated 12 February 2008 has allowed SCB to extend financial
assistance to support the factoring business of Factoring Companies which
comply with specified criteria.
14

Insurance
Advertisement, Promotion and Publicity
With the intent to protect the interest of the insuring public, enhance their level of
confidence in the nature of sales material used and ultimately encourage fair
business practice, in May 2007, the IRDA issued a Circular giving out the
guidelines on advertisement, promotion & publicity of insurance companies, and
insurance intermediaries.

The Circular is effective from 1 July 2007. The Circular classifies the
advertisement in two categories, viz. Institutional advertisements (advertisements
for promoting the brand image of the company) and Insurance advertisements
(advertisements with the specific purpose of soliciting insurance business). Also,
the Circular gives out the general do and don’ts for all advertisements.
The advertisements should comply with the general requirements, specific
requirements, and mandatory disclosure as specified in the circulars.

Definition - Infrastructure
In February 2008, the IRDA issued a notification whereby the definition of the
term ‘infrastructure’ has been amended in the IRDA (Registration of Indian
Insurance Companies) Regulations, 2000.

Every insurance company is required to invest a part of its assets in the

‘infrastructure’ sector. The definition of the term ‘infrastructure’ has now been
amended to bring in line with the Reserve Bank of India definition which is as
follows,

“Infrastructure covers roads, highways, port, airport, inland waterway/port, water

supply and sanitation, telecom services, industrial park or SEZ, power generation,
transmission and distribution. Besides, as per the central bank’s norm, public
activities of similar nature, which the Central Board of Direct Taxes will notify in
due course, would also be treated as infrastructure.”

Declaration of Bonus – Relaxation for Life Insurance

Companies

In April 2007, the IRDA issued a Circular whereby it has extended the relief
granted to Life Insurance Companies for declaring bonus in case the Life Fund is
in a deficit. As per the existing regulations, a life insurance company can declare
bonus within a period of five years even in case it has a deficit, which has now
been extended by another two years thereby making it to seven financial years,
commencing from the year in which the life insurance business operations are
started.
15

Appointment of a C.E.O. / M.D.

The Insurance Act, 1938 provides that no appointment, re-appointment or
termination of CEO, Whole-time Director or Managing Director of an insurance
company is valid unless the previous approval of the IRDA is sought.

In August 2007, the IRDA advised that the application for such an approval should
be made at least 30 days prior to the commencement of the appointment so as to
allow sufficient time to IRDA to examine such proposals. The application needs to
be made in the specified format as prescribed by the IRDA. The application also
enquires as to whether the insurance company has complied with the relevant
provisions of the Companies Act, 1956.

Reporting of Maintenance of Solvency Margin

Post relaxation of controls on the tariffs for the non-life insurance industry, in
November 2007, the IRDA issued a Circular making it mandatory for all non-life
insurance companies to file their solvency position as at the end of each quarter.
This stipulation was already effective for life insurance companies and now the
same has also been made applicable to non-life and reinsurance companies.
Quarterly submission of Financial statements

In November 2007, the IRDA issued a Circular whereby it has made mandatory for
all insurers to submit un-audited segment-wise financial statements on a quarterly
basis. The manner of preparing the un-audited financial statements shall be as per
the instructions contained in the IRDA (Preparation of Financial Statements and
Auditor’s Report of Insurance Companies) Regulations, 2002 and various circulars
/ instructions issued there under.

Amendment to IRDA (Obligations of Insurers to Rural or Social

Sector) Regulations, 2008
The Insurance Act, 1938 makes it mandatory for an insurer to undertake a
particular percentage of life and general insurance business in the rural or social
sector. These percentages were notified in the IRDA (Obligations of Insurers to
Rural or Social Sector) Regulations, 2002. The regulations specified the
percentage of obligations to be undertaken by the insurers in the first six years
after the implementation of these regulations.

The IRDA has now amended these regulations and specified the obligations of
insurers to rural or social sectors for the 7th, 8th, 9th and 10th financial year and
also clarified that the obligations of the insurers towards the rural and social
sectors for the 10th financial year shall also be applicable in respect of the
financial years thereafter.

The regulations also specify the obligations for the existing insurers as on the date
of the commencement of the IRDA Act, 1999 towards the rural and social sector
from financial year 2007-08 to financial year 2009-10.
16

Mutual Funds
Investments in ADRs/ GDRs/ Foreign Securities and overseas Exchange Traded
Fund (‘ETF’)

The Securities and Exchange Board of India (‘SEBI’) has vide its circular in May
2007 made the following changes pertaining to investments in ADRs/ GDRs and
Foreign Securities by mutual funds :

• The aggregate ceiling for the mutual fund to invest in ADRs/GDRs issued by
Indian companies, equity of overseas companies listed on recognized stock
exchanges overseas, and rated debt securities raised from USD 3 billion to
USD 4 billion. The investment is permitted with a sub-ceiling for individual
mutual funds which should not exceed 10 percent of the net assets managed
by them as on March 31 of each relevant year, subject to a maximum of USD
200 million per mutual fund.

The SEBI has further vide its circular in September 2007 made the following
changes pertaining to investments in ADRs/ GDRs and Foreign Securities by
mutual funds:

• The aggregate ceiling for the mutual fund to invest in ADRs/GDRs issued by
Indian or foreign companies, equity of overseas companies listed on
recognized stock exchanges overseas, rated debt securities and derivatives
traded on overseas recognized stock exchange raised from USD 4 billion to
USD 5 billion. The investment is permitted with a sub-ceiling for individual
mutual funds to a maximum of USD 300 million.

The other conditions with respect to the investments in ADRs/GDRs/Foreign

Securities and overseas ETF remain the same.
17

Parking of Funds in Short-Term Deposits of Schedule

Commercial Banks by Mutual Funds- Pending deployment

The SEBI has vide its circular in April 2007/October 2007, issued the following
guidelines for parking of funds in short-term deposits (short-term shall be treated
as a period not exceeding 91 days/raised to 182 days in case deposits are placed
as margin for trading in derivatives) of scheduled commercial banks pending
deployment. The guidelines provide that, no mutual fund shall park more than-

• 15 percent of the net assets in short-term deposit(s) of all the scheduled

commercial banks put together. It may be raised to 20 percent with prior
approval of the trustees.
• 20 percent of total deployment by it in short term deposits.
of associate and sponsor scheduled commercial banks
• 10 percent of the net assets of its scheme in short term deposit(s), with any
one scheduled commercial bank, including the banks subsidiaries

Also, no funds can be parked by a scheme in a bank which has invested in that
scheme.
18

Real Estate InvestmentTrusts (REITs)

SEBI has issued the draft regulations on Real Estate Investment Trusts (REITs) in
December 2007, yet to be enacted.

The draft regulation lays the procedures for administering REITS and the
compliance requirements of the Trustee, AMC, etc

REITs means a trust registered under the Indian Trusts Act, 1882 and registered
with SEBI under these regulations, whose object is to organize, operate and
manage real estate collective investment.

REIT’s needs to float schemes which are close ended schemes and which are
appraised by an appraising authority. Further, the schemes are prohibited from
investing in vacant land or property development activities.

It has also been proposed that the schemes would be required to distribute
atleast 90 percent of its net income after tax as dividends each year to unit
holders.

Click here for more details.

Short Selling
SEBI has vide its circular in November 2007 provided that a mutual fund can
engage in short selling of securities as well as lending and borrowing of securities
as per framework to be specified by the SEBI.

Index Fund Scheme

SEBI has introduced Index Fund schemes vide its circular in November 2007.
‘Index fund scheme’ means a mutual fund scheme that invests in securities in the
same proportion as an index of securities;”
19

Waiver of entry load for direct applications

Effective 4 January 2008, investors who apply directly for schemes of mutual
funds, without routing the application through any distributor/agent/broker, via
Internet to the AMC or collection centre/Investor Service Centre would avoid
entry load.

Also, they will forgo an entry load if they transact directly for additional purchases
under the same folio and switch-in to a scheme for other schemes.

Removal of charging of initial issue expenses by close ended

schemes to the investors
SEBI has vide its circular in January 2008 provided that close-ended schemes of
mutual fund launched after 31 January 2008 will have to meet the sales,
marketing and other such expenses connected with sales and distribution of
schemes from the entry load. These schemes can neither charge nor amortise
the initial issue expenses.

Investors will now find such schemes more cheaper and will probably have more
clarity and transparency on expenses charged to them.
20

NBFCs
Ceiling on rate of interest
In April 2007, the RBI revised the rate of interest payable on public deposits by
NBFCs (including chit fund companies, other than residuary non-banking financial
companies) to12.5 percent from the existing 11 percent per annum taking into
account the market developments. This is the maximum permissible rate an NBFC
can pay on its public deposits and they may offer lower rates. This new rate of
interest applies to fresh public deposits and renewals of matured public deposits.

Corporate Governance
In May 2007, the RBI issued proposed guidelines on corporate governance in
order to enable NBFCs to adopt best practices and greater transparency in their
operations. Emphasis had been placed on formation of an audit committee,
constitution of risk management committee and compliance with the instructions
on connected lending relationships. Further, in July 2007, the RBI issued a
notification stating that the guidelines on ‘connected lending’ were being re-
evaluated. Apart from these, all other instructions issued earlier had to be
complied with.

Declaration of Net Asset Value of Security Receipts

In May 2007, the RBI issued guidelines on declaration of net asset value of
security receipts issued by securitisation companies / reconstruction companies at
periodical intervals in order to enable the Qualified Institutional Buyers to know
the value of their investment.

Overseas Presence
NBFCs will now need to also meet additional conditions before they are allowed
to set-up subsidiary/JV/representative office abroad or invest abroad. In this
regard, the banking regulator, Reserve Bank of India has issued draft guidelines on
24 January 2008 to be complied by an NBFC besides the extant ones.

An NBFC that intends overseas presence could adopt any of the following four
options i.e. Subsidiary, Joint Venture, other Investments and Representative
office. As a general policy, NBFCs would not be allowed to set up branches
abroad. Overseas existing branches of NBFCs would need to comply with the
proposed guidelines.

Click here for the flash news

21

Mortgage Guarantee Companies (‘MGC’)

Based on the proposals for the Union Budget 2007-08, the RBI had issued draft
guidelines in January 2008 and notified a Mortgage Guarantee Companies
(‘MGC’) as a NBFC. Further in January 2008, the RBI also issued draft guidelines
on the registration and operation of a MGC, which were to be complied by every
NBFC carrying on mortgage guarantee business. In February 2008, RBI issued the
final guidelines on the registration and operation of a MGC. Along with the final
guidelines, the RBI also issued prudential norms for MGCs on:

- Income recognition
- Asset classification
- Accounting standards
- Provisioning requirements

The RBI has also issued Mortgage Guarantee Companies Investment (Reserve
Bank) Directions in February 2008, basically covering directions in relation to:

- Investment policy of MGC and pattern of investment

- Income recognition
- Accounting of investments

Click here for the flash news

22

Portfolio Manager
Renewal of Certificate of Registration
A portfolio manager can function only under a Certificate of Registration issued by
SEBI which is valid for three years from the date of its issue. Renewal application
has to be made three months before the expiry of the validity of the certificate.

In May 2007, SEBI clarified that where the renewal application is not received by
the expiry date of the registration certificate, the portfolio manager will cease to
be as such and will immediately stop carrying on portfolio manager activities from
the date of such expiry. The portfolio manager can either transfer the business to
another SEBI registered portfolio manager or allow the client to withdraw the
securities and funds in its custody at the option granted to each client separately.
Similar treatment would be in case SEBI refuses to grant renewal.

Renewal application made after expiry of registration will be considered as fresh

application for registration.

Portfolio manager will stop taking any fresh business/clients from the date of
expiry of registration if renewal application is made less than three months before
the expiry and SEBI has not advised otherwise by the date of expiry of
registration.

A portfolio manager can surrender the registration voluntarily before its expiry by
intimating the existing clients about the same at least one month in advance
before requesting for surrender of certificate to SEBI.

Draft SEBI (Investment Advisers) Regulations, 2007

There was always an ambiguity on whether an Investment Advisory Company,
establishing itself in India, was required to register under SEBI (Portfolio
Managers) Regulations, 1993.

To resolve this ambiguity, in October 2007, SEBI released draft “Investment

Adviser Regulations”, under which an Investment Adviser will be required to obtain
a Certificate of Registration from SEBI to commence or continue the said
business.

Click here for the key features of the draft regulations

23

Venture Capital Funds

Overseas Investments by Venture Capital Funds
In August 2007, the SEBI allowed registered Venture Capital Fund (VCFs) to invest
in equity and equity-linked instruments only of off-shore venture capital
undertakings (‘off-shore VCUs’) subject to an overall limit of USD 500 million. The
key provisions are:

• VCFs, desirous of making investments in off-shore VCUs need to apply in the

specified format to the SEBI for its prior approval. No separate permission
from the RBI is necessary in this regard.
• Such investments would be made only in those VCUs who have an Indian
connection (i.e. company which has a front office overseas, while back office
operations are in India) and up to 10 percent of the investible funds of a VCF.
• The SEBI would allocate investment limits on ‘first come- first serve’ basis,
depending on the availability in the overall limit of USD 500 million.

This allowance is subject to the Foreign Exchange Management (Transfer or issue

of any foreign security), regulations, 2004 being amended. The amendment to
these regulations is yet to be made.
24

Securitisation
Declaration of Net Asset Value
For enabling the Qualified Institutional Buyers to know the value of their
investment in the Security Receipts, the RBI has issued guidelines to registered
Securitisation Company / Reconstruction Company (‘SC / RC’) requiring them to
declare Net Asset Value of the Security Receipts issued by them at periodical
intervals.

Guidelines to Securitisation Companies and Reconstruction

Companies
In July 2007, the RBI has issued guidelines and directions to SC / RC relating to
registration, owned fund, permissible business, operational structure for giving
effect to the business of securitisation and asset reconstruction, deployment of
surplus funds, internal control system, prudential norms, disclosure requirements,
etc.
25

Foreign Exchange Management

External Commercial Borrowing (ECB)

Modification of ECB policy

Effective 7 August 2007, ECB in excess of USD 20 million is allowed only for
meeting foreign currency expenditure.

ECB up to USD 20 million is allowed for meeting rupee and foreign currency
expenditure.

Click here for more details.

All-in-cost ceilings
Effective 21 May 2007, the revised the all-in-cost ceilings for ECB are:

All in cost ceiling over 6 months LIBOR

Average Maturity Period
Existing Revised

3-5 years 200 basis points 150 basis points

More than 5 years 350 basis points 250 basis points

Prepayment of ECB
Effective 26 September 2007, ECBs upto USD 500 million can be prepaid without
prior approval of the RBI, subject to conditions. The earlier limit, effective 30 April
2007, was USD 400 million.

End use restriction

Effective 21 May 2007, ECB cannot be used also for development of integrated
township.
26

Overseas investments

Liberalisation

Overseas Direct Investments (ODI) were further liberalised and rationalised as

under:

i. Enhancement of limit for ODI:

• effective 14 June 2007 - from 200 to 300 percent of networth of the
investing company; and
• effective 26 September 2007 - from 300 to 400 percent of networth of the
investing company.

ii. Enhancement of limit for portfolio investment by listed Indian companies:

• effective 14 June 2007 from 25 to 35 percent of networth; and
• effective 26 September 2007 from 35 percent to 50 percent of networth.

Further, the requirement of a reciprocal 10 percent share holding in Indian

companies has been done away with effect from 26 September 2007.

iii.Guarantees issued by an Indian party to or on behalf of the JV/WOS are to be

reckoned at 100 percent of the amount of guarantees effective 14 June 2007
(limit enhanced from 50 percent).

Click here for more details.

Liberalisation in the hedging of ODI by residents

Resident entities having ODI are permitted to hedge the consequent exchange
risks by entering into forwards and options with banks. Earlier, one could only
deliver or roll over such contracts on the due date.

Effective 19 June 2007, one could also cancel such forward contracts. Further, 50
percent of the cancelled contracts may be allowed to be rebooked.

Shares acquired in exchange

Acquisition of shares in a foreign company by an Indian party in exchange of issue
of ADRs/GDRs, will be considered as ODI and be subsumed under the limit
stipulated for such ODI.
27

Pledge of shares
Indian parties can also transfer shares held in overseas joint venture/ wholly
owned subsidiary (JV/ WOS) by way of pledge to an overseas lender for availing
overseas fund based and non-based facilities.

This is subject to the condition the overseas lender is regulated and supervised as
a bank and the total commitments of the Indian party are within the stipulated
limits.

Convertible instruments
The Ministry of Finance issued revised guidelines to the effect that from 1 May
2007, investment by way of only fully convertible preference shares would be
treated as part of share capital.

Foreign investment by way of any other type of preference shares (non-

convertible, optionally convertible or partially convertible) would be considered as
debt and would be in conformity with ECB guidelines and caps.

Click here for further details

It has also been clarified that effective 8 June 2007, debentures that are fully and
mandatorily convertible into equity within specified time would be reckoned as a
part of equity under foreign direct investment (FDI) scheme of the Government of
India.

Acquisition under open offers etc.

Effective 24 May 2007 non-resident corporates can open escrow accounts
without prior approval of RBI for acquisition/transfer of shares/convertible
debentures via open offers/delisting/exit offers, subject to applicable guidelines.

Issue of shares
Effective 29 November 2007, Indian companies are required to issue
shares/convertible debentures within 180 days from the date of receipt of the
inward remittance or date of debit to NRE/FCNR(B) account.

If shares are not issued within such period, the funds will have remitted back to
the concerned person, unless RBI specifically permits a longer tenure.

Rupee loans for share purchase under ESOP

Effective 22 August 2007, non-resident Indian (NRI) employees of Indian
companies can avail rupee loan for acquiring shares of companies issued under
employee stock option plans (ESOP), subject to certain terms and conditions.
28

Purchase of securities

Foreign Central Banks are permitted to purchase securities, other than shares or
convertible debentures, of an Indian company and government securities in
secondary market, subject to stipulated terms and conditions.

Investment in stock/ commodity exchanges

Effective 30 January 2008, foreign investment in Indian stock / commodity
exchange is allowed up to 49 percent, which includes 26 percent in the form of
FDI and 23 percent in the form of foreign institutional investment (FII) / portfolio
investment. The cap for holding by a single investor is 5 percent.

Exporters
Effective 6 October 2007, it is possible for exporters to earn interest on EEFC
accounts to the extent of outstanding balances of US $ 1 million per exporter. RBI
has allowed this as purely a temporary measure and valid upto 31 October 2008
and would be subject to further review.

Exporters are thus allowed to maintain outstanding balances to the extent of US $

1 million in the form of term deposits up to one year maturing on or before 31
October 2008. The rate of interest payable on such deposits has been left to the
discretion of the banks.

Enhancement of corporate remittance limits

Effective 30 April 2007, an Indian company can remit, without prior approval:
• up to 5 percent of the investment made or USD 100,000, whichever is higher
as reimbursement of pre-incorporation expenses incurred in India (limit
enhanced from USD 100,000).
• in respect of infrastructure projects executed by the company, any sum up to
USD 10 million per project (limit enhanced from USD 1 million).
29

Surrender of foreign exchange

Effective 14 November 2007, individual Indian residents are obliged to surrender
received/ realised/ unspent/ unused foreign exchange to the authorised person
within 180 days from such receipt/ realization / purchase/ acquisition or date of his
return to India.

Limit for overseas remittance for resident individuals

enhanced
Existing limit for resident individuals for making overseas remittances have been
enhanced as under:
• Effective 8 May 2007 – from USD 50,000 to USD 100,000 per financial year
(April - March).
• Effective 26 September 2007 - from USD 100,000 to USD 200,000 per
financial year

The limit applies to any permitted current or capital account transaction or a

combination of both.

Operation of non-resident ordinary (NRO) accounts

Effective 25 May 2007, a non resident individual account holder can authorize any
resident individual to operate (i.e, for making local payments and remittance
outside India to account holder) his/ her NRO account by executing a power of
attorney.
30

Glossary

American Depository Receipt ADR

Asset Management Company AMC

Bank Holding Companies BHC

Cash Reserve Ratio CRR

Central Board of Direct Taxes CBDT

Chief Executive Officer CEO

Clearing Corporation of India CCI

Collateralised Borrowing and Lending

CBLO
Obligations

Commodities Transaction Tax CTT

Employee Stock Option Plans ESOP

Exchange Traded Fund ETF

Export Earners Foreign Currency EEFC

External Commercial Borrowing ECB

Financial Holding Companies FHC

Financial Institution FI

Foreign Currency Exchangeable Bonds FCEB

Foreign Direct Investment FDI

Foreign Institutional Investment FII

Global Depository Receipt GDR

Insurance Regulatory Development

IRDA
Authority

Irrevocable Payment Commitments IPC

Managing Director MD

Mortgage Guarantee Companies MGC

Non-banking Financial Company NBFC

One time settlement OTS

Overseas Direct Investment ODI

Permanent Account Number PAN

31

Perpetual Cumulative Preference

PCPS
Shares
Perpetual Non-cumulative Preference
PNPS
Shares

Public Sector Undertaking PSU

Qualified Institutional Buyers QIB

Real Estate Investment Trust REIT

Reconstruction Company RC

Redeemable Non-cumulative
RNPS
Preference Shares

Regional Rural Banks RRB

Scheduled Commercial Bank SCB

Securities Transaction Tax STT

Securitisation Company SC

Short Term Capital Gains STCG

Statutory Liquid Ratio SLR

Tax Collection at Source TCS

Tax Deduction at Source TDS

The Reserve Bank of India RBI

The Securities and Exchange Board of

SEBI
India

Venture Capital Fund VCF

Venture Capital Undertaking VCU

 in.kpmg.com

KPMG in India KPMG Contact

Mumbai Sanjay Aggarwal
KPMG House, Kamala Mills Compound Nationa Industry Director
448, Senapati Bapat Marg, Financial Services
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Mumbai 400 013 e-Mail: saggarwal@kpmg.com
Tel: +91 22 3989 6000
Fax: +91 22 3983 6000 Naresh Makhijani
Executive Director
Delhi Tel: +91 22 3983 5703
4B, DLF Corporate Park e-Mail: nareshmakhijani@kpmg.com
DLF City, Phase III
Gurgaon 122 002 Pradeep Udhas
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