An offshore investment fund that appoints an Indian fund manager must consider two connected questions: whether the manager’s activities in India could expose the fund to Indian taxation, and whether the remuneration paid to the manager satisfies the arm’s length principle. Section 9A of the Income-tax Act, 1961 addresses the first concern through a safe harbour for eligible investment funds. However, access to this protection is conditional, and the arm’s length nature of the fund manager’s remuneration is an important requirement.
Section 9A: The Safe Harbour Framework
Section 9A provides that an eligible investment fund will not be regarded as resident in India merely because its fund manager undertakes fund management activities from India or because of the manager’s control and management of the fund, subject to the prescribed conditions.
This framework enables offshore funds to access investment management expertise in India without automatically creating adverse tax residency consequences. However, the protection is not unconditional. The fund must satisfy the applicable eligibility requirements, including conditions relating to its investor base, activities and remuneration arrangements.
The Arm’s Length Remuneration Requirement
One of the key conditions is that the Indian fund manager receives remuneration for its fund management activities at an arm’s length level. The fee cannot simply be determined by mutual agreement between associated enterprises. It must be supported by an analysis of the functions performed, assets employed and risks assumed by the manager.
The remuneration should reflect the actual scope of services and the responsibilities undertaken. A fee that does not adequately compensate the manager, or one that cannot be supported through a transfer pricing analysis, may put the availability of the safe harbour at risk.
Evaluating Management Fees and Performance-Based Returns
Fund managers commonly receive a management fee calculated with reference to committed or invested capital. In certain structures, they may also receive a performance-linked fee or carried interest based on the fund’s returns.
These components should be examined separately where their underlying drivers differ. Benchmarking should consider the fund’s investment strategy, size, structure and the nature of services provided. The analysis should also account for the manager’s responsibilities, including investment research, portfolio monitoring and risk oversight.
Where the manager contributes capital, assumes meaningful commercial exposure or performs additional functions, these factors may also be relevant to the remuneration analysis.
Allocating Functions Between Offshore and Indian Teams
Some fund structures involve an offshore manager responsible for investment decisions and an Indian entity providing research, deal sourcing or execution support. The allocation of remuneration should reflect the actual division of responsibilities.
The analysis should identify who evaluates investment opportunities, approves transactions, has authority to commit the fund and monitors investment performance. If the Indian team effectively exercises investment decision-making authority despite being described contractually as an adviser, the arrangement may require closer examination, including from a business connection perspective.
Documentation and Ongoing Monitoring
The fund and manager should maintain the investment management agreement, functional analysis, benchmarking study and records identifying the individuals responsible for investment approvals. These documents should be consistent with the actual conduct of the parties.
Eligibility under Section 9A should also be reviewed periodically. Changes in investor composition, fund activities or management arrangements may affect compliance with the applicable conditions.
Conclusion
For offshore funds managed from India, the arm’s length fee is both a transfer pricing requirement and an important element of the Section 9A safe harbour. A defensible arrangement requires properly benchmarked remuneration, a clear allocation of responsibilities between offshore and Indian teams, and regular monitoring of the conditions governing the fund’s eligibility.
