[Economy] Infrastructure Debt Funds (IDF), Withholding Tax, EPFO Angle: Meaning, Concept, Explained

1. What is Infrastructure?
2. Why is Infrastructure important?
3. What is the problem with Infrastructure?
4. What is problem with Banks?
5. Mechanism of Infrastructure Debt Fund
6. Attracting investors
7. What is withholding Tax?
8. First IDF
9. Why EPFO interested in Infra-Debt Funds?

What is Infrastructure?

Things that are essential for functioning of economy: roads, sea-ports, airports, railways, metro rail, electricity-generation etc.

Why is Infrastructure important?

• GDP=Money value of all goods and services produced in a country within a year.
• If there is shortage of electricity, factory owners cannot produce lot of mobilesets, TVs, refrigerators. = Production of goods decreases.
• If there is shortage of electricity, hospitals cannot carryout X-ray, CAT-scan etc. = Production of services decreases.
• Therefore, good quality Infrastructure is essential for achieving high GDP growth (9%).

What is the problem with Infrastructure?

• Government estimates that one trillion dollars will be required in next 5 years to finance all the important infrastructure projects.
• But Government cannot finance all those projects by itself. Because they’re already spending lot of money on Food-Fertilizer subsidies, MNREGA, Air-India etc.
• Government cannot merely print more suitcases full of money to finance these infrastructure projects, else it’ll create inflation. click me to know why
• If Government borrows money from public, to finance these infrastructure projects, else it’ll severe the problem of fiscal deficit.
• So, Government wants 50% of that required money to come from private sector (banks, domestic and foreign investors.)

What is problem with Banks?

• Such infrastructure projects require long-term funding for 20-25 years, but banks are already ‘exposed’ to too much risk (loans given to 2G players, Vijay Mallya etc.) In the present situation, banks are unable to finance infrastructure projects for more than 5-7 years time-frame.
• Hence, there is need to channel money from the hands of investors into infrastructure projects. (+ also need to reduce investment in Gold, because it increases current-account-deficit.)
• To achieve this, Government has come up with new idea = Infrastructure Debt Funds.

Mechanism of Infrastructure Debt Fund

You already know about Debt Vs Equity, Shares vs Bonds, if not click ME
In technically-not-so-correct term, Infrastructure Debt Fund (IDF) essentially means that

1. You invest money in an IDF company.
2. IDF company lends your money in some Infrastructure project company (as Debt).
3. That infrastructure project company pays interest rate to IDF Company.
4. IDF company gives that interest money to you. (after cutting its commission). Thus you make profit on your investment.

Tax Policy to Attracting investors

By merely allowing creation Infra Debt Funds, Government cannot bring in the investment in infrastructure projects.
Government also needed to give some benefit (carrots) to lure the investors.
Finance Minister has given two carrots

1. Withholding Tax reduced from 20% to 5% (for foreign investors)
2. Money earned from IDF is exempt from income tax. (for desi investors)

What is withholding Tax?

• Suppose a non-resident (foreigner), lends money to an Indian company and earns Rs.100 interest per year.
• Earlier he was supposed to pay Rs.20 to the Government, but from now onwards only Rs.5
• It is called withholding tax, because he (foreigner) doesn’t need to pay the tax himself, but the company who borrowed money, is required to ‘withhold’ it and give money to Government.
• Example you (foreigner) loaned me (Indian company) some money. On 1^st December, I’m supposed to pay you Rs.100 as interest, but I’ll give you only Rs.95, and put aside Rs.5 and send it to Government as ‘withholding tax’.
• Since Government reduced withholding tax from 20% to 5%, that mean you (foreign investor) can earn more money, so this way Government has tried to seduce the foreign investors, into investing in Infra-Debt Fund in India.

First Infra-Debt Fund of India

• The first IDF-fund of India, was setup by a consortium (gang) of ICICI, BoB, Citi bank and LIC.
• This entity will work as a Non-Banking Finance Company (IDF-NBFC), and hence they’ll come under the jurisdiction of RBI.
• They could have set it up as a mutual fund company, but then they’d have come under the jurisdiction of SEBI.

Anyways, shareholding pattern is

Member	%
ICICI	31
Bank of Baroda	30
Citi Bank	29
LIC	10
Total	100%

^there is no need to mugup, this is just for information.
We can speculate that near future, SBI will also come up with something like this, to counter ICICI.

Why EPFO interested in Infra-Debt Funds?

Problem with EPFO

• Employees’ Provident Fund Organization (EPFO) takes money from people, invests it shares and bonds, earns money and pays it to the EPFO subscribers. (After cutting its commission).
• Central Board of Trustees= the decision making body of EPFO. It is headed by Labour minister.
• They’ve made rule : EPFO must invest in Government-securities (G-sec) and companies AAA credit rating only.
• Problem: Most companies don’t have AAA-rating, so EPFO is forced to park majority of its money in Government-securities (G-sec).
• Recall the concept of Gilt-edged securities (click me). Government/ treasury bonds are more ‘reliable’, hence, they pay less interest. (because they don’t need to seduce investors by offering higher interest rate, unlike some junk bond company with “C” or “D” credit rating.)
• So, ultimately problem for EPFO managers= G-sec doesn’t pay much interest. (Around 8% only).
• While New Pension Scheme (NPS) managers, invests in many other places, including risky bonds, and make around 12% profit.
• If things go on as usual, then in long term, people might switch from EPFO to NPS and other various pension-provident-retirement policies offered by private firms like Max Life insurance, Bajaj Alliance, Kotak Mahindra etc. to get better deals.

Solution

• Therefore, EPFO wants to invest money in Infrastructure Debt Funds (IDF) to earn more profit to give better ‘return-on-investment’ to its subscriber. It is looking forward to invest about 5 lakh crores in IDF funds.
• But newly formed Infrastructure Debt Funds (IDF) companies will not get AAA credit rating immediately. So EPFO needs approval from Central Board of trustees to modify the investment rules. And since Central Board of Trustees, is headed by labour minister so essentially EPFO needs approval of Labour Ministry.

Mock Questions

Q1. Regarding Infrastructure Debt Funds (IDF) in India

1. The first IDF fund was setup by State Bank of India (SBI)
2. IDF is exempted from Withholding tax.

Which of above is/are correct?

1. Only 1
2. Only 2
3. Both
4. None

Q2. Find Incorrect Statement

1. The apex decision making authority for EPFO rests with the Finance Minister of India.
2. Withholding tax is an example of Indirect Tax

1. Only 1
2. Only 2
3. Both
4. None

Q3. Which of the following fund receives the proceeds from disinvestment?

1. Infrastructure Debt Fund
2. Consolidated fund of India
3. National Investment Fund

1. Only 1
2. Only 2 and 3
3. Only 1 and 2
4. Only 3