The proposed move of treating income arising from transactions conducted by FPIs as capital gains, rather than business income that attracts higher taxes, would help remove uncertainties related to characterisation of their income and encourage their fund managers to shift to India.
"FPIs have invested more than Rs 8 lakh crore (about USD 130 billion) in India. One of their concerns is uncertainty in taxation on account of characterisation of their income," Finance Minister Arun Jaitley said while presenting the union budget for fiscal 2014-15.
"Moreover, the fund managers of these foreign investors remain outside India under the apprehension that their presence in India may have adverse tax consequences.
"With a view to put an end to this uncertainty and to encourage these fund managers to shift to India, I propose to provide that income arising to foreign portfolio investors from transaction in securities will be treated as capital gains," he said.
FPIs are a newly created category of foreign investors and encompass all existing structures like foreign institutional investors (FIIs), their sub-accounts and qualified foreign investors (QFI).
This new regime came into force on June 1. Existing overseas investor classes such as FIIs, subaccounts and QFIs are in process of converting themselves into FPIs.
The new liberal regime divides FPIs into three categories as per their risk profile and the KYC (Know Your Client) requirements.
To treat income from FPI as capital gains, the government has said amendments would be made to norms governing FPIs with effect from April 1, 2015.
Under the proposed amendments, any security held by FII which would be treated as capital asset only so that any income arising from transfer of such security by FPI would be in the nature of capital gain.
As per norms, there are no tax on long term capital gains while short term capital gains are taxable at the rate of 15 per cent.