Tax on FPIs: Relief to less volatile investors not easy — here’s why

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Updated: July 16, 2019 7:05:42 AM

FPIs remained net buyers in most part of 2019, having bought shares and local papers worth $13.08 billion so far this year. This compares with last year’s sale of $4.6 billion in equity and $6.7 billion in bonds.

FPI surcharge, FPI, FPI Tax, volatile investor, economy news, post tax returns,  tax returns, FPI full formIn a trust structure, it is easy for investors to move capital in and out of trusts without paying high taxes.

While there is a thinking in some sections of the government that FPIs with investors not focused on profit maximisation could be exempted from the proposed higher surcharge on the super rich, tax experts have doubted the feasibility of the move. It would be difficult to define a special dispensation linked to the nature of beneficiary investors, as most India-focused funds are open-ended ones, where the investors keep changing, experts noted.

According to an official source, the matter was discussed among the finance ministry officials, the CBDT and the Sebi last week. The source, however, added the meeting was of a preliminary nature and there was no concrete proposal on the table right now. It hasn’t even been decided whether to give any relief from the proposed surcharge hike to any category of investors, the source added.

Sources said even though the FPI community is lobbying for withdrawal of the extra tax on the investors, which use the convenient trust structure to invest in Indian financial markets, they are unlikely to pull back unless other determinants like corporate earnings here and the fundamentals of the Indian economy compared with other nations also tend to turn worse.

FPIs remained net buyers in most part of 2019, having bought shares and local papers worth $13.08 billion so far this year. This compares with last year’s sale of $4.6 billion in equity and $6.7 billion in bonds.

The Budget proposal to impose a higher surcharge on the super rich — also applicable on capital gains made by FPIs so long as they use the preferred trust route — is believed to have an effect on at least a third of the FPIs with exposure to India’s equity, debt and hybrid instrument markets.

FPI surcharge, FPI, FPI Tax, volatile investor, economy news, post tax returns,  tax returns, FPI full form

The proposal to raise the surcharge on categories of taxpayers with income above Rs 5 crore by 22 percentage points would mean that post-Finance Act 2019, the long-term capital gains tax on FPIs using the trust structure would effectively be 14.25% against 12% now; short-term gains would rise to 21.4 % from 17.9%.

“I don’t see how the tax authorities can make that distinction (of exempting FPIs with pension/retirement funds, educational endowment funds, etc, as investors from the extra tax). Most of the FPIs that are trusts, especially the ones from the US, are open-ended mutual funds whose beneficiaries could constantly be changing. Conceptually, what would be the rationale for making such a distinction based on investor profile? Why should the tax treatment in India be different if, say, the beneficiaries are endowments or foundations or individuals? The moot point is whether the law should at all be making a distinction in the context of FPIs based on how they are legally formed given that their formation as a corporate or non corporate in the first instance was not driven by tax considerations,” said Subramaniam Krishnan, partner, private equity & financial services at EY India.

According to another tax expert, who doesn’t wish to be identified, “It is not normally possible to identify the beneficiaries of the trust… Where one can make distinction between FPIs which are largely made up of pension and sovereign funds and those that are not, then one could look at exempting the (former).”
FPIs register as private trusts partly to address the various disclosure rules and other compliance requirements. If structured as a corporate fund, they require to pay a minimum alternate tax of 18.5% on their returns and an additional 20% as dividend distribution tax.

In a trust structure, it is easy for investors to move capital in and out of trusts without paying high taxes. Even after the tax increase proposed in the recent Budget, the trust structure could still remain to be more tax-efficient for many investors. The government, on the other hand, believes that that trust route is opaque and it is used by many volatile investors to escape compliance rules and increase the post-tax returns.

“The hike in surcharge has created an arbitrage between corporate and non-corporate funds. A fund chooses to organise itself either as a corporate, LLP or a trust depending on various factors, including alignment with their home countries. For instance, almost all mutual funds are structured as trusts and nearly half the trusts are non-corporates,” Krishnan said.

Daksha Baxi, head of international tax at Cyril Amarchand Mangaldas, however, said the argument that a tax arbitrage has been created between a corporate and trust fund might not be entirely correct. Such arbitrage was always there, she said. Earlier, the surcharge for funds organised as trusts or AOPs was 15% against 2% or 5% for those organised as corporates. Baxi added that if resident HNIs and private trusts are paying high surcharge, it does not seem unfair that the FPIs organised as trusts or AOPs should also pay such high surcharge. Experts pointed out,it was primarily the indeterminate trusts — beneficiaries and individual shares not expressly stated — that would attract the higher tax.

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