FPI tax stays; no threat of investor flight, says FM Nirmala Sitharaman

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Updated: July 19, 2019 6:57 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.

Lok Sabha, Finance Bill 2019, Finance Bill 2019 passed, Finance Bill,investor flight, Finance minister, Nirmala Sitharaman, FPI, pension, retirement funds, educational endowment fund, taxFinance minister Nirmala Sitharaman (File/ Agencies)

Finance minister Nirmala Sitharaman on Thursday declined to remove or relax the applicability of the new surcharge on the super rich on foreign portfolio investors (FPIs), but advised those staring at an increase in tax outflows to shift to the corporate structure where the Budget hasn’t made any change in tax treatment.

Tax experts, however, said such a shift by FPIs using the trust structure would have been easier if the government had given them a one-time waiver from capital gains tax. Since many of these ‘Trust FPIs’ may also have considerable unrealised gains, the tax cost of conversion could dissuade them, the experts warned. Also, they said, such conversion might not be structurally possible in many jurisdictions from where the FPIs, which typically invest in India, operate.

“If the FPIs are registered as companies, they don’t have the problem of higher surcharge on income tax. When it (FPI) is registered as a trust, which is treated as a taxable entity and therefore, as an individual entity, (it) comes under taxation. Many of our officials have also been (saying) that such FPIs who have registered themselves as trusts may consider the option of registering as a company,” the minister said in the Lok Sabha, replying to the discussions on the Finance Bill. The minister asserted that the fear of flight of capital as a result of the move was “not well-founded”.

More than a fifth of the FPIs investing in India equity, debt and hybrid instruments use the trust route. The Bill was later passed by the lower House.

With the surcharge on categories of taxpayers with income above `5 crore rising by 22 percentage points, long-term capital gains tax on FPIs using the trust structure would now be 14.25% against 12% earlier; short-term gains would rise to 21.4% from 17.9%.

FPIs, including pension and retirement funds, educational endowment fund, etc, come in through trusts route because it has been the most tax-efficient structure. Typically, a corporate fund would have to pay MAT at over 18.5% and an additional 20% as dividend distribution tax. Despite the hike in surcharge, FPIs might find the trusts still the least taxing structure, although the post-tax returns in the hands of the foreign investors could fall. Given that emerging market like India provide better returns, most Trust funds could continue to invest in India; they would pull back only if other determinants like corporate earnings here and the fundamentals of the Indian economy compared with other nations also tend to turn worse.

“This (the advice to FPIs to convert to corporate structure) is likely to disappoint FPIs because it’s not easy to restructure global funds only for Indian tax reasons. The government doesn’t seem to appreciate that just as our mutual funds are formed as trusts because regulations require so, in various countries, funds are set up as trusts because of home-country regulations, industry practice and commercial reasons, and not because they saw an advantage in India earlier,” said an analyst. He said a uniform rate for all FPIs because corporate or non-corporate status is entirely a home country creation.

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.

Sitharaman mooted a host of amendment to the Bill before it was put to voice vote. She clarified that only gift paid by a resident as money to a non-resident would be deemed to arise in India, even when the act of gifting occurs outside India. It has now been clarified that the ‘gift’ in the law pertains to money and not immovable property.

While the government had earlier exempted start-ups from angel tax contingent on the firms fulfilling certain condition, the amendment to Finance Bill, 2019, seeks to penalise the firms that violate such conditions by imposing claw-back clause in the law. Angel tax refers to the taxability of the amount which is the difference between the consideration received from issue of share and the fair market value of such shares.

“If a start-up claims exemptions from angel tax but subsequently buys, say, a motor vehicle, in contravention to the condition of notification issued by the DPIIT, it shall be liable to pay angel tax and 200% penalty on the tax sought to be evaded,” Naveen Wadhwa, DGM, Taxmann, said.

Further, while the Bill initially exempted a category III alternate investment fund (AIF) investing on an exchange in an International Financial Services Centre from capital gains tax only if all the investors in the fund were non-residents, the waiver will be available to such funds even with resident investors on board, but only to the extent that gains are in respect to units held by non-residents. “The amendment recognises the fact that a resident sponsor or fund manager located at IFSC or elsewhere in India would also be required to hold investments in the fund. Hence, reacting to industry demand, it is now proposed to exclude such resident investors for the fund to qualify for capital gains exemption,” a tax expert said.

On the proposed 2% TDS on cash withdrawal exceeding Rs 1 crore in a year, the minister said that if a person maintains more than one account with the same bank, the bank is required to aggregate the withdrawals made from all such accounts to compute the threshold. “This amendment plugs the loophole only partially as a person can maintain various accounts with different banks and withdraw less than Rs 1 crore from each such bank to avoid the TDS,” said Rakesh Nangia, managing partner at Nangia Advisors (Andersen Global).

Sitharaman also told Parliament that the amendment to the RBI Act, proposed in the Finance Bill, was meant to enable the central bank’s powers to effectively regulate Non-banking financial companies (NBFCs). The Budget also empowers the RBI to regulate housing finance companies (HFCs), replacing National Housing Bank, which will remain only a re-financier to the HFCs. A day after presenting the Budget, the finance minister had said the crisis in the shadow-banking sector seemed to have bottomed out even though woes of some players still persisted.

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