FPIs excluded from purview of MAT; GAAR deferred till 2017; foreign investment allowed in AIFs
In a bid to attract continued participation from foreign portfolio investors (FPIs) in India’s capital markets, the government on Saturday excluded foreign funds from the purview of minimum alternate tax (MAT) on their capital gains income and also deferred the General Anti-Avoidance Rules (GAAR) by two years. The Budget allowed foreign investment in alternative investment funds (AIFs) and proposed to allow tax pass-through to category I and category II AIFs. The move brings much needed clarity to private equity firms since capital gains will not be taxed at the level of the fund and will be passed on to investors. The proposal hopes to create a level playing field for domestic private equity firms vis-a-vis their foreign counterparts.
The NDA-government’s first full-year Budget also proposed to modify the permanent establishment (PE) norms with an aim to bring foreign fund managers, especially of Indian origin, to India.
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Corporate lawyers and experts on international law hailed the FM’s proposals aimed at greater FPI participation. “Clarification that FPIs will not be liable to pay MAT is a welcome clarification and will remove the uncertainty surrounding recent tax notices to FPIs asking them to pay MAT. Deferment of GAAR by two years will be cheered too,” said Rajesh H Gandhi, partner, Deloitte Haskins & Sells .
With respect to MAT, various stake holders and industry leaders had made representations to the government, seeking removal of MAT on FPIs under the double tax treaty agreements with countries like Mauritius, Singapore, the Netherlands among others.
Under the current regime, foreign institutions are not required to pay any tax on long-term capital gains . Institutions are liable to pay short-term capital gains tax at 15%.
Deferring GAAR to April 2017 will also prove beneficial to private equity firms exit portfolio companies through M&A route or secondary transactions. Indian equity markets saw net outflows of roughly $1 billion in the two months following the Budget 2012, in which then finance minister Pranab Mukherjee introduced GAAR with a view to increase tax collections. The quantum of outflows resulted into a 12% fall in the Sensex in those two months, official data shows.
“The tax pass-through to Category I and II AIFs is a big relief for investors and funds embroiled in prolonged controversies on who pays the tax on income of such AIFs. However, the fine print suggests that the pass through is available only if the income of the AIF is not in the nature of ‘profits and gains from income or profession’. Hence, in spite of this announcement, AIFs will still be embroiled in litigation as to whether its income is business income or otherwise,” said Bijal Ajinkya, partner, Khaitan & Co.
Ajinkya said the FM offered no clairty on taxability of Category III AIFs, leading to uncertainty on classification of business income and payment of tax.
Nevertheless, enabling direct foreign investment in domestic AIFs will help both domestic and foreign private equity funds to raise capital on a common platform. This allows private equity firms to invest via a single platform, eliminating the need for using overseas structure like routing investments through Mauritius and Singapore. Raja Lahiri, partner at Grant Thornton, says long awaited issues around PE have been addressed in this Budget. However, the Budget does not tap the significant capital opportunity from the pension funds which could be a game-changer for the Indian PE industry,” he adds.