FPIs see red over Madras High Court’s withholding tax ruling

By: |
Mumbai | Published: May 3, 2016 5:19:19 AM

Foreign portfolio investors (FPIs) have raised concerns over the recent verdict of the Madras High Court imposing the withholding tax on foreign funds investing through Cyprus.

Foreign portfolio investors (FPIs) have raised concerns over the recent verdict of the Madras High Court imposing the withholding tax on foreign funds investing through Cyprus.

The judgment has made Cyprus a notified jurisdictional area under Section 94-A of the Income-tax Act, 1961, as the country was not sharing the requested information with Indian tax authorities. This is against the exchange of information provisions of the double taxation avoidance agreement (DTAA) to which India and Cyprus are signatories.

Tax consultants and legal experts FE spoke to said the judgment could impact the fund flows received through the route. As per sources, Cyprus accounts for 15% of the total FPI remittances to India.

“The judgment is certainly against the regular tax procedures as the withholding tax should be applied on gains made, and not remittances. The argument is relevant especially in case of real estate funds which used Cyprus for remitances. Although they have made losses in the recent past, they will now have to pay withholding tax on gross proceeds,” said Siddharth Shah, partner at Khaitan & Co.

The purpose of DTAA is to provide protection against double taxation for investors. It also helps attract foreign funds. India has a similar agreement with more than 70 countries including Mauritius and Lebanon.

The judgment comes less than a year after the controversy over the minimum alternative tax (MAT), where tax authorities sent notices to more than 50 FPIs demanding them to pay MAT for their Indian operations.

Foreign funds opposed the move on the grounds that MAT could be levied on profits – which FPIs do not maintain in India. During May 2015, the government appointed a committee headed by justice AP Shah to resolve the issue. The committee had recommended that MAT could not be imposed on FPIs as well as foreign firms having no permanent establishment in India.

In October 2015, the government ended the controversy by amending section 115JB of the Income Tax Act to ensure that MAT provisions are not applicable to a foreign company that does not have a permanent establishment in India and is resident of a nation having DTAA with India.

FPIs in India are regulated through the Securities and Exchange Board of India’s foreign portfolio regulations, 2014. As per the norms, foreign funds are divided into three categories based on their risk profile.

Category-I FPIs, entities with the lowest risk, include foreign governments and government-related foreign investors.

Category-II FPIs include appropriately regulated broad-based funds, university funds, and university-related endowments and pension funds, among others. Category-III FPIs include all others not eligible under the first two categories.

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