Hike in surcharge: Markets tank on higher FPI tax

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New Delhi | Updated: July 9, 2019 10:57:36 AM

Many believe the move to tax FPIs is unintentional and that the sole aim of raising the surcharge is to tax wealthy individuals.

markets, stock market, Asian shares, US China trade talks, stock market,The surcharge has been raised by three percentage points for taxable incomes of `2-5 crore, taking it from 15% to 25%, and by five percentage points for incomes above `5 crore,taking it from 15% to 37%.

Unless the government rolls back the proposal, foreign portfolio investors (FPIs) will need to pay a higher surcharge on their capital gains. This would result in the effective long-term capital gains tax going up to around 14.25% from about 12%. Similarly, the new effective short-term capital gains tax will be at 21.4 %, up from the current 17.9%. The measure, specified in the Union Budget for 2019-20, could impact at least half the FPIs.

Finance minister Nirmala Sitharaman said on Monday, after the customary post-Budget meeting with the Reserve Bank of India board, there was no need for a clarification on whether the higher surcharge would apply to FPIs. Sitharaman said, if needed, she would make a statement in Parliament since it was in session.

Experts pointed out it was primarily the indeterminate trusts — beneficiaries and individual shares not expressly stated — that would attract the new surcharge rates. Under the Income-Tax Act, ‘indeterminate trusts’ are to be taxed at the maximum marginal rate under certain circumstances.

The surcharge has been raised by three percentage points for taxable incomes of `2-5 crore, taking it from 15% to 25%, and by five percentage points for incomes above `5 crore,taking it from 15% to 37%.

In her speech in Parliament, Sitharaman said the higher surcharge rates would apply to individuals. The Finance Bill, 2019, says the new rates are also applicable for association of persons (AoPs), among other categories. Tax experts said the definition would effectively cover most funds registered as AoPs, including Category-III funds, which are mostly hedge funds making short-term investments.

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Many believe the move to tax FPIs is unintentional and that the sole aim of raising the surcharge is to tax wealthy individuals. Sudhir Kapadia, partner and national tax leader at EY observed, on a leading television channel on Monday, that had the government intended to levy this higher surcharge on FPIs, it would have set a higher threshold. He explained that a `5-crore income threshold was relatively small for a fund although it might be big for an individual. Kapadia added that worldwide FPIs operate as trusts as it provides them with administrative ease.

Speaking at a post-Budget event, CBDT member Akhilesh Ranjan said the department was gathering facts and would issue a clarification soon. Ranjan also said that it was important to know why so many FPIs are structured as trusts, which tend to be generally more opaque in their construct.

“As you are aware, the income tax rate structure for individual, Hindu Undivided Family (HUF) and AoPs are the same and the new surcharge rate applies to all three categories. Our understanding of FPI investment is that it is normally a collective investment vehicle in the form of funds, LLPs or corporate structures. It seems there are FPIs who are coming in through the trust structure, which will make them an AoP and hence coming under the new surcharge,” Ranjan said.

While an AIF can be structured as a trust, an LLP(Limited Liability Partnership) or a company, experts say the trust structure is the most efficient since LLPs need to make many more disclosures. Following the increase in surcharge, the effective income tax rate for individuals with a taxable income of `2-5 crore will go up from 35.88% to 39%, and for those above `5 crore, it would go up to 42.7%.

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