The tax regime in a country plays a major role in attracting potential foreign investments. Predictability and certainty of capital gains regime holds centerstage for majority of investment decision, by strategic as well as portfolio investors. The Government of India has taken multiple steps over the last few years to provide a consistent tax regime for gains earned by foreign investors investing into India. Despite this, the current tax regime for taxing gains on investment in Indian securities is fraught with multiple rate slabs, differentiated outcomes linked to holding periods even for same class of assets (i.e., short term vs long term) and inconsistency on characterization of gains in case of certain securities.
With the rupee depreciating against the dollar on account of global factors such as Russia-Ukraine conflict, soaring crude oil prices, and tightening of global financial conditions, the net dollar returns of foreign investors have also taken a hit. As per the data available on the SEBI website, FPI have withdrawn more than INR 130,000 crore in the calendar year 2022.
A rationalized, simplified and predictable structure for taxing capital gains on equity and debt can further add to vibrancy of the Indian capital market and provide more certain return framework for foreign investors, which may boost foreign investments into India. Listed below are a few measures that the government could consider in this regard:
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* There are different periods for classification of assets into short-term and long-term, depending on the class of asset. This differential treatment for different classes of assets causes difficulty for foreign investors to decide on their investment / divestment strategies and creates complexities for the investors to compute the capital gains in case where the investors hold multiple classes of assets. Hence, the holding period for different types of capital assets should be rationalized.
* Currently, there are numerous tax rates for different types of capital assets depending on holding period, such as capital gains on sale of unlisted shares are taxed at 40% / 10%, capital gains on sale of listed shares are taxed at 15% / 10%, capital gains on sale of bonds are taxed at 40% / 10%, etc. Applicable tax rates should be reduced to a maximum of 2 or 3 rates. A typical FPI whose mere activity is to invest in listed securities might have to deal with over 20 effective tax rates depending on the income type and level.
* Tax rates are further increased by surcharge and cess. While the rate of cess is uniform for all taxpayers, surcharge rate differs based on the type of the foreign investors. For example, the maximum rate of surcharge for a foreign company is 5% but the rate of surcharge for a foreign individual / funds is 15%. To provide certainty, a uniform rate of surcharge should be applied for all types of foreign investors.
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* Certain expenses incurred by foreign investors while investing / divesting from India are not allowed to be reduced while computing the capital gains, resulting into foreign investors paying taxes on a higher gain compared to the actual cash gain. Hence, STT and other expenses incurred by investors (e.g., legal fees, portfolio management fees, tax consultant fees) should be allowed as expenses to compute capital gains.
* The current tax regime allows set-off of long-term capital loss only against long-term capital gains. Due to which even after suffering losses on a totality basis, foreign investors have to pay taxes in case of short-term capital gains, resulting into cash trap in India. To avoid this, set-off of all capital losses should be allowed.
* Specific exemption should be provided for re-organization of non-corporate funds outside India including by way of conversion of a non-corporate entity into a corporate entity, similar to current exemption with respect to amalgamation of foreign corporates.
* Currently, the law is silent on the classification of income arising to PMS, AIF, mutual funds, etc from different modes. In the absence of any law, the fund vehicles place reliance on available circulars / guidelines / judicial precedents. Hence, certainty should be provided on the classification of income arising from investments made through different modes.
* The law is silent on the taxability of certain receipts such as capital reduction or amortization of SPV level debt distributed by the business trust to its investors. Hence, clarity should be provided on capital gains tax calculation in different situations specially in relation to new and complex vehicles such as REITs / InVITs, Security Receipts etc.
Others:
- Currently, the cost of acquisition of bonus shares is considered to be Nil. To rationalise the capital gains computation mechanism, the government can consider averaging out the cost of bonus shares and original shares
- Introduction of a single and simplified tax return for taxpayers earning only capital gains / dividend/ interest income
The aforesaid measures will significantly help in providing a rationalized, consistent and predictable tax regime for foreign investors investing into India and may boost foreign investments into India, which will help in improving the balance of payments as well as counter depreciation of the rupee.
(By Rajesh H. Gandhi, Partner, Deloitte India; Shivani Kotadia, Manager, Deloitte Haskins & Sells LLP; and Shivani Kankaria, Deputy Manager, Deloitte Haskins & Sells LLP)
Disclaimer: Views expressed in this article are personal.