Finance Bill, 2023 proved to have an unexpected sting in the tail, with the government moving as many as 64 amendments before it was passed by the Lok Sabha on Friday. The amendments included an unsettling tax blow to debt mutual funds, and a hike in the transaction tax on futures and options by 25% each.
At a broader level, these and the several other changes in the Bill, which was tabled in Parliament on February 1 along with a generally acclaimed and pain-free Union Budget 2023-24, displayed the government’s intent to ensure a level playing field among different asset classes and minimise arbitrage opportunities for investors, irrespective of their profiles and even domiciliary status.
Finance secretary T V Somanathan made the government’s stand clear when he said, “income earning instruments should be treated as income earning instruments, that is the direction in which it is going.”
The changes also reflect a policy thrust to spur flow of funds into the real economy and the financial sector, as the many tax sops with regard to the country’s lone international financial services centre (Gujarat International Finance Tech-city or GIFT City) would testify.
A few tax loopholes have been plugged diligently, as deft tax planners, including high net worth individuals, large fund houses and firms have been found to take unfair advantage of them.
All capital gains of debt mutual funds – those with 35% or less of assets under management in domestic equities – acquired on or after April 1, 2023 will now be taxed at the slab rate of the investor. As the concept of long-term capital gains has been done away with for this asset category, its competitive edge with term deposits in banks will be blunted.
Between the two, returns are comparable, especially for longer holdings, but a significant tax advantage has been available for debt MFs, where investors pay tax at the slab rate for holdings up to 3 years and a 20% tax with indexation benefits or 10% without indexation on gains from longer holdings. With bank deposits attracting income tax at slab rate, the comparative benefit of debt MFs used to be more in high-inflation periods, thanks to the indexation facility.
While banks are expected to benefit from higher deposit inflows, the jury is out on whether tax parity between term deposits and debt funds will increase the funds available for investments and lead to an incremental push to capital formation. Since the total value of savings won’t be altered by the step, impact on investments would at best be marginal.
It was proposed in the Budget that capital gains earned on redemption of market linked debentures (MLD) would be treated as short-term capital gains taxable at slab rates without indexation benefit, irrespective of the holding period. The new proposal is to treat MLDs and debt mutual funds at par.
Sales of options in securities will attract securities transaction rate at 0.0625% effective FY24, as against the current rate of 0.05% and the rate for futures will change from 0.01% to 0.0125%. The move would hit high frequency traders (hedgers) and will have a marginal-to-significant impact on overall trade volumes, the abundance of which helps in price discovery. Retail investors may get to slightly increase their share in trade volumes.
Another amendment would reduce the burden on infrastructure and real estate investment trusts (InvIT/REIT) from the proposed new income tax at slab rate on amortisation of debt in the hands of the unit holders. Debt repayment by the trusts being a significant income stream for the investors in these instruments (dividends and interest/rental incomes are the other components), but haven’t been subject to tax so far.
According to the new amendment, the tax will be restricted to the excess sum received by them over the issue price, that is, the initial investment, and not on the sum including the initial capital, as was originally proposed. The lightening of the tax burden will help address the concerns that the new impost could dampen fresh investments into these instruments. A few of them, including Brookfield REIT, Embassy REIT and Mindspace REIT and the trusts floated by the public-sector NHAI and PowerGrid, are already listed, and more are likely to go public, given their vital role in mobilising resources for infrastructure investments.
In another change, withholding tax rate on royalties and fee for technical services paid to non-residents has been doubled to 20%, a move that could dent technology imports but is aimed at encouraging foreign entities to set up R&D units here. Treaty cover could still allow investors from a host of countries to get beneficial rates of 10% and 15%, but the compliance requirements may not be easy to meet in all cases.
Among a clutch of tax concessions offered to the investors in IFSC (GIFT City) is 100% tax holiday for 10 years for offshore banking units. The benefit will be limited to the extent income accrues or arises outside India. Currently, a 100% tax holiday is available for a five year period and a 50% exemption for the next 5 years. Also, the withholding tax on dividends received by non-residents has been halved to 10% and the surcharge on capital gains earned by Category III investors been removed.
However, in keeping with the plank of level playing field, payments made by a resident to GIFT City entities under the liberalised remittance scheme will be subject to a 20% tax collected at source (TCS
Even as it made an unprecedented number of changes in the Finance Bill, extending its length to 220 pages, the government hasn’t yielded to stakeholders’ requests for review of the some of the Budget proposals. For instance, the proposal to extend the “angel tax”provisions to investments from non-resident investors stays and the new impost will kick in from April 1, 2024, despite the start-up fraternity raising concerns.
However, in a note clarifying the amendments, the finance ministry said, “all concerns raised by the stakeholders in the implementation of the proposal would be addressed” and draft valuation rules would be published in April. The ministry added that exclusions from the new tax similar to the domestic venture capital funds, would be considered for overseas entities as well. The angel tax, by definition, seeks to tax the excess amount of consideration over and above the fair market value of the shares issued, by closely held companies from their investors at the time of raising capital.
The Budget proposal to tax income from aggregate insurance premium above Rs 5 lakh a year hasn’t been rolled back either.
While there was no debate in the Lower House before the passing the key money Bill due to ruckus, finance minister Nirmala Sitharaman said a committee under the finance secretary would be set up “to look into the issue of pensions and evolve an approach which addresses the needs of employees while maintaining fiscal prudence to protect common citizens”. The move is significant given the re-introduction of the old pension system (OPS) with assured benefits by many Opposition-ruled state governments, and the huge onus it could put on government finances. The Centre and some BJP