FIIs withhold debenture investments

FinMin in budget had cut withholding tax on interest earned on long-term infrastructure bonds to 5% from 20%

The finance ministry might need to tweak the wording of withholding tax laws for foreign investors if it has to attract more overseas flows into the debt market. Many foreign institutional investors (FIIs) are holding back on their investments in debentures of Indian companies in the absence of clarity on whether this instrument too would attract lower withholding tax like other bonds.

The finance ministry, in the Budget, had cut the withholding tax on interest earned on long-term infrastructure bonds to five per cent from 20 per cent. Later, it extended the lower withholding tax to all bonds to attract more FII inflows into the country.

Now, FIIs are confused whether the cut in withholding tax would be applicable to debentures also because the concerned Income Tax Act, introduced in the Finance Bill of 2013, specifically uses the term ‘bond’ and does not mention ‘debenture’. While the bond market generally uses the terms ‘bonds’ and ‘debentures’ without any differentiation,  the concern among these investors is whether the tax department would permit this for tax calculations.

“Though the market uses the terms bonds and debentures interchangeably, FIIs do not want to take a chance to avoid confusion about taxation at a later stage,” said Anish Sanghvi, associate director – tax and regulatory services, PwC India. “There is a need for the government to clarify on this matter because FIIs may be holding back on their investments / acquisitions from the secondary market of Indian debentures, awaiting clarity on whether debentures would also enjoy the lower withholding tax.”

Tax lawyers said FIIs are more cautious these days while looking to take advantage of favourable tax laws offered by the Indian government because of recent controversies surrounding the Mauritius tax treaty and tax demands on various multinational companies.

“No foreign investor wants to leave anything that is linked to taxes open to interpretation. They want everything in writing because nobody is sure when the taxman would come knocking,” said a Mumbai-based senior tax lawyer.  

Since the phased opening up of the bond market to foreign investors, FIIs have largely stuck to government securities partly due to the recent rally. Bond market participants said it would be crucial to iron out tax issues to broaden the activity in the domestic bond market. While making bonds more attractive to FIIs, lower withholding taxes would also make it cheaper for Indian companies to raise money from overseas investors.

Tax experts said FIIs wanting to invest in company bonds are also awaiting the government’s notification on the interest rate benchmark for them to qualify for lower withholding tax. The Income Tax Act introduced in 2013 mentions that the interest rate for company bonds should not exceed the rate notified by the government.
CAUTIOUS MOVE

• FIIs are confused whether the cut in withholding tax would be applicable to debentures like in the case of bonds 
• Tax lawyers say FIIs are more cautious these days while looking to take advantage of favourable tax laws offered by India
• While making bonds more attractive to FIIs, lower withholding taxes would also make it cheaper for Indian companies to raise money from overseas investors