Budget 2020: Here are a few hits and misses for overseas investors

There were no big-bang measures for foreign portfolio investors (FPIs) in the Budget. Here are a few hits and misses: 

HITS

Dividend distribution tax (DDT): The tax rate for dividend in the hands of FPIs will be 20 per cent, plus surcharge and cess. India's treaties with certain countries provide for a lower rate of tax on dividends, and FPIs may be able to lower their India tax bill if they are eligible to claim the treaty benefits and meet requirements under the domestic GAAR (General Anti-Avoidance Rules) and MLI (Multilateral Instruments), a framework that aims to prevent base erosion and profit shifting.

“Foreign shareholders will be entitled to take the benefit of lower withholding tax under the tax treaty, subject to the principal purpose test being satisfied,” said Saumil Shah, partner, Dhruva Advisors. “With the DDT (dividend distribution tax) being replaced by shareholder taxation, the treaty rate would be available to foreign investors. For example, the Mauritius and Singapore treaties provide for a 5 per cent tax rate on dividends if holding in Indian companies is at least 10-25 per cent of the paid-up share capital. Else it is 15 per cent,” said Sunil Gidwani, partner, Nangia Andersen.

FPIs, however, may choose to claim credit for the taxes paid in India against their home country taxes and not claim lower rates under the treaty to the extent their home country tax on dividend is equal to or higher than 20 per cent.

According to Hiten Kotak, leader of M&A tax at PwC India, the DDT was as an additional cost for repatriation of dividends from Indian companies and this made acquisition of holding companies or investment in Indian operating entities by foreign companies expensive. 

Sunset clause extension: The Budget has extended the concession rate of tax to be paid by FPIs on the interest they earn on rupee-denominated bonds issued by Indian firms and government securities. The concessional tax rate is 5 per cent on the interest paid provided for under Section 194LD of the I-T Act. This has been extended until June 30, 2023. 

The government had introduced the lower tax rate in 2013 after a crash in the rupee led to a flight of foreign money. These were applicable on interest payable until May 31, 2015. Record FPI inflows in the debt segment in 2014 prompted the Centre to extend these concessions twice in subsequent years.

Experts believe the lower tax rate is a significant contributor towards making India’s debt market attractive to overseas investors. The concessional rate has also helped reduce borrowing costs for the government and firms.

Bond limits: Certain specified categories of government securities will be opened fully for non-resident investors. The limit for FPI in corporate bonds, currently at 9 per cent of outstanding stock, will be increased to 15 per cent of the outstanding stock of corporate bonds.

MISSES

Indirect transfer provisions: The Budget has clarified that Category-II FPIs will be subject to indirect transfer provisions. Earlier these provisions were applicable to unregulated funds falling under Category-III and it was expected that they would now apply to Category-II after the regulator merged three categories into two last year. FPIs from Mauritius, Cayman Islands, Cyprus, and British Virgin Islands may be at a disadvantage as most of these funds are classified as Category-II.

In 2012, the government had amended the domestic law to provide that gains from transfer of shares or interest in an entity outside India would be taxable in India if such shares or interest derived their value (directly or indirectly) substantially from assets located in India. These provisions were referred to as indirect transfer provisions.

Safe harbour norms: The Budget has relaxed a few safe harbour rules that aim to make it easier for fund managers overseeing offshore India-focused funds to relocate to the country. One of the onerous requirements for such funds was that the aggregate investment, directly or indirectly, by persons resident in India should not exceed 5 per cent of the corpus of the fund.

The Budget has now proposed that an Indian fund manager's investment for the first three years not exceeding Rs 25 crore will not be counted towards above 5 per cent cap. “While this is relaxation, it does not resolve the problem of identifying Indian residents in case of investments made through omnibus investments via distributors or prime brokers at offshore level,” said Gidwani. The offshore fund can now achieve the corpus of Rs 100 crore within a year of getting incorporated, instead of six months earlier.