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Foreign portfolio investors, hit by the minimum alternate tax (MAT) issue, might find a fresh problem snapping at their heels. This time, rules governing indirect transfers are emerging as a cause for concern, especially for foreign portfolio investors running multi-billion-dollar India-focused funds.
Indirect transfer rules look to tax the transactions where foreign companies buy or sell their India assets. Sometimes, such transactions take place through holding companies set up in jurisdictions with favourable tax laws. The government has taken the position that such indirect asset transfers are also to be taxed, as the route can otherwise be used for getting around paying taxes in India.
The government recently clarified that any such transaction where at least 50 per cent of assets are Indian would require taxes to be paid in India, with some exceptions. The exceptions do not extend to foreign investors. Foreign investors coming through India-focused funds will have more than 50 per cent invested in Indian assets, experts point out. This could mean that investors in such funds would be taxed when they redeem their units.
"Investors in such India-focused funds appear to be hit by these offshore transfer provisions. These funds, in such cases, are required to withhold appropriate taxes before paying redemption proceeds to investors. These nuances are likely to increase the administrative burden on India-focused FPIs, especially where the funds are listed and it is difficult to compute the withholding tax component on behalf of each investor," says Suresh Swamy, partner (financial services), PwC Tax and Regulatory Services.
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"The application of indirect transfer provisions would mean that foreign investors in offshore India-focused funds could risk being subject to a 20 per cent long-term capital gains tax on sale or redemption of their investments in the fund. The tax rate would be 40 per cent if investors held shares or units of the fund for less than three years," says Rajesh H Gandhi, partner (tax), Deloitte Haskins & Sells.
"We hope it will not result in adverse action. It could hurt investor sentiment at a time when foreign capital is strongly required, especially in the infrastructure space," says Harish HV, partner, Grant Thornton India. The concerns have come up in the past few months as foreign investors have digested the Budget proposals. The Finance Bill, which defined 'substantial' as 50 per cent, became official after receiving Presidential assent on May 14.
The Budget had provided some relief, such as clarification that it would not apply to transactions of less than Rs 10 crore. This was in line with the recommendations of an expert tax committee looking into the matter.
"Overall, while the amendments provide some relief to investors, a number of recommendations from the expert committee have not been considered by the government. Some of those related to exemption for listed securities, participatory notes and availability of treaty benefits. Further, there are no provisions for grandfathering of existing investment made in the past… Yet another issue not considered is the potential double taxation that could happen, especially in multi-layered structures," says Suresh Swamy.
The only respite would be for investors themselves based out of treaty jurisdictions, such as Mauritius, Singapore, France, the Netherlands, etc. An investor from the US or UK would have to pay tax since India's tax treatment with these countries allows India to tax capital gains according to domestic law.
The US, accounting for Rs 6.95 lakh crore, is the single-biggest portfolio investor in India. The UK is the fifth-biggest, with Rs 1 lakh crore.
A Kotak Institutional Equities 'Foreign fund flow tracker' report, released on May 11, detailed at least 73 India-dedicated funds with assets under management of $30 billion. The report, authored by analyst Saifullah Rais, looked at data from fund-tracker EPFR, not an exhaustive source of such funds. The actual number could be higher.
A source said that the matter was likely to be taken up with the AP Shah Committee, also looking into the MAT issue.
The issue revolved around foreign investors being asked to pay a minimum of 20 per cent tax on their gains. A query on the matter sent to a tax department spokesperson did not immediately elicit any response.
