 "Foreign portfolio investor exodus: Financial sector bears the brunt, FPI")
With the government rectifying an anomaly in the tax regime, foreign portfolio investors (FPIs) will no longer benefit from the lower tax rate on listed bonds, debentures, debt mutual funds (MFs), and listed preference shares. The Union Budget has clarified that FPIs will have to pay long-term capital gains tax (LTCG) at 12.5 per cent, up from the previous rate of 10 per cent.
Experts predict that this change could lead to some liquidation of investments before the higher tax rates take effect. The higher tax outgo will come into force on April 1, 2025, and will apply to the assessment year 2026-27 and subsequent years.
“FPI inflows are typically characterised as hot money and are highly sensitive to variables such as tax rates. Changes in tax rates for debt instruments can meaningfully impact after-tax returns, which is a crucial factor in investment decisions,” said Vivek Iyer, partner and financial services risk leader at Grant Thornton Bharat.
He added that there could be reduced allocation to instruments with higher tax outgo. However, the overall exposure to India may not change, as investors may reallocate funds to other asset classes rather than reduce their overall investment in the country.
Experts noted that the government has ended the differentiation that FPIs enjoyed in the last Budget. Previously, LTCG on assets such as government securities and other debt instruments remained at 10 per cent, while the same for equity MFs was increased to 12.5 per cent. This discrepancy has now been rectified.
Also Read
Another tax consultant suggested that the previous difference may have been an oversight, which has now been corrected.
“The tax rates for FPIs are specified in Section 115AD, not Section 112. The Finance (No. 2) Act, 2024, amended Section 115AD to tax long-term capital gains arising from the transfer of listed equity shares at 12.5 per cent (plus applicable surcharge and cess). However, LTCG from all other assets continued to be taxed at 10 per cent. This anomaly is now being corrected by the Bill. Going forward, any LTCG arising to an FPI will be subject to tax at a rate of 12.5 per cent (plus applicable surcharge and cess),” observed a note by Nishith Desai Associates.
According to National Securities Depository data, net FPI investments in debt in the Indian markets stood at Rs 1.1 trillion in 2024, while investments in debt MFs were Rs 507 crore. Net investments in debt through the voluntary retention route were Rs 13,000 crore, and those through the fully accessible route were nearly Rs 29,000 crore.
