Budget 2014: What is in store for foreign portfolio investors?

The finance minister (FM), while presenting the Union Budget 2014 in the Parliament assured the investor community that the government is committed to provide a stable and predictable taxation regime that would be investor friendly and reassured that the government will not ordinarily bring about any change retrospectively which creates a fresh liability. By the time the FM ended his speech, the Sensex was up by around 330 points at 25,772 making one speculate as to which part of his announcements had such an impact. 

Tax rate 

FM has not proposed any change in the tax rates on capital gains, interest income, etc earned by FPIs in India. 

The tax rate of 15% for short term capital gains on transfer of equity shares [subject to Securities Transaction Tax (‘STT’)] continues; while long-term capital gains (subject to STT) continues to be exempt from tax. The tax rate on short-term capital gains from other securities will continue to be 30%; while the long-term capital gains will be taxed at 10% (excluding surcharge and education cess).

Anti-avoidance provisions 

The General Anti Avoidance Rules (GAAR) are to come into effect from April 1, 2015. It was widely expected that FM would defer implementation of GAAR in this Budget. However, this has not materialised. 

Safe harbour for fund managers: Characterisation of income as capital gains by FPIs

FM has proposed to introduce provisions requiring characterisation of income from the transfer of securities by FPIs as ‘capital gains’ and not as ‘business income’. This effectively provides a safe harbour to fund managers having presence in India which could constitute a business connection or a permanent establishment of the fund in India if such fund would have characterised its income as business income. Going forward, the offshore fund can appoint asset managers based in India without exposing its income to tax in India.

Investment in unlisted shares and debt oriented mutual fund

Hitherto, for categorisation as short-term capital asset in case of unlisted shares and debt oriented mutual funds, the test was 12 months or less. It has now been proposed to increase the period of holding to 36 months or less for categorisation as short term. Effectively, an investor will be able to categorise such securities as long term only after holding it for more than 36 months to avail lower tax rates on capital gains. 

Indirect transfer provisions

The indirect transfer provisions, introduced in 2012 with retrospective effect from April 1, 1961, provide that an asset or a capital asset being any share or interest in a company or entity registered or incorporated in India shall be deemed to be situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India. In such case a withholding tax liability arises on the payer of the income– Vodafone case is a case in point.

FM in his Budget speech has proposed that a High Level Committee that will be constituted by the tax regulator - Central Board of Direct Taxes – will scrutinise new cases arising out of the retrospective amendments in respect of indirect transfers before any action is initiated by the tax authorities. 

Lower withholding tax on interest on debenture

Last year, a lower withholding tax rate of 5 per cent was introduced on interest income from rupee denominated bonds of an Indian company and government securities, subject to fulfilment of certain conditions. It was expected that FM would clarify on eligibility of ‘debentures’ also for the lower withholding tax rate. However, no such clarification was made.

Offshore transaction in listed government securities out of tax ambit

Transfer outside India between two non-residents of government securities carrying periodic interest payment is proposed to be exempt from capital gains tax where such transfers are made through an intermediary dealing in settlement of securities.   

Policy announcements

FM has announced various policy measures in his Budget speech - Indian Depository Receipt framework to be revamped and a much more liberal and ambitious Bharat Depository Receipt to be introduced; American Depository Receipt/Global Depository Receipt regime to be liberalised for allowing issuance of depository receipts on all permissible securities; proposal to allow international settlement of Indian debt securities; financial sector regulators to take early steps for a vibrant, deep and liquid corporate bond market and deepen the currency derivatives market by eliminating unnecessary restrictions; measures to be taken for the introduction of uniform know your customer (KYC) norms and inter-usability of the KYC records across the entire financial sector; and one single operating securities account (dematerialised account) for all financial transactions to be introduced.

(Sunil Gidwani is a tax partner while Tushar Patel is senior manager, PwC – Tax and Regulatory Services, Mumbai)

To become a guest contributor with VCCircle, write to shrija@vccircle.com.

Leave Your Comment(s)