A Tax Circular That Will Make Foreign Portfolio Investors Happy
Tax dept gets into damage control mode & foreign portfolio investors heave a sigh of relief
Foreign portfolio investors (FPIs) in India had bid adieu to 2016 on a nervous note. That was because of a clarificatory circular, issued in December, by the Central Board of Direct Taxes (CBDT) on indirect transfer provisions under the Income Tax Act, 1961. According to the clarification,
If an investor or unit holder owning 5 percent or more in a fund registered as an FPI in India sells or redeems shares or units, and the fund has 50 percent or more of its money invested in India, then the investor will be liable to pay tax in India, even though the fund, when it buys and sells equity shares in India, pays the relevant taxes.
Experts had pointed out the issue of double taxation that would arise as a result of this clarification by the CBDT.
Daksha Baxi, executive director at law firm Khaitan & Co. told BloombergQuint that the December circular had made FPIs wary.
While most funds have capital allocation for investing in India, the double taxation would have led to a significant flight of capital from funds investing in private and public markets in India and would have acted as a strong deterrent for fresh capital allocations to India.Daksha Baxi, Executive Director, Khaitan & Co.
Damage Control By CBDT?
Baxi’s views could’ve become reality but for a damage-control circular issued by the CBDT on Tuesday. The tax department has now clarified that the December circular pertaining to indirect transfer provisions will be kept in abeyance until a final decision is taken on the matter.
...representations have been received from various FPIs, FIIs, VCFs and other stakeholders. The stakeholders have presented their concerns stating that the circular does not address the issue of possible multiple taxation of the same income.CBDT Circular on January 17, 2017
Daksha explained that most funds are set up in multi-tiered investment structures for multiple reasons and if the tax department had persisted with its earlier stance, it would have caused tax incidence at various levels of a fund.
Where the fund divests an asset in its portfolio (pursuant to a transfer that qualifies as a taxable direct transfer), if the sale proceeds are not re-invested, typically, a series of redemptions would be triggered at every level in the fund structure. If there is no treaty benefit available, then based on the December circular, the gains on redemption would be taxed as many times as the funds are up-streamed in the structure before being paid to the ultimate investors in the fund.Daksha Baxi, Executive Director, Khaitan & Co.
The decision of the tax department signals that the government is open to understanding and addressing genuine concerns, she added.
