Budget 2020 Undoes Tax Relief For Certain Foreign Portfolio Investors
The worst fear of certain foreign portfolio investors has come true.
Tax relief provided to certain foreign portfolio investors under Budget 2017 has been undone this year. Starting April 2020, Category-II FPIs will be subject to indirect transfer provision of the income tax law. The language of the provision makes matters worse for this category as investments made post September last year may retrospectively be hit by it. That’s because market regulator SEBI had notified a new regime for FPIs five months ago and Budget 2020 proposal impacts all investments since then.
Among other changes, the Securities and Exchange Board of India had reduced the FPI categories from three to two. Stakeholders were awaiting the consequent tax implications, which have now been spelled out in the Finance Bill, 2020 to say:
- Indirect transfer provisions won’t be applicable to those FPIs that come under Category-I. Under SEBI regulations, these include governments and government-related investors such as central banks, sovereign wealth funds; pension and university funds; regulated entities such as insurance entities, banks, portfolio managers, broker dealers and swap dealers, etc.; entities from the Financial Action Task Force member countries which are appropriately regulated.
- Investments made under the 2014 FPI regime will be grandfathered, that is, investments made before September 2019 would continue to be exempt from indirect transfer provisions. That means investments made between September 2019 and budget day (Feb. 1), by FPIs who don’t qualify as Category-I, won’t get this tax exemption.
Retrospectivity of the provision apart, the changes to FPI categorisation has undone the Budget 2017-benefit that was given to certain investment structures, that is, the exemption granted to Category-I and II FPIs from indirect transfer provisions. These categories included government entities and regulated broad-based funds.
And they got tax relief from the indirect transfer provision that says transactions involving transfer of shares or interest in a foreign entity deriving its value substantially from Indian assets would be taxable in India. Gains from such transactions attract capital gains tax in India as per this provision.
If the government had intended to withdraw the tax relief from September onwards, it seems fair to expect that this position should have been clarified at the time SEBI regulations changed, Daksha Baxi, partner at Cyril Amarchand, told BloombergQuint. But since they didn’t, it’s unfair to now apply this provision retrospectively even if it is for a period of three months, she said.
The expectation is that the government will clarify that investments up to March 31 will be grandfathered. And April 1 onwards, exemption from indirect transfer provision would only be applicable if the FPI is registered as category-I.Daksha Baxi, Partner, Cyril Amarchand Mangaldas
For this, FPIs should either fulfil the Category-I criteria starting April 1 or be subject to the indirect tax provision, Baxi said.
Fulfilling the criteria would entail the FPI itself being in FATF-compliant jurisdiction or having an investment manager who is from an FATF-complaint jurisdiction or at least 75 percent investors of the FPI from FATF-compliant jurisdiction. Satisfaction of one of these conditions would qualify the FPI as category-I, according to SEBI regulations.