Equity Capital Gains Enhanced Surcharge Partial Rollback: Understanding The Fineprint
Since derivatives are considered as capital assets for FPIs, they would also be exempted from the levy of an enhanced surcharge.
The first budget of the Modi government’s second term was announced on July 5, 2019. Among others, one of the important changes proposed was to increase the surcharge on the income of individuals/Hindu Undivided Family/association of persons/body of individuals/artificial juridical persons, earning income above Rs 2 crore and Rs 5 crore. This had a huge impact on the capital markets as this led to an increase in the effective tax rates for foreign portfolio investors and alternate investment funds who are organised as trusts. As many as 40 percent of FPIs are said to have been impacted by the increased tax rate.
This change in the budget resulted in the Indian stock market sliding as FPIs started pulling out money. From the date of the budget, it is estimated that FPI sold shares worth around Rs 23,000 crore from domestic equities. The entire issue of the FPI surcharge underwent many versions and change of positions. Immediately after the budget, there was an indication from the government that this was an unintended error and would be corrected before passing of the Finance Bill in the Lok Sabha. Then, the rhetoric changed to say that this is a calculated move to increase tax collections and FPIs who are aggrieved should look at changing their status from a trust to a company.
This confusion led to discomfort among the FPIs, as conversion from a trust to a company would have been extremely difficult for large funds, as many pensions funds and sovereign funds cannot function as companies.
Looking at the stock market conditions and sentiment, the Finance Minister held meetings with FPIs and other financial institutions in early August. After all the drama, the Finance Minister called for a press conference on Aug. 23, 2019, where she announced that the government has decided to withdraw the enhanced surcharge introduced in the budget for foreign as well as local investors, for income earned as capital gains and covered under Section 111A and 112A of the Income Tax Act.
This means that although the enhanced surcharge rate is now proposed to be removed, it is only for the capital gains earned on the sale of equity shares, units of equity-oriented fund and units of business trusts on which Securities Transaction Tax has been paid. Further, the press release issued on Aug. 24, 2019, also clarifies that since derivatives are considered as capital assets for FPIs, the same would also be exempted from the levy of the enhanced surcharge.
For all other incomes earned by FPIs and AIFs such as gains on the sale of unlisted securities, debt funds, preference shares, interest income and also the business income of an AIF (including derivative income for AIF), the enhanced surcharge rates would continue to apply.
This move would provide relief to a great extent for foreign portfolio investors as well as alternative investment funds registered with the Securities and Exchange Board of India as a trust/fund. The taxability of income in the nature of capital gains for them has been restored to the pre-budget position.
While this was a verbal announcement, we expect the government to issue a circular to give effect to these changes.
Maulik Doshi is Partner at SKP Business Consulting LLP, and Nishit Parikh is Principal at SKP & Co.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.