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DTC, 2013: Cautious Optimism For FIIs

Published on Tue, May 13,2014 | 23:32, Updated at Tue, May 13 at 23:33Source : 

By: Manoj Purohit, Director, Tax and Regulatory services, Walker Chandiok and Co. LLP

Over the last two decades, Foreign Institutional Investors (FIIs) have enjoyed the benefits of the favourable tax regime, specifically under Section 115 AD of the existing domestic tax laws. However, the proposed Direct Tax Code (DTC), 2013 has done away with these specific provisions pertaining to FIIs.    

Introduction to DTC
DTC was first introduced in August 2009 with a view to create an efficient direct tax system and to replace the existing Income-tax Act, 1961 (ITA), which, nevertheless, has undergone numerous amendments since its enactment. In view of the responses received from the various stakeholders and representations made before the Ministry of Finance (MoF), the revised discussion paper on DTC was released in June 2010. Thereafter, it was referred to the Standing Committee on Finance (SCF) for its review and comments. The SCF submitted its report to the Parliament in March 2012.  

Recently, the MoF released the draft DTC 2013 for public discussion and comments. Provisions in DTC 2013 have been modified primarily on account of the recommendations made by the SCF, and the various amendments carried out in the ITA vide Finance Act, 2011, Finance Act, 2012 and the Finance Act, 2013. Despite the acceptance of some key recommendations made by the SCF in DTC 2013, there is very little to cheer for the FIIs.  

Income classification
As per the guidelines of DTC, any securities held by an FII would be classified as ‘an investment asset.’ Thus, the income of FIIs from sale of securities, including derivative transactions, would be deemed as capital gains only. The proposed classification under DTC ignores key factors such as volume, frequency and size of sale/ purchase transactions, pattern of activity i.e. trading vis-à-vis investment, etc., which have conventionally been followed for determining the nature of income. One of the key recommendations of the SCF regarding the exclusion of investment by FIIs from the definition of investment assets has not been accepted by the Ministry of Finance. Thus, as per DTC 2013, income from the transfer of securities, including derivatives, would continue to be classified as capital gains. Hence, the question as to whether the various activities of an FII would constitute a permanent establishment in India through brokers, custodians, fund managers, etc. would be irrelevant, going forward.
As per the ITA, an asset is considered to be a long-term asset, if it is held for more than 36 months. An exception to this rule is the case of shares and listed securities for which the relevant holding period is 12 months. As per DTC, in respect of all assets other than listed securities, the applicable threshold i.e. holding period for the asset that is to be classified as long-term is one year from the end of the financial year in which the asset is acquired. Therefore, the holding period test would be calculated from the end of the financial year and not from the date of acquisition of the said asset. 

Applicable rates of taxes
The rates of taxes applicable to FIIs prescribed in DTC 2010 have been retained in DTC 2013 without any variations. DTC has principally reinstated the tax regime for taxation of capital gains under the ITA. The tax rates applicable to FIIs under DTC vis-à-vis ITA are mentioned hereunder:

Capital gains ITA DTC 2013
Long-term capital gains subject to securities transaction tax (STT) Exempt Exempt* (by way of 100% deduction of gains)
Long-term capital gains not subject to STT 10% 30% (indexation benefit available for computing cost of acquisition)
Short-term capital gains subject to STT 15% 15%* (by way of 50% deduction of gains)
Short-term capital gains not subject to STT 30% 30%









Effective tax rate after deduction
# The tax rates are exclusive of surcharge and cess

Losses arising from the sale of long-term assets subject to STT will not be permitted to be set-off and carried forward. In case of losses from the sale of short-term assets which are subject to STT, only 50% of the losses will be allowed to be set-off and carried forward to the subsequent years.
As per the current domestic tax laws, interest on securities is chargeable to tax @ 20%. However, interest on income-tax refund, interest on delay in open offers, etc. is chargeable to tax at the rates of 30% and 40% for non-corporate and corporate FIIs, respectively. Under DTC, all interest earned by FIIs in India would be taxable at the rate of 20%. On the other hand, in case of interest on specified Government securities and rupee-denominated corporate bonds, the tax rate would be as low as 5%.
As per DTC, dividend on shares will be exempt in the hands of FIIs, provided the dividend distribution tax is paid by the company that is distributing the dividend. This is consistent with the current approach under the ITA. Although income from equity-oriented mutual-fund ("the Fund") would be exempt under DTC, if income distribution tax is paid by the Fund, income from mutual-funds other than equity-oriented fund would be subject to tax.
Tax treaty benefits
The provisions regarding benefits under the treaty are on similar lines as that of current tax laws. Consequently, the treaty provisions would prevail over domestic laws if the same are beneficial to the taxpayer. An exception to this is a scenario wherein General Anti-Avoidance Rule (GAAR) or any other anti-avoidance provisions are invoked. In order to claim treaty benefits, taxpayers will be required to obtain a tax residency certificate from the specified authority, as well as provide documents and information as may be prescribed.
The way forward
It is pertinent to note that the current version of DTC 2013 is a draft, which would be presented before the Parliament for discussion. It would be enacted as law only after it is approved in the Parliament. This would occur only when the general elections, which are currently underway across various parts of India, conclude, with the subsequent formation of a new Government that concurs with the view of the previous Government (in case there is any change). Further, a report on the 'Roadmap for Fiscal Consolidation' was submitted by the Kelkar Committee in September 2012, which recommended a comprehensive review of DTC. Hence, the fate of DTC would remain uncertain till the policies of the new Government are announced. Considering the current political scenario a question that comes up is, whether DTC will ever see the light of day?


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