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Budget 2015: What Do FPIs Want?

Published on Thu, Feb 12,2015 | 19:12, Updated at Mon, Feb 16 at 16:40Source : 

By: Rajesh Gandhi, Partner & Karamjeet Singh, Senior Manager, Deloitte Haskins & Sells LLP

Thanks to the buying spree of Foreign Portfolio Investors (FPIs), the Indian stock markets are once again scaling new highs except for the blip seen this month. The market experts are predicting a further rally in the run up to the budget and obviously FPIs are expected to be the most prominent contributors to such rally. The latest euphoria is believed to have triggered from the 25 basis points rate cut by the Reserve Bank of India (RBI) on 14 January 2015 and furthered by the Quantitative Easing (QE) measures announced by the European Central Bank (ECB) wherein the ECB has announced to buy government bonds aggregating   €1.1 trillion at a rate of €60bn (£46bn) a month into financial markets until September 2016.

India is expected to close the current year 2014-15 with a 5.5% gross domestic product (GDP) growth, though under the new method of GDP calculation adopted by the Government, the growth rate is pegged at 7.5%. The International Monetary Fund (IMF) has said that India’s GDP growth rate will surpass China in 2016 when the Indian economy will grow at 6.5% against 6.3% expected in China. The new government since taking power in May 2014 has already implemented certain key reforms including labor reforms, complete deregulation of diesel price, clearance of mega infrastructure projects, liberalization in foreign direct investment regime in various sectors such as defense, insurance, construction and railways. While the new Government has still a long way to go, the initial gestures are promising and this is evident in the improved economic outlook in the country.
The thumbs up given by FPIs to the steps taken by the new government and the resultant improved economic outlook is encouraging and one can expect the happy times to continue. This said, one needs to watch out for any measures taken by the revenue authorities that could play a spoilsport. The recent notices issued by the revenue authorities to FPIs questioning why Minimum Alternate Tax (MAT) provisions should not apply to them have been unwelcomed by FPIs. The legislative intention of the MAT provision is clear that these provisions have been enacted in the Income Tax Act, 1961 (Act) to tax such domestic companies who despite having distributable book profits do not pay any tax by availing various exemption & deductions available under the Act. Accordingly, for foreign companies, MAT should apply only if they have operations or permanent establishment in India as a foreign company will be required to maintain books of account as per company law and have book profits only in such circumstances and not otherwise. However, given that there is no specific exclusion provided to foreign companies from MAT provisions and the adverse comments by the authority of advance ruling in the case of Castleton Investments, revenue authorities are claiming that MAT should apply to FPIs as well. Given the uncertainty, FPIs are concerned that revenue authorities will proceed to tax their income at the MAT rate of around 20% instead of lower capital gains tax rate of 0% / 15% applicable to long term / short term capital gains on sale of listed securities. Various representations have already been made by industry bodies to the CBDT and FPIs are hopeful that the Budget 2015 will clarify that MAT provisions do not apply to them in absence of operations / permanent establishment in India.
The other major area of concern for FPIs is the enactment of GAAR from April 1, 2015. There is a concern that under GAAR, FPIs claiming treaty benefits will be denied the benefits and taxed as per domestic law. FPIs are expecting the Government to postpone GAAR and utilize the interim period to issue detailed guidelines on how GAAR will be invoked in specific situations. This will provide better transparency and certainty to FPIs.

The other issue relates to Indian tax implications arising from merger / restructuring of funds overseas. It is not uncommon for funds to merger / restructure overseas  for reasons such as operational efficiency, administrative benefits, tax certainty, economies of scale etc. At times, such restructuring results in transfer of Indian shares without any cash consideration being exchanged between the predecessor and successor entity. Internationally, such mergers / restructuring are typically tax neutral. Since there is no provision in the Indian Income Tax Act excluding such merger / restructuring of funds, these could be classified as a taxable transfer by the revenue authorities. Further, as a fallout of the Vodafone judgment, the retrospective amendment of the Act to tax transfer of shares of entities abroad that derive significant value from India (indirect transfer of Indian shares) has also increased the tax uncertainty for FPIs. A clarity on these aspects confirming that the indirect transfer rules will not apply to internal reorganizations and stock market transactions would be cheered by FPIs.
In a bid to encourage FPI investment in debt securities, the Government had in 2013 reduced the tax rate on interest income earned by FPIs from debt securities to 5% instead of 20%. This concessional rate is available for interest received by FPIs on Government securities and those corporate bonds where the coupon rate does not exceed 500 basis points of the prime lending rate of State Bank of India. This concessional rate was announced on the interest payable between June 2013 to May 2015. This measure by the Government has certainly paid off as evident from the 57% increase in net cumulative FPI investment in Indian debt from Rs 179,770 crores (USD 29.01 billion at current rates) at the end of May 2013 to Rs. 291,946 crores as of 10 February 2015 (USD 47.12 billion at current rates). As per the Debt Utilisation status reflected on the National Securities Depository Limited (NSDL) website as of 10 Feb 2015, the FPIs have exhausted almost all the limits available for investments in government bonds (USD 30 billion) and in excess of 69% of the limits in corporate bonds (USD 51 billion). Also, In the financial year 2014-15 up to 10 February 2015, out of the total net investments by FPIs of INR 243,980 crores (USD 39.37 billion), 62% investment has been in debt securities and rest in equities. In order to retain such apparent attractiveness of the Indian debt, the Government could consider extending the current concessional tax rate of 5% on the interest income on securities held by FPIs beyond May 2015. Further, since there is some uncertainty around the type of debt securities on which the concessional tax rate is available, it would be helpful if clarity is provided in the budget that the concessional tax rate applies to all types of corporate debt securities that comply with coupon rate condition including debentures and all types of Government Securities.

It will be interesting to see to what extent the Government accepts the recommendations of the FPI community when the Budget is presented at the end of this month.


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