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'Budget 2015 – Should Foreign Investors Cheer Or Jeer?'

Published on Mon, Mar 02,2015 | 17:39, Updated at Mon, Mar 02 at 17:56Source : 

By: Ameet Patel, Practicing Chartered Accountant & Past President - Bombay Chartered Accountants' Society

Foreign investment is important for every country. Whether it is FDI or whether it is portfolio investment, every country would make best efforts to draw as much foreign exchange as possible.

For India, the past few years have seen a dramatic reduction in new investment coming in from foreigners. In particular, the FIIs (which are now known as FPIs) have stayed away from India insofar as new registrations are concerned. One of the main causes for this has been the intimidating tax laws that the previous UPA government inflicted on everyone. Tax cases like Vodafone, Shell & Nokia have battered India’s reputation as an investment destination due to unstable & irrational tax laws. In this background, when the NDA government came to power with a landslide majority in May 2014, there was considerable euphoria amongst the capital market players. It was generally felt by all that India’s image is in for a positive change amongst foreign investors. The Budget that our Finance Minister Mr Arun Jaitley presented today was keenly awaited not only by Indians but also by foreign fund houses, investors and tax experts. Everyone was waiting to see whether the business friendly Prime Minister was able to put his distinct stamp on the budget or not.

When Mr Jaitley finished his speech, a few clear messages that came across were:

•    the government is willing to listen to tax payers and address genuine concerns
•    fresh retrospective amendments are clearly not on the cards
•    the shortcomings in the law that was enacted in the past will be dealt with favourably
•    the government is serious about assuring foreign investors that India is a good place to do business in
Some of the important amendments proposed in the Finance Bill which affect foreign investors are discussed in this article.

1.  MAT related amendment affecting FPIs:
MAT is the acronym for Minimum Alternate Tax which aims at taxing corporate tax payers on their book profits if the tax payable by them in the normal course is less than the MAT. The basic requirement for computing MAT is “book profit”. For this, one would require the Profit and Loss Account of the concerned company. There are set rules for computing MAT. There are also a large number of judicial decisions on this subject. MAT has given rise to a lot of litigation in the country.

The latest casualties of this provision have been FIIs / FPIs. Generally, FPIs earn interest income, capital gains and dividend income. While dividend is tax free in India and MAT is also not payable on the same, in case of FPIs also, there was no controversy as far as dividend income is concerned. However, the problems arise when the FPI earns interest income and / or capital gains and in particular when the FPI hails from a country with which India has a tax treaty (DTAA) and as per that treaty, the income is either not taxable in India or is taxable at a low rate In such cases, if MAT is applied then it is possible that the FPI will attract a higher tax liability than its normal tax liability.

Till last year, this was not an issue for FPIs and it was an accepted position that MAT does not apply to FPIs (as also to other foreign companies). However, lately, a few over zealous tax officers in the country started sending out notices to corporate FPIs and sought an explanation as to why MAT should not be charged from them on their income in India.

The key issue here is whether an FPI based in another country and which has no business connection in India and which does not maintain a separate Balance Sheet or Profit & Loss Account for its Indian FPI activities can be covered by MAT? If yes, how does one compute the book profit? From where does one get that book profit (in the absence of an Indian Profit & Loss Account)?

This issue has caused a lot of anxiety amongst FPIs. Therefore several representations had been made to the Finance Minister to address this issue and bring clarity.

In the Budget, this issue has been dealt with. It has been provided that in case of FPIs and FIIs, MAT will not be applicable on any capital gains on which Securities Transaction Tax (STT) has been paid. Unfortunately, this provision is drafted very shabbily. As per the amendment, if the FPI earns short term capital gains from any security and no STT is paid on such a transaction, then such short term capital gains would not be excluded from the purview of MAT. A corollary to this would be that if the FPI earns any long term capital gains on which STT is not paid (for e.g. from units of non equity oriented mutual funds or from debt instruments), then the same would be excluded from the purview of MAT.

While the MAT on such income may ultimately be less than the actual tax payable (and therefore, the question of computing the MAT would only be an academic exercise), the FPI will still be left with the problem of how to disclose the book profit in its tax return. If there is no Profit & Loss Account, how does one calculate the MAT? On the other hand, in case of FPIs based in countries like Singapore or Mauritius with which India has a very favourable tax treaty and as per which any capital gains earned in India by such an FPI will not be taxable in India, there would be a problem. In such cases, under the treaty, the short term capital gains from debt instruments as well as units of non equity oriented mutual funds would also be exempt from tax in India. But, now, because of the clear provisions of MAT, they would have to pay MAT on such capital gains. Similar problem will be faced by FPIs paying a 5% tax on interest income under the domestic law. The MAT would obviously be higher than this 5%. Will such FPIs be forced to pay MAT?  This seems to be an unintended anomaly and I hope that the FM amends the provision to clearly lay down that FPIs are excluded from the purview of MAT altogether.

It may not be out of place to mention here that most FPIs do not fill up the Balance Sheet and Profit & Loss Account details in the tax return form (ITR Form). All the fields of these two sections are kept blank (or NIL). For the past couple of years, in most such cases (where the FPI is a corporate entity), the concerned FPIs have got notices from the income-tax department saying that the tax return filed by them is defective because the Balance Sheet and Profit & Loss Account figures are not filled in. Now, it would be very difficult to defend such FPIs if the amendment as proposed is carried out without changes (and MAT becomes applicable to them).

2.  GAAR:
The GAAR provisions have been causing concern to domestic as well as foreign investors. There has been a justified doubt that GAAR would result in unilateral over riding of the DTAA by the Indian tax officers. There were several recent press reports that said that GAAR would be deferred by another year or so.

The FM has accepted the suggestions of the anti GAAR lobby and has provided that GAAR provisions will come into effect not from 1st April, 2015 but from 1st April, 2017. Another important change that he has proposed is that when GAAR comes into effect, it will apply to investments made prospectively i.e. on or after 1st April, 2017. This is a significant step. Readers would recollect that as per earlier provisions, the grandfathering of investments was from 2010. Now, the amendment brings clarity and fairness into the law.

3.   Combining the FPI & FDI investments:
Another significant announcement made by the FM in his speech was that with a view to simplify the procedures for Indian companies to attract foreign investment, the distinction between the different foreign investments will be done away with – particularly between Foreign Direct Investment and Foreign Portfolio Investment. These will be replaced by composite caps. At the same time, those sectors which are already on a 100 percent automatic route would not be affected. A Press Release to this effect has also been issued today ( In the near future, one can expect concrete action on this front.

It may be noted however that the rationalisation of the different foreign investment routes was done only recently based on the Chandrashekhar Committee Report. The roll out of the FPI regulations took a long time and had its own share of hurdles. Now, again the entire scenario is sought to be changed. I hope that the roll out of the new regulations will be smooth.

4.   Fund Manager in India will not constitute a Permanent Establishment
Yet another important step in the direction of making life simpler for foreign investors is the announcement that the presence of a Fund Manager in India will not result in constitution of a PE in India for offshore funds. This is a sensible step. Because of the risk of PE, this function of fund management was being performed from other countries. Now, with clarity being given, hopefully, we will see more funds being managed from India.

At the same time, one must be aware of the long list of conditions laid down in order to qualify for this favourable treatment. Ostensibly, these conditions are laid down on the lines of international best practices.

5.   Concessional tax rate for interest earned by FPIs
Interest income earned by FPIs on rupee denominated corporate bonds and Government securities is subjected to a concessional tax rate of 5%. This has made Indian debt very attractive for foreigners. In particular, Japanese investors have shown tremendous interest in the debt instruments. This concessional tax treatment had a sunset clause that would have come to an end on 30th June 2015.

In the Budget, it has been proposed to extend the concession upto 30th June, 2017. Thus, interest earned by FPIs upto 30th June, 2017 would now continue to be taxable at 5% plus applicable surcharge and education cess.

This is a welcome amendment but it would have been much better if the sunset clause had been deleted all together and the concessional tax rate made applicable on an ongoing basis. Such a move would help foreign investors in looking at a longer horizon and investing in Indian debt for a longer period.

6.   Alternative Investment Funds
The erstwhile Venture Capital Fund Regulations had been replaced with the AIF Regulations by SEBI a few years ago. However, the same had not kicked off in right earnest primarily because of the tax clouds hanging over the same. The internationally accepted concept of Pass Through was not clearly made applicable to the AIFs. This was criticised by investors from all across.

Now, it is proposed that for Category I and II AIFs, the Pass Through status will be accorded and the income earned by such funds would be taxable in the hands of the investors and not the fund. It has also been provided that this would apply to any type of structure of AIF i.e. LLP, Trust, Company etc. This is also a welcome move. However, it would have been even more welcome if the Category III AIFs were also accorded the same status. Unfortunately, for such funds, the tax issues remain.

Another interesting announcement made by the FM in his speech was that foreign investment would be permitted in AIFs. The Press Release referred to earlier also mentions this. One will need to await the actual notification before one can comment on this proposal.

7.   Consolidation of Mutual Fund Schemes
Lately, several mutual fund houses have been consolidating some of their schemes. Thus, for example, two or three equity oriented schemes of a mutual fund may get merged into one. When this happens, the unit holders of the merging schemes get units of the merged scheme in lieu of their units of the merging scheme. This resulted in a transfer within the meaning of the Income-tax Act. A transfer would give rise to a capital gains or loss. With a view to encouraging consolidation without causing unnecessary tax liability for investors, it is now provided that an investor who gives up his units in the merging scheme for units of the merger scheme will not be considered to have transferred his units. Thus, there would be no capital gains or loss in such a case.

This is an interesting amendment and would be very helpful to mutual fund investors. The only downside is that the amendment applies only to a situation where the schemes that are being consolidated are of the same type (i.e. two or more equity oriented schemes or two or more non equity oriented schemes). If one equity oriented scheme gets consolidated into a debt fund or vice versa then the concession would not be available. Also, this provision does not apply to consolidation arising on account of merger of two different mutual funds. One hopes that in the years ahead, these kinds of situations will also be accorded favourable tax treatment.

8.   Real Estate Investment Trusts (REIT):
Internationally, REIT is a well known and popular instrument for raising funds for the real estate sector. In particular, for infrastructure projects, REITs or INVITs are very useful.

In the previous Budget, the FM had brought in a new Chapter in the Income-tax Act to take care of taxation of the trusts and the sponsors. However, there were several gaps in the said provisions.

In the latest Budget, the deficiencies in the earlier provisions have been sought to be removed. When a sponsor transfers his shares in the real estate company to the trust and is allotted units of the trust, it was provided earlier that when the said units were later sold by him, even though STT would have been charged on that sale, the investor would not get the concessional tax treatment for short term capital gains (which is applicable for STT paid units). This was a dampener which has now been removed. Similarly, the rental income of a REIT will also have a pass through status and would be taxed in the hands of the investors and would be subjected to a withholding tax by the REIT.

Both these amendments will go a long way in making REITs attractive and hopefully help the ailing real estate developer companies in raising much needed finance for their ongoing projects.

There are many more provisions in the fine print of the Finance Bill that have a bearing on the taxation of both domestic and foreign investors. However, based on the important amendments dealt with above, I am of the view that foreign investors would be cheering the arrival of the promised “achche din” in India.


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