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Budget 2013: Case For Easing QFI Route

Published on Thu, Jan 31,2013 | 17:48, Updated at Thu, Jan 31 at 17:48Source : 

By: Ameet Patel, Partner, Sudit K Parekh & Co.

Attracting foreign investments has been a priority for the Government of India (GOI) for many years now. Significant attempts have been made and several policies regularly formulated in the annual budgets to increase foreign investments. To attract more investors and to strengthen the Indian Capital Market, the GOI introduced the QFI (Qualified Financial Investors) regime. Under this regime, even individual foreign investors can invest in India via a QDP (Qualified Depository Participant). The response to this decision, though positive, has been marred by doubts about corresponding administrative framework and taxation ambiguity. The aggressive image of the Indian tax authorities has also aggravated the situation by creating a doubt in the minds of foreign investors.

Recent actions on the part of the GOI have sought to assuage these fears and provide comfort to foreign investors. The GOI has made known its intention to defer GAAR by 2 years. This is a welcome move as GAAR had created a lot of uncertainty and fear in the minds of foreign investors. Similarly, the CBDT (Central Board of Direct Taxes) has recently issued clarifications in the form of FAQs to clarify its stand as far as taxation of QFIs is concerned.

Some of the important matters sought to be clarified by the said FAQs are as follows:

• The Qualified Depository Participants (QDP) are responsible for deducting tax at source (TDS) before allowing any amount to be credited to the bank account of a QFI.

• The QDPs are to act as the single point of contact for all QFIs for all purposes.

• Whether to treat an income of the QFI as business income or capital gains is to be decided on a case to case basis. Reference has been invited to an old circular issued by the CBDT in this regard.

• Computation of TDS is to be done on settlement basis (which is daily in case of most Indian Stock Exchanges).

• For computing TDS, set off of losses is available only when it is available at the time of such deduction. TDS once affected cannot be reduced.

• Tax Residency Certificate though necessary is not a sufficient proof of residency. There is also no standard set of documents prescribed to enable a QDP to provide DTAA benefit to a QFI. If the QDP, having relied on the documentation and in good faith provided treaty benefit which is later denied, QDPs shall be liable for any short/non-deduction. This will apply even if the concerned QFI is no longer the client of the said QDP.

• There is no time limit for scrutiny of transactions for TDS purposes by the tax department.


Indian Government introduced the QFI regime to attract foreign investors. Though the intention was that of clarity, these FAQs have cast an onerous responsibility on the QDPs. Also decisions like providing of treaty benefit, obtaining proof of residency and other documentation required for treaty benefit and categorization of income are to be taken by the QDPs. These areas are not only highly complex but also litigative in nature. Any error of judgement or interpretation would render the QDP responsible for short/non-deduction of tax at source.

It would therefore not be surprising if the QDPs are hesitant in encouraging the QFI regime whole-heartedly. The FII route on the other hand has clear tax provisions outlining processes which are simpler to operate and where positions are by now, quite settled. With this logic, QFI regime may not gain that much popularity. This would hamper the success of the QFI initiative of the government and adversely affect foreign investment growth.

What can be done in the Budget to ease the situation?

In spite of the CBDT circular, the government can endeavour to make certain procedural changes through the budget. This would significantly reduce the certain ambiguities.

Rather than releasing the FAQs or a press release, the Income-tax Act itself should be amended to provide concrete clarity with regards to applicability. It would also hold well in the court of law in case of any judicial proceedings.

The set of documents required for proof of residency and that for providing DTAA benefits may be prescribed, considering that if the Revenue opines otherwise, the QDP will be at fault whether or not it acted in good faith. If not an exhaustive list, a more comprehensive & detailed list covering as many documents as possible may be prescribed. This would reduce indecision in most cases avoiding resulting litigations.

Suggestions and Expectations from the Budget

With the election year near, it is expected that the Government will try for a more people-friendly budget. Also the necessity to reduce fiscal deficit and increase foreign investment has become all the more significant. For this, increased investment through the QFI regime is imperative.

It is clear from the FAQs that the government wants to cast all responsibilities on the QDPs. The intention is to protect revenue and avoid loss through all possible means. The mechanism is based on the idea of collecting maximum taxes at source as opposed to paying self-assessed tax. This however can act as a major deterrent. Hence it is proposed that a balance can be cast between revenue protection and encouragement to the QFIs.

There does not seem to be any reason why the QFIs and FIIs should not be treated at par for tax purposes. If fact, the QFI regime might even be expected to be more liberal as it is another step forward after FIIs in strengthening foreign investment into India. A special exemption is granted to FIIs from TDS. The same should be extended to QFIs and the mechanism should be thereby shifted to that of self-assessment from the proposed TDS mechanism.

The major drawback of the proposed tax regulation is that of setting off of losses while calculating TDS. TDS is affected on a settlement basis (usually daily). The setting off is allowed only when losses are available at the time of deduction. TDS once affected cannot be reduced even if there is subsequent loss. Hence TDS of Rs 500/- on profit of Rs 5,000/- cannot be reduced even if there is a subsequent loss of Rs 20,000/-. This seems unnecessary given the fact that the payment of TDS is to be made by the 7th of the next month. It would therefore be only fair to allow set off of all profits and losses intra-month instead of on settlement basis.

Losses of the previous year are not allowed to be set-off for calculation of TDS. This can only be done in the return of income filed by the QFI. This appears unjust from the QFI’s perspective. Deducting tax at source and then ignoring that profit at a later date when a loss arises would tantamount to collecting tax in spite of being aware that the payee may have to claim a refund of the said amount. Can a concession be given in this regard by allowing set off of losses on an intra month or intra quarter basis?

In any case, the QFIs should be mandatorily required to file their return of income in the electronic form so that the same can be processed faster and delays in refund processing can be avoided.

There is no time limit for scrutiny of transactions for TDS purposes. This keeps the QDPs at constant risk. An amendment specific to QFIs can be made whereby a time limit is prescribed. This will ensure that the QDPs are not hassled by TDS scrutiny made years after the transaction, when obtaining of information may not be possible.

The Revenue has left categorization of income at the opinion on the QDPs by merely giving reference to Circular No.4/2007 dated15/06/2007. The issue is highly vexed and controversial. The administrative and litigative hassles can be avoided by laying down clearly in the legislature itself that income from securities is Capital Gains and not business Income. Further, intra-security set off of losses for TDS purposes is allowed only when STT is paid. This would render unlisted securities, bonds etc outside the allowable criteria. This can lead to unnecessary refund procedures and blockage of funds for QFIs. This restriction should also be removed.


This year's budget is significant not only from the point of view of economic development but also from the point of view India's portrayal as a favourable investment destination in the international investor community. The Govt has a great opportunity in its hands to set the right tone and send the right signals to the foreign investors. One hopes that this opportunity is not lost on account of political or other reasons.


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