Jaitley proposes to make gains in India tax-free for foreign funds

Presenting the Union Budget 2017-18 in Parliament on Wednesday, finance minister Arun Jaitley proposed to exempt foreign portfolio investors (FPIs) who thrive on the Indian secondary market investments, from the tax provisions governing indirect transfer of assets, setting aside a December circular that had sought to bring such transactions by overseas funds within the ambit of Indian taxes.

Foreign funds welcomed the proposal, which is aimed at giving a boost to overseas investments as foreign players have been the backbone of Indian stock markets and have big stakes here.

The government has now proposed to amend the I-T Act to exempt category I and II FPIs from taxation on indirect transfers, with retrospective effect from 2012, when the Income Tax Act was amended to provide for taxation of those transactions of transfer of shares or interest in a foreign entity deriving its value substantially from Indian assets.

The move allays apprehensions of foreign fund managers over the difficulties that arise in the case of transfer of stake of investors of India-focused funds located abroad, but investing in India-based companies.

Overseas fund managers had sought clarity on the Central Board of Direct Taxes (CBDT) circular that said FPIs would be subject to tax on indirect transfer of shares, a move the market sees as a repeat of the Vodafone story, which could lead to protracted litigation and international arbitration.

According to the tax authorities, all income arising from Indian assets or through the transfer of a capital asset situated in India was to be deemed to accrue or arise in India and taxed here. The budget announcement has now removed FPIs from the ambit of such taxation.

FPIs, which include large pension and endowment funds, allocate their capital in lieu of redeemable units to step-down offshore investment vehicles, such as emerging market (EM) funds. These funds further invest in Singapore or Mauritius-based India-focused funds, which finally deploy the money in India. Since Indian funds are subject to securities transaction and short-term capital gains taxes, experts argued that taxing ultimate beneficiaries too, on redemption of their units was double taxation.

The finance minister has clarified that indirect transfer provisions will not apply in case of redemption of shares or interests outside India as a result of, or arising out of redemption, or sale of investment in India -transactions that are chargeable to tax in India.