Safe landing, no pain, all gain: FPIs exempted from transfer provisions

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The government on Wednesday exempted Foreign Portfolio Investors (FPIs) 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.

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 Street believed would leave room for protracted future litigation and international arbitration that India has recently witnessed over the transfer of shares involving UK mobilephone company Vodafone.

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.

“We are very pleased with tax-related clarifications in the Budget,“ said Samir Arora, Singapore-based fund manager of Helios Capital. “Non-applicability of provisions of foreign transfer of underlying Indian assets to FPIs is a major relief.Also, keeping the tenure for applicability of long-term capital gains to one year will make it easier for FPIs to transition to the new India-Mauritius and Singapore treaties.“

Usually, 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 trans action and short-term capital gains taxes, experts argued that taxing ultimate beneficiaries too, on redemption of their units was double taxation.

Finance Minister 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.

On the surface, overseas funds sounded optimistic, although tax experts said further clarification from the government was required on the same tax law for other categories of foreign investors, such as private equity (PE) and venture capital (VC) funds.

“The Finance Bill seems to have addressed the indirect transfer issue specifically for certain categories of FPIs but not directly for private eq uity investors,“ said Siddharth Shah, partner, Khaitan & Co. “Of course, it may have been more desirable if AIFs (alternative investment funds), PEs, and VCs were included alongside FPIs, as they too, are regulated entities,“ Shah added. “There is no reason to not exempt category III FPIs like PEs and VCs from tax under indirect transfer of assets. Investors other than FPIs will eagerly await further clarification as promised in the Budget speech,“ said Suresh Swamy, Partner, PwC.

Both Shah and Swamy believe that there is hope for PEs and VCs as well. “The Budget speech clearly suggested that the issue around double taxation of the same stream of income will be addressed through a necessary clarification. This should address the concerns of the PE and VC funds to a great extent,“ Shah said.