CBDT shelves proposal to tax India-dedicated funds

CBDT circular issued last month had raised multiple taxation concerns. 

Foreign portfolio investors can now breathe easy, with the income-Tax department on Tuesday keeping in abeyance its controversial circular on taxing India-dedicated funds.

Experts said clarity was necessary on the issue at the earliest so that FPIs were certain. They expect the finance ministry to amend the law in the Budget to put an end to the controversy.

The circular, in the form of frequently asked questions (FAQs), had spooked the markets when it was issued last month. 

It also gave rise to fears of retrospective taxation as the principal amendment to the Income Tax Act on indirect transfers was such in nature. 

These provisions were first introduced in 2012, with retrospective effect, after the government failed in levying a tax on the British telecom giant Vodafone Group Plc’s purchase of Hutchison Whampoa’s India telecommunications business.

The Central Board of Direct Taxes and the capital markets division of the finance ministry have received a number of representations from various FPIs, venture capital funds and other stakeholders, expressing concern that the circular does not address the issue of possible multiple taxation of the same income. 

“Representations made by the stakeholders are currently under consideration and examination. Pending a decision in the matter, the operation of the above-mentioned circular is kept in abeyance for the time being,” CBDT said in a notification.    

The circular gave rise to fears that there would be “triple taxation” on the activities of the India-focussed funds overseas. The circular implied that India-dedicated funds would be taxed if they sell shares overseas. 

Besides, overseas individual investor of the fund would also be taxed in India and would not get any tax credit in his home country. The direct taxation avoidance agreement also does not come to the rescue of investors.  

The tax arises when Indian assets of the funds constitute 50 per cent of the total asset value of funds globally or Rs 10 crore. However, those having less than five per cent of fund shares would be exempted from the tax. 

The circular would have put at risk particularly the 181 publicly traded funds whose India exposure is more than half of total assets. They have almost $39 billion under management, Andy Mukherjee wrote in Bloomberg.

Amit Maheshwari, managing partner, Ashok Maheshwary and Associates, said the circular had caused a lot of anxiety among FPIs and the investors.

“A quick closure to this controversy is required, keeping in mind the practical difficulties and business realities of fund structures,” he said.

According to sources, the government might confine the applicability of the circular to private equity and the mergers and acquisitions space, thereby exempting the activity in the listed space and offshore derivative instruments.

After a representation by FPIs, the capital markets division under the department of economic affairs had raised the matter with the revenue department, seeking a quick clarification on the matter.

At least one of the big four accounting and consulting firms and four large Indian offshore fund players were part of the representation. According to sources, this move by the government to put the circular under abeyance was intended to soothe the nerves of FPIs for the time being. 

“This will bring a lot of cheer to FPIs. They were concerned about the fallout of the circular in terms of tax provisioning as well as past liability. All those concerns have at least temporarily been put to rest. Specific amendment to the tax law, exempting foreign investors investing directly or indirectly in FPIs will put this issue to rest forever,” said Suresh Swamy, partner, PwC.

The move shows that the Centre was concerned about foreign investors, said U R Bhat, managing director, Dalton Capital Advisors.

“It couldn’t have come at a better time as emerging markets are no longer attractive destinations for overseas funds. The change was bound to happen as you cannot expect a tax regime that would triple tax FPIs.”

Nirmal Jain, founder and chairman, IIFL, said, “The circular was not practical, more so if the government intends to attract FPI flows. This would be a positive move for markets in the near- to medium-term but FPIs will look for the Budget to provide more clarity.”