CBDT missive fuels FPI fears
The latest clarification issued by the Central Board of Direct Taxes (CBDT) is sparking retrospective taxation fear among foreign investors in the stock markets.
According to the clarification, indirect taxes would be applicable on internal transfers among India-dedicated funds—investment vehicles that deployed more than half of their total investments in domestic securities. By sector estimates, such funds account for nearly a third of all foreign investments in the markets.
As the CBDT clarification on Wednesday reiterated the original rules notified in 2012, legal experts fear this could have retrospective ramifications. “We have been receiving a lot of enquiries from our clients since CBDT put up the clarifications. They fear a withholding tax on any transactions that occurred in the past four years and it would become difficult for the fund to determine which of its investors will have to take the burden,” said a tax consultant.
Legal experts say the indirect transfer rules were primarily aimed at offshore merger & acquisition (M&A) activity involving domestic assets. This is the first time that portfolio investments would come under the ambit of a withholding tax. And, that the new interpretation is difficult to enforce, as funds investing in India operate through a multi-tier structure, where the previous end-beneficiaries would be difficult to trace.
Just as with a mutual fund, foreign portfolio investors (FPIs) pool funds from various investors; computation of taxes is done at the fund level. Later, depending on the holding of each investor, the fund transfers the liability to endinvestors. If an investor had completely exited the fund in, say, 2013, the fund will no longer be able to collect tax from him. However, based on the transaction, the fund will be subject to withholding tax.
Further, such transactions could have also been taxed in the respective jurisdiction. It would be double taxation for the FPI if asked to pay taxes in the India as well.
“The circular will have an adverse impact on FPIs. In fact, some of the clarifications are impossible to implement. Now, FPIs will have to track and report all such transactions to Indian tax authorities, which won’t be easy,” said Punit Shah, partner, Dhruva Associates.
Taxing of indirect transfers is implementable if there are fewer investors involved. However, extending these to broad-based funds, with investors spanning across regions, is something no jurisdiction has attempted, say experts.
“While the circular doesn’t make any new announcements, it was generally understood that indirect transfer rules were applicable only to private equity deals involving transfer of Indian assets. In that sense, the circular would disappoint FPIs. Tax authorities might now want to now probe offshore transactions happening in the case of Indiafocused funds and try to determine whether such transactions are taxable under Indian law. This could also have interest and penal consequences for such funds and their investors,” said Rajesh Gandhi, partner, Deloitte.