Bonus issues may land FPIs in tax tangle

New tax treaties, GAAR don’t provide for grandfathering of shares acquired through this route

Foreign portfolio investors (FPIs) are staring at tax disputes as India’s amended tax treaties with erstwhile tax havens such as Mauritius and Singapore have not ‘grandfathered’ shares acquired through the bonus route. Even the general anti-avoidance rules (GAAR) provide no relief in this regard. This has hit FPIs hard as many companies have issued bonus shares in the recent past.

In other words, shares acquired by way of bonus on equity holdings acquired prior to April 1, 2017— when the revised tax treaties came into effect — have not been extended the tax exemptions given to the core holdings under the ‘grandfathering’ clause.

Therefore, in the event of FPIs liquidating their holdings, the tax benefit under the new Double Tax Avoidance Agreement (DTAA) will not be applicable to the additional shares acquired through bonus issuances.

According to sources, several stakeholders, including FPI lobby group Asia Securities Industry and Financial Markets Association (Asifma), have written to the Indian government, seeking relief. Shares acquired through bonus, FPIs contend, are free shares and don’t inflate the value of holdings. “Even though the bonus shares are new shares, the investor is not required to bring in fresh investment to acquire these shares. There seems to be no apparent reason for not extending the grandfathering benefit to bonus shares. In fact, this leaves room for doubts to creep in. The authorities should clarify that bonus shares received on shares acquired prior to April 1 are grandfathered as well under the amended treaties,” said Suresh Swamy, partner, PWC.

Another key concern for the foreign funds in this perspective is the applicability of GAAR. Experts say the anti-avoidance rules grandfather only capital gains or income arising from assets held prior to April 1, but not the business arrangements.

For instance, say an FPI ‘A’ owned a 10 per cent stake in a company ‘X’ prior to April 1, if he sells these shares now, he would be exempt from any capital gains tax as the investment has been grandfathered. However, if ‘ X’ has declared bonus shares to ‘A’ after April 1, the income he derives from sale of the bonus shares needs to satisfy GAAR — even though, effectively, the stake remains at 10 per cent. Even other priorexisting business arrangements like lease agreements are also not exempt from grandfathering.

“Although there is a grandfathering provision for income arising from investment prior to April 1, under GAAR, the said provision will not be applicable to any tax benefit and is only limited to income arising from the transfer of investment made prior to April 1. In that perspective, there is a limited grandfathering provided under GAAR,” said Amit Singhania, partner, Shradul Amarchand Mangaldas.

Foreign institutions have been concerned about the current tax scenario in India as the country underwent a paradigm shift in its taxation system this fiscal year.

The Centre had amended the tax treaties with a number of tax-friendly jurisdictions such as Singapore, Mauritius, and Cyprus. GAAR, which has been designed to crack down on tax avoidance arrangements, has also come into effect. One interesting provision of GAAR is that it overrides all the tax laws. Hence, even if an investor is clean under the DTAA, if he doesn’t fulfil GAAR, he could still be prosecuted.

The government has also signed multi-lateral instruments (MLIs) under the Organisation for Economic Cooperation and Development (OECD). These instruments are expected to plug the loopholes in the current global tax laws, which multinational companies (MNCs) have been exploiting.

Experts say the anti-avoidance rules grandfather only capital gains or income arising from assets held prior to April 1, but not the business arrangements