India: Budget 2017- Key Tax Proposals Relevant For Foreign Portfolio Investors

Last Updated: 10 February 2017
Article by Trilegal .

The Union Budget 2017 aims to revive foreign investments and create a favourable business environment by removing ambiguities in tax laws and rationalising tax rates.

The Union Budget, announced on 1 February 2017, has come as good news for foreign investors by providing clarity and certainty on pertinent issues such as the long standing ambiguity on taxation of indirect transfers of Indian assets held by Foreign Portfolio Investors (FPIs).

Summarised below are key tax proposals relevant for foreign investors:

1.Key proposals which impact investments in India

(a) Clarification regarding applicability of indirect transfer provisions on FPIs

The domestic tax law provides for a deeming fiction whereby transfer of any share or interest in a foreign company is deemed to be liable to capital gains tax in India, if its value is substantially derived, directly or indirectly, from assets located in India. On account of this indirect transfer provision, investors in FPI vehicles located offshore were liable to tax in India on the sale of their units in the FPI, or the shares of the offshore investment vehicle.

The Budget clarifies that the indirect transfer provision will not apply to investments held by Category I and Category II registered FPIs, whether directly or indirectly. This amendment will apply retrospectively from the date of enactment of the indirect transfer provision. Accordingly, there will be no capital gains tax in India, on sale or redemption of units held by non-resident investors in the FPI.

(b)Concessional tax rate on interest earned by FPIs

Currently, the interest earned by FPIs from rupee denominated bonds or masala bonds are subject to a concessional withholding rate of 5%. However, this concessional rate was available only for interest earned till 30 June 2017.

It has now been proposed that this concessional tax rate will be extended for interest income earned till 30 June 2020.

(c)Modification of regime governing offshore funds

The current law sets out circumstances pursuant to which income of non-residents is deemed to accrue or arise in India, and is taxable in India. One such circumstance is the existence of a 'business connection' in India. Consequently, to facilitate the location of fund managers of offshore funds in India, the law provides for a special regime. Under this special regime, a fund manager located in India will not constitute a 'business connection' in India if certain prescribed conditions are met. One such condition is that the minimum monthly fund size cannot be less than INR 1,000 million at the end of the financial year, except where the fund has been established in the previous year.

The Budget now proposes that the minimum fund size requirement will not apply where the offshore fund is wound up in the relevant financial year, and accordingly, the fund manager will not constitute a business connection in India.

(d)Tax neutral conversion of preference shares to equity shares

The position with regard to conversion of preference shares into equity shares has historically been marred with ambiguity as there were no specific provisions dealing with the capital gains tax implication on such conversion.

The Budget clarifies that conversion of preference shares to equity shares will be exempt from capital gains tax. Further, for the computation of capital gains at the time of transferring the converted equity shares, the cost of acquisition and period of holding prior to such conversion will be considered.

2.Tax regime applicable to FPIs

After the proposals made in the Budget, the tax rates applicable to FPIs are as follows:

Income Tax Implications
Capital gains Long term capital gains
  • Listed shares sold on a stock exchange : Nil
  • Other securities including off-market sale of listed shares : 10%
Short term capital gains
  • Listed shares sold on a stock exchange : 15%
  • Other securities including off-market sale of listed shares : 30%
Interest Income Earned till 30 June 2020 : 5%
Earned after 30 June 2020 : 20%

A surcharge @ 2% is additionally applicable for income more than INR 10 million but less than INR 100 million, and @ 5% for income of INR 100 million or more. Education cess is also applicable @ 3%. The cess and surcharge is applicable on the tax amount.

The above tax rates applicable on FPIs are subject to change in cases where India has entered into a Double Taxation Avoidance Agreement (DTAA) with the FPI's jurisdiction. We have set out below, the tax implications of investing into India through various jurisdictions:

Country with which India has a DTAA Capital gains implications at the stage of exit by way of sale on the stock exchange
Mauritius & Singapore If investment is made prior to 1 April 2017: Exempt
If investment is made on or after 1 April 2017, and sold before 1 April 2019: 7.5%
If investment is made on or after 1 April 2017, and sold after 1 April 2019:
  • Shares held for more than one year : Exempt
  • Shares held for one year or less : 15%
USA Shares held for more than one year : Exempt
Shares held for one year or less : 15%
Netherlands Exempt, if the following any of the conditions are satisfied:
  • Transferor owns less than 10% shares in the Indian company
  • Shares are sold to another non-resident.
Taxable in India in the manner provided in the case of USA.
Cyprus Investment made prior to 1 April 2017: Exempt
Investment made on or after 1 April 2017: Taxable in India in the manner provided in the case of USA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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