Funds from Mauritius, Caymans to lose out on key tax benefits

For bulge-bracket overseas shoppers of Indian stocks on D-Street, the Budget Day has ended with gains and losses rather evenly matched.First, bringing money into Indian equities from destinations such as Mauritius and Cayman Islands could be subject to additional capital gains tax. In the Union budget, the government has restricted the exemption on indirect transfers to category-I FPIs only.But another budget proposal to tax dividends in the hands of the investors could place various overseas funds domiciled in the US and Canada at a disadvantage over those from countries such as Mauritius or Cayman Islands. 73863388 ADDITIONAL CAPITAL GAINS TAXIndirect share transfer provisions apply to funds that have deployed more than 50% of their portfolio investments in India. The rules say that transfer of shares or units of such funds even outside India will be subject to capital gains tax domestically. For instance, if an investor in an offshore fund that qualifies under the provisions sells the units to some other investor, the transaction will attract 10% capital gains tax if the shares or units were held for 12 months. However, if held for less than a year, the units could attract tax in the range of 30-40% of the net capital gains.The development comes after the Securities and Exchange Board of India introduced new categorisation rules for FPIs in 2019. Under the old rules, there were three categories of FPIs, and category-I & -II were exempt from the indirect transfer provisions. But now Sebi has constituted FPIs into two categories and only category-I will get exemptions.“The indirect transfer regime under tax laws has been synchronised with Sebi FPI regulations by reducing three categories of FPIs into two,” said Amit Singhania, partner, Shardul Amarchand.“Investors of the erstwhile category-II FPIs who have remained category-II FPI in the new regime will come under the indirect transfer provisions,” said Suresh Swamy, partner, PWC. He added that funds coming from Mauritius, Caymans and Cyprus would primarily be affected since they were not eligible for category-I status under the new rules as the countries weren’t Financial Action Task Force (FATF)-compliant.Any investments made by such FPIs until September 23 have been grandfathered or exempted from the new provisions.DDT IMPACTThe finance minister also proposed abolishing the Dividend Distribution Tax (DDT). Currently, dividends are taxed at the company level at a rate of 20.5%. However, now companies will pay the full dividend to investors, who in turn will have to pay taxes. Taxes on FPIs are determined by the rates specified in the double taxation avoidance agreements with India. FPIs based out of the US and Canada will see no effective change in tax rates at 20% on dividends since India’s tax treaties with them come with higher withholding tax. Over a third of FPI inflows into India come from the US and Canada.“The only advantage that FPIs from these two countries would get is that they will be able to get tax credits for the taxes they have paid on dividends,” said Rajesh Gandhi, partner, Deloitte.

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