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Budget 2019: FPI surcharge may stay, ‘trust route opaque’, feels government

FE Bureau
Budget 2019-20: In her Budget speech in Parliament, Sitharaman said the higher surcharge rates would apply to individuals.

Union Budget 2019 India: The Budget proposal to impose a higher surcharge on the super rich - also applicable on capital gains made by foreign portfolio investors (FPIs) so long as they use the preferred trust route - is likely to stay, as the government on Tuesday seemed averse to making any relaxations in this regard. Speaking to FE, senior tax officials justified the move saying scores of FPIs were apparently using the trust route to invest in India to circumvent the Sebi's disclosure norms. Central Board of Direct Taxes (CBDT) chairman PC Mody said at a post-Budget event organised by industry body Ficci that, the board saw "no need to clarify the matter over and above what finance minister Nirmala Sitharaman had said on Monday."

The minister had said there was no need to clarify the matter and even if a need arose, she would respond in Parliament.

The extra impost had spooked the markets on Monday - benchmark BSE Sensex ended marginally higher after a see-saw trade on Tuesday.

Income Tax Calculator: Know post-Budget 2019 Income Tax out go here

The Budget proposal, to raise the surcharge on categories of taxpayers with income above Rs 5 crore by 22 percentage points, would mean that post-Finance Act 2019, the long-term capital gains tax on FPIs would effectively be 14.25% against 12% now, and short-term gains would be 21.4 % (17.9%).

"There does not seem to be any reason for the government to be concerned about the way funds are organised as long as they satisfy the laid-down KYC regulations and are registered as FPIs," Daksha Baxi, head of international tax at Cyril Amarchand Mangaldas said. The measure could impact at least half the FPIs investing in India, sources said.

In her Budget speech in Parliament, Sitharaman said the higher surcharge rates would apply to individuals. The Finance Bill 2019, however, says the new rates are also applicable for association of persons (AoP) among other categories. Tax experts said that the definition would effectively cover most funds registered as AoPs, including Category-III funds, which are mostly hedge funds making short-term investments.

S Vasudevan, partner at Lakshmikumaran & Sridharan, said: "FPIs come in through trusts route because it is the most tax-efficient structure. A corporate fund would have to pay MAT at over 18.5% and an additional 20% as dividend distribution tax (DDT)." He added that despite the hike in surcharge, FPIs might find the trusts still the least taxing structure. This higher tax will of course cut the the post-tax returns in the hands of the foreign investors, and this could result in lower inflows. However, given emerging market like India provide better returns, most funds would continue to invest in India, he said.

The Budget has helped the FPIs by providing them more investible stocks and easing the KYC norms but the enhanced surcharge on capital gains turned out to be a spoiler. Given the threat of the current account deficit widening from the benign level reported in Q4FY19, strong capital flows are crucial financing of the CAD.

"This hike in surcharge has created an arbitrage between corporate and non-corporate funds. A fund chooses to organise itself either as a corporate, LLP or a trust depending on various factors including alignment with their home countries. For instance, almost all mutual funds are structured as trusts and nearly half the trusts are non-corporates," Subramaniam Krishnan, Partner, Private Equity & Financial Services, EY India. Baxi, however, said the argument that a tax arbitrage has been created between a corporate and trust fund might not be entirely correct. Such arbitrage was always there, she said. Earlier, the surcharge for funds organised as trusts or AOPs was 15% as against 2% or 5% for those organised as corporates. Baxi added that if resident HNIs and private trusts are paying high surcharge, it does not seem unfair that the FPIs organised as trusts or AOPs should also pay such high surcharge.

Experts pointed out, it was primarily the indeterminate trusts-beneficiaries and individual shares not expressly stated-that would attract the new surcharge rates.