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Budget 2020: Abolition of DDT, demerger of debt mutual funds, key changes to impact capital markets

Union Budget 2020 India
  • Sunil Gidwani

Budget 2020 India: While a lot of recommendations were made to the Finance Minister in an endeavor to retain the confidence among its investors, the Budget presented by Nirmala Sitharaman today has not met the popular recommendations of the investors viz no changes to the long term capital gains tax and benefits to category III alternative investment funds, etc. We have covered below some of the key changes impacting the capital markets.

1. Abolition of Dividend distribution tax (DDT) and taxing dividend income in the hands of the shareholders

In the proposed changes, DDT in the hands of the company is abolished and the dividend income will now be directly taxable in the hands of the investors at the applicable rates. It would be important for all foreign investors to seek benefits under their respective tax treaties to claim the lower rates of 5%/10%/15%, else the same could be subject to the highest tax rate of 40% plus applicable surcharge and cess.

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2. Exemption for Foreign Sovereign wealth funds (SWFs)

As a welcome move for SWFs owned by governments of other foreign countries an exemption is proposed for a period of four years till March 2024 for capital gains, interest and dividends earned from investments in Indian infrastructure projects provided the investment is held for 3 years. The SWFs are to be notified by the government. This is a huge unilateral concession provided by the Indian government because India’s tax treaties with other countries do not provide any special status to investments by foreign governments or sovereign funds.

3. Deepening the bond market in India

In order to deepen the bond markets in India, the FPI limit in corporate bonds are proposed to be increased from 9% to 15%. Also, in the budget speech the Finance Minister mentioned that the non-resident individuals would be allowed to invest in certain categories of Government securities. Further, the lower tax rate of 5% with respect to interest income earned on bonds and Government securities by the foreign investors has been extended to 30 June 2023. Also, the provision of concessional rate has been extended to bonds listed in IFSC, India.

4. Modifications in the conditions of offshore funds managed from India

In order to be eligible for managing an offshore fund from India, the fund had to achieve a corpus of Rs 100 crore by the year-end. Last year a period of 6 month from setting up was inserted which is now proposed to be extended to 12 months in lines with industry expectations. 

Also, the condition of Indian residents not holding more than 5% has been bothering many players who are otherwise interested in setting up such structures. It is now proposed that the Indian fund manager’s investment for the first 3 years not exceeding Rs 25 crore will not be counted towards above 5% cap. This, however, does not resolve the key reason for not being able to meet the condition i.e. the difficulty in not being able to identify Indian residents in case of investments made through omnibus investments through distributors or prime brokers at the offshore level. Further, one hopes that if the Indian fund manager’s investment does exceed Rs 25 crore only the excess shall be counted and the entire amount for the purpose of a 5% cap. Ideally, the relaxation should have been open-ended rather than only for the first 3 years.

5. International Financial Services Centre (IFSC)

The Finance minister announced that with the approval of the regulator, GIFT City would set up an International Bullion Exchange(s) in GIFT-IFSC as an additional option for trade by global market participants which would enable India to enhance its position worldwide, create jobs, and will lead to better price discovery of gold.

6. Demerger of debt mutual funds

Some of the large debt mutual funds have adopted SEBI’s ‘side pocketing’ mechanism by segregating the bad debt portfolio and issuing separate units to investors. There was a lack of clarity on taxation for investors. The provision on the lines of demerger has been introduced to ensure that the investors get the original holding period as well as the proportionate cost for the calculation of capital gains.

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