USD 42 billion erased off Indian share markets as misgivings on tax linger

Mumbai: To paraphrase an old saying, the devil lies in details of the fine print of India’s budget documents.

 A budget proposal of higher income tax surcharge on wealthy Indians has scared non-Indian and overseas funds enough to erase 2.3 trillion rupees (USD 42 billion) in market value from S&P BSE Sensex listed corporations in the three sessions since budget on Friday, July 05, 2019 through Tuesday.

The reason being the understanding that the new tax rate applies not just to high net worth individuals (HNI) but also to trusts -- a structure of choice for a huge  number of overseas funds that make investments in the country.

The budget plan “seems to have inadvertently” pulled foreign portfolio investors (FPI) into the tax net and must be clarified by the government, said K R Sekar, a partner at Deloitte Touche Tohmatsu India LLP to Bloomberg.

Finance Minister Nirmala Sitharaman in her budget speech on July 5 proposed to increase the surcharge from 15 per cent to 25 per cent for persons with taxable incomes of between 20 million rupees and 50 million rupees, and to 37 per cent for those earning more than 50 million rupees. This takes the effective tax rate for those two groups to 39 per cent and 42.74 per cent, respectively.

Global and non-resident investors make investments in India via so-called association of persons (AOP) and non-corporate trusts. Problem is, the structures are treated as individuals for tax/ legal purposes. At a period when the India has emerged as Asia’s biggest destination for equity money in 2019, this has led to concerns about the tax being applicable to foreigners.

“An investment vehicle -- such as a category III alternative investment or an FPI -- taxed at a fund level is likely to get affected as the income may easily exceed 50 million rupees,” said Vaibhav Sanghavi, co-chief executive officer at Avendus Capital PBC Markets Alternate Strategies LLP in Mumbai. Alternative investments, like hedge funds, which use complicated trading methodologies, are classified as category III by Indian markets regulator Securities and Exchange Board of India (Sebi).

The government said it is not specifically targeting overseas investors, who have an option to restructure their trust into a corporate entity to avail of a lower tax rate available to such entities, BloombergQuint reported Wednesday, citing Central Board of Direct Taxes Chairman P C Mody.

Converting the investment vehicles into companies isn’t easy, Deloitte’s Sekar said. Global funds also look for stability in tax rates while assessing an investment destination, he said.

“The clarification from the government isn’t encouraging and India should relook at FPI taxation not only from stock market angle, but also from the perspective of stability,” added Sekar.