New direct tax code may hinder FII inflows

Foreign institutional investors (FIIs) have pumped in USD 7.8 billion in the Indian securities market since the beginning of 2009. But future FII inflow might be impacted as the new direct tax code (DTC) could hit FIIs on three counts: tax rates, tax avoidance and tax treaties. CNBC-TV18's Ashwin Mohan reports.

Below is a transcript of Ashwin Mohan's report on CNBC-TV18. Also watch the accompanying video.

More than 1600 foreign funds registered in India are jittery. That's because some of the tax benefits previously enjoyed by them, may be taken away by the new tax code. In the past, FIIs have enjoyed tax exemption on their profits by referring to treaty benefits or by contending that they do not have a permanent establishment in India and therefore their income is not taxable. But, the new code may plug all that.

The code proposes that FIIs will be taxed at a flat rate of 30% on the net capital gains as against nil/10/20% on long-term capital gains and 15/30% on short-term capital gains under the existing law.

It also introduces general anti avoidance rules, under which any transaction could be considered to be a tax avoidance transaction and the onus for proving otherwise is on the tax payer. Currently, double taxation avoidance agreements overide the domestic law. However, the new code proposes that the provisions under the act or DTAA, whichever is later in time, shall prevail.

This negates the provisions of 74 comprehensive DTAA which India has signed with other countries, thereby erode the subsequent tax benefits. Experts feel that this move may also impact the ownership structure of FIIs, and re-organisation may be necessary if required.