The devil is in the detail. But the stock market has braved it all as the worst fears of a selling exodus after the super rich tax did not actually come true
A near 2 percent drop in the Sensex and the Nifty a day after the Budget was largely attributed to a surcharge on foreign portfolio investors (FPIs). The Budget speech only mentioned that a surcharge would be imposed on wealthy individuals earning upwards of Rs 2 crore annually, but the fine print revealed that the surcharge was applicable to FPIs, also.
The stock market’s knee-jerk reaction, however, lasted only for a day. Though foreign investors have been net sellers in every session from the Budget day, the selling has been in trickles. The flood gates, as prophesied by many, did not open. The reason for this is in the details.
Let’s look at FPIs in detail to understand the repercussion of the move to tax FPIs.
There are various routes through which a foreign investor can bring money in India. FPI is one such route. FPIs are those set of investors who satisfy the eligibility criteria prescribed under the FPI regulations. Globally, FPIs are known as those entities who are short-term players and do not hold more than 10 percent stake in a company.
According to rules, an existing foreign institutional investor (FII) or a sub-account -- where a bank acts on behalf of the account holder under strict guidelines -- holding a valid certificate of registration is deemed to be an FPI till the expiry of the block of three years.
FPIs came into existence after the Union Budget 2013-14, vide para 95, as the finance minister announced his intention to go by the internationally accepted definition for foreign investors.
The move was prompted after market regulator SEBI had constituted a Committee on Rationalisation of Investment Routes and Monitoring of Foreign Portfolio Investments under the chairmanship of K M Chandrasekhar. The mandate given to the committee was to suggest ways to rationalise various foreign portfolio investment routes and establish a unified, simple regulatory framework.
Based on the committee report, on January 7, 2014, the FPI Regulations, 2014, were notified in the Gazette of India. The new FPI Regime came into effect from June 1, 2014.
All foreign investors – FII, sub-accounts and qualified foreign investors – are now classified as FPIs. Sebi now provides a single-window clearance through designated depository participants (DDP).The eligibility criteria for an FPI are:
- An applicant is a person not resident in India;
- The applicant is a resident of a country whose securities market regulator is a signatory to the International Organisation of Securities Commission’s Multilateral Memorandum of Understanding or a signatory to a bilateral Memorandum of Understanding with SEBI;
- The applicant is not residing in a jurisdiction identified by the Financial Action Task Force (FATF):
o as having strategic Anti-Money Laundering deficiencies; or
o combating the Financing of Terrorism deficiencies; oro as not having made significant progress in addressing the deficiencies or not committed to an action plan developed with the FATF to address the deficiencies.
- The applicant is a bank, is a resident of a country whose central bank is a member of Bank for International Settlements;
- The applicant is not a non-resident Indian;
- The applicant is a fit and proper person as per the SEBI (Intermediaries) Regulations, 2008.
Categories of FPIs
The FPI Regulations classify FPIs into three categories based on their perceived risk profile.
Category I: These include government and government-related investors such as central banks, governmental agencies, sovereign wealth funds, and international or multilateral organizations or agencies.Category II:
- Appropriately-regulated, broad-based funds such as mutual funds, investment trusts, insurance/reinsurance companies;
- Appropriately-regulated persons such as banks, asset management companies, investment managers/ advisors, portfolio managers;
- Broad-based funds that are not appropriately regulated, but whose investment manager is appropriately regulated. Provided that the investment manager of such broad-based fund is itself registered as Category II foreign portfolio investor.
- University funds and pension funds; and
- University-related endowments already registered with the board as foreign institutional investors or sub-accounts.
Category III: These shall include all others not eligible under Category I and II foreign portfolios investors such as endowments, charitable societies, charitable trusts, foundations, corporate bodies, trusts, individuals and family offices.
Of these three categories of FPI, the finance minister’s surcharge is applicable only to those who are registered under Category III.
Since Category III is the most loosely defined of the three categories, FPIs, especially those which want to hide the identity of the beneficiary investors use these routes. Besides, there is also the advantage of lower tax liability.
On the face of it, the proposal appears to be a win-win for the government.
Should these FPIs decide to restructure themselves as corporate entities, the government will be better placed to ascertain the identity of the investor. In case these FPIs remain under Category III, the government will benefit by way of additional tax revenues.
Reports say the Category III type of FPI investor accounts for 40 percent of all FPIs registered in the country. SEBI on its part is looking at the quantum of money flowing in through various categories.Media reports say SEBI may ask the government to reconsider its position if the amount of money coming in through Category III is high.