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Last Updated : Jul 15, 2019 12:24 PM IST | Source: Moneycontrol.com

It is getting harder for FPIs to dodge the super-rich tax

Foreign portfolio investors are a baffled lot. The trouble is the increase in tax surcharge doesn’t sit well with government’s stated intention of making India an investment hotspot.

Moneycontrol Contributor @moneycontrolcom

Divaspati Singh, Ritu Shaktawat and Ishita Khare

While Budget 2019-20 was welcomed in India Inc, the potential impact of the announcement regarding the increase in surcharge applicable to ‘individuals’ (with income exceeding Rs 2 crore) was only realised upon reading the fine print.

Unlike the Budget speech, the proposal in the Finance Bill 2019 is wider and covers all taxpayers other than companies and partnership firms. Thus, once implemented, this move may adversely impact FPIs which are set up as non-corporate vehicles.

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Typically, FPIs are set up as trusts or limited partnerships in their home jurisdictions. The definition of a partnership firm under Indian tax law refers to the Indian Partnership Act, which does not recognise foreign partnerships or limited partnerships. To determine classification of such entities for Indian tax purposes, one needs to analyse their features to evaluate whether they can be treated as a partnership firm under the Indian Partnership Act.

In the case of a limited partnership which significantly differs from a general partnership in terms of relationship inter se partners, liability of partners etc., this analysis becomes complex. Consequently, such vehicles -- depending on their characteristics -- are generally classified as association of persons (AOP), or, at best categorised under the residuary category (artificial juridical person), for Indian tax purposes.

While the rationale behind such increase in surcharge may have been to levy a higher surcharge only on HNIs, the sting of the unintended consequence is definitely being felt by non-corporate FPIs. After the initial furore, the Central Board of Direct Taxes (CBDT) chairman proffered a simple “panacea” to such FPIs structured as non-corporate entities to restructure themselves as corporate entities.

Is it really that simple?

In order to effectively combat tax burden on FPIs, it is important to understand key affected players among the largest asset allocators to India. Most of FPIs investing in India are offshore mutual funds, sovereign wealth funds, university funds, endowments, European UCITs (Undertakings for the Collective Investment in Transferable Securities), large pension funds and the like which are largely established as trusts or limited partnerships, in accordance with the respective applicable local laws, and therefore, cannot afford to simply convert into a corporate structure from a non-corporate one, in the face of this increased surcharge.

The larger issues to deal with are - whether such conversion itself will be tax-neutral, and will this not be seen as a tax avoidance step taken only to save taxes which enables the tax officer to invoke the General Anti Avoidance Rules (GAAR) to ignore the ‘form’ and levy tax based on ‘substance’. It is pertinent to note in this regard that GAAR targets such arrangements that are formed either for the sole purpose to obtain tax benefit; or while being permitted arrangements under the tax law, are used to obtain tax benefits, their use being inconsistent with the economic substance of such arrangements.

Also, changing the FPI structure may also entail taking approvals from funds’ respective investors and may subject such funds to additional regulatory registrations in their respective home jurisdictions. Further, FPIs contemplating to alter their structure shall be required to undergo long-drawn amendments to their charter documents.

Well, why can’t non-corporate FPIs invest through a corporate SPV?

First, all existing investments made by such FPIs will continue to be subject to such higher taxation since most forms of transfer would not be free of taxation. Furthermore, there is uncertainty whether the tax authorities will try to look through the FPI structure to test the ‘substance’ for non-corporate FPIs under GAAR, which ironically comes under the CBDT!

With the FPI route hauling massive foreign investment inflow in the country, this move under the Budget seems to be detrimental to the goal of making India an attractive investment destination, at a global level. The industry is baffled with the government’s predisposition towards rearrangement of FPIs as corporate entities, especially in light of increased promotion of FPIs by the government under the Budget and otherwise. This comes in the form of rationalisation of Know Your Customer (KYC) norms, facilitation of transfer of debt securities issued by Infrastructure Debt Fund – NBFCs by FPIs to domestic investors, alignment of investment limit for FPIs to applicable sectoral foreign investment limits, permitting FPIs to subscribe to listed debt securities issued by REITs (Real Estate Investment Trusts) and InvITs (Infrastructure Investment Trusts), and merger of the NRI (Non Resident Indian)-PIS (Portfolio Investment Scheme) and the FPI route to enhance FPI participation in the Indian capital markets.

It is notable that FPIs, which have been loyal investors in India for many years, principally rely on political stability and favourable policy framework, which have been, in the past, reposed as the touchstone by the NDA regime. It was expected that with the NDA coming back to power, FPIs would only witness ameliorating fiscal facilitation in India.

However, in light of the recent trend of increase of effective taxation for FPIs, coupled with the lackadaisical attitude of tax authorities towards such big-ticket foreign investors, it is not surprising that FPIs are caught in the frenzy for restructuring their entities to alleviate the pinch of increased surcharge.

With FPIs championing India’s march towards a more mature and vibrant economy, it is imperative that the government opens avenues for this route, making way for increasing FPI inflow in the country. While there is a possibility that such increase in surcharge for non-corporate FPIs is a result of an oversight by the government, it may be hoped that with the enactment of the Finance Bill 2019, this burden of increased taxation is adequately addressed for non-corporate FPIs.

Singh and Shaktawat are Partners, and Khare an associate at law firm Khaitan & Co. Views are personal.

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First Published on Jul 15, 2019 12:24 pm
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