FIIs will now budget taxes & want higher returns: Kanabar

Certain tax changes could hamper foreign portfolio investors (FPIs) as the Central Board of Direct Taxes (CBDT) has issued clarification on applicability of indirect transfer provisions.

Under the indirect transfer provisions contained in Section 9 (1Xi) of the Income Tax Act, all income arising from any asset or source of income in India or through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India.Speaking to CNBC-TV18, Dinesh Kanabar, CEO of Dhruva Advisors said, "Negative point would be that the foreign investors will now budget taxes and therefore will want higher returns and will allocate funds to India only if the net of tax returns meet their threshold."

Below is the verbatim transcript of Dinesh Kanabar’s interview to Prashant Nair and Ekta Batra on CNBC-TV18. Prashant: Can you explain the sequence of events because this is not new, this ties back to the changes which were made under Pranab Mukherjee as Finance Minister many years back; the Supreme Court came in, then the government changed the law and now you got this circular. A: We had the Supreme Court in the case of Vodafone saying that if there are transfer of shares of an overseas entity, even if there is underlying value in India, such value is not taxable in India at all. Pursuant to that we had the very famous or infamous retrospective amendment which is now come to be told as Vodafone amendment which actually provided that if a foreign company has underlying value in India which is substantial, then that foreign company will be regarded as Indian company and therefore any transfer of value of that overseas entity will be regarded as a transfer of value in an India entity and therefore would be liable to tax. A number of issues arose because the amendment was brought about if I may dare say in a bit of a hurry. The wordings were a bit unclear, there was no clarity as to what constituted substantial, etc and therefore a series of changes happened. First there was an amendment in the law itself which provided that substantial means more than 50 percent, meaning that if the underlying value in India was more than 50 percent, only then would a foreign company be regarded as an Indian entity. Then came a question as to how do you value the assets in India, outside India, how does one determine whether the 50 percent threshold has or has not been exceeded and then came a series of rules to really prescribe that. When all of that happened, a question arose and which is the genesis of the current circular which you are referring to, where the foreign funds represented that they make investments in India. The gains arising from those funds may or may not be liable to tax in India at all. If for example, they make long term capital gains and the sale happens on a stock exchange, then there is no tax liability in India. Therefore the question was that if there was an exit overseas at a fund level, would that be liable to tax in India or not. Representations were made, a clarification was sought with a view to really providing that such gains would not be liable to tax. Now, the CBDT has come out with a circular expressing its own point of view. That is the genesis of the whole circular. Prashant: They have expressed their point of view to say that they will be liable for tax? A: Yes. Before going to the circular, for some time now, over the last one year particularly, one has seen several circulars come from CBDT, many of which have been very pro-assessee, so, if there was a litigation and a court accepted a point of view, they did not carry the matter to Supreme Court or higher forums of appeal, etc. and very beneficial circulars. After a long time the clock seems to have swung back where they have come out with a circular which is if I may dare say fairly negative. At some level, the circular merely says what the law says. That was not really the issue. The issue was really was the law really meant to tax certain situations. I will give you two very specific examples which will illustrate the point I am making. So, the point here is that we have an overseas fund, the fund let us assume has got 60 percent investments on Indian listed equity, 40 percent is elsewhere and is therefore regarded as being a resident of India. If there is a redemption of units overseas, is those redemption of units liable to tax in India the underlying fact being that the investment for example is in Indian listed equity and the gains from that are not liable to tax in India. Now, the proposition was that in a similar situation, an Indian company would be liable to tax but a foreign company, would it be liable or not liable? Indeed the law, the way it is time today, shows that it is liable and a circular was requested to clarify it is not so and the CBDT has come back to say please read the law, it is liable to tax and we are reaffirming that we would tax you. However, that is one situation. Prashant: What is the damage this can do or do you think this is going to be very difficult to implement so it makes no difference, on the ground what difference will this make? A: Two things, on the ground what it means is a huge amount of compliance cost because how will you ever really determine transfers of overseas entities who are not liable to file returns in India. Negative point would be that the foreign investors will now budget taxes and therefore will want higher returns and will allocate funds to India only if the net of tax returns meet their threshold.