Foreign funds may be stuck with tax credits with little use as they sell Indian shares

FPIs have been on selling spree since October 2024.

Foreign portfolio investors (FPIs), including pension funds, university endowments and some sovereign funds, who have trimmed their exposure to India face another key challenge: what to do with the India tax credits they will receive for this financial year. Tax experts say these could be a "sunk cost" for such FPIs.

Their recent selling of Indian shares has resulted in incidence of capital gains tax payable in India under various Double Tax Avoidance Agreements (DTAAs). Foreign funds get tax credits for payment of capital gains tax in India. These credits can be used by the entities to adjust their tax liability in their home country. However, most of these funds are not subject to taxes in their home jurisdictions, which makes the tax credits of little use for such FPIs.

The development assumes significance as foreign funds have been on a selling spree since October and have net sold equities worth Rs 2.24 lakh crore, NSDL data shows.

“FPIs that are tax-exempt in their home countries may not be able to utilise the tax credits received in India for capital gains tax payments, as they do not have corresponding tax liabilities in their domestic jurisdictions. As a result, the tax paid in India would effectively be a sunk cost for such investors, forming part of the overall cost of doing business in the Indian market,” said Suresh Swamy, partner, Price Waterhouse & Co LLP.

Indian tax laws allow taxpayers to offset the taxes on capital gains with capital losses incurred over an eight-year period, starting from the year in which the tax is paid. However, given the quantum of gains, it is improbable that they will be able to fully adjust the tax on gains against losses, say tax experts.

“The current tax framework presents a challenge for certain FPIs such as pension funds, university endowments, etc in their inability to utilize Indian tax credits in their home country due to their tax-exempt status there, potentially creating a higher effective tax burden. This disparity can impact their strategies wrt India as an investment jurisdiction especially for long-term, stable capital,” said Ritika Nayyar, partner, Singhania & Co.

In addition to the capital gains tax, FPIs like other investors in India pay Securities Transaction Tax(STT) and stamp duty on the sale or purchase of shares, experts say.  Unlike capital gains tax where FPIs are eligible for tax credits, STT and stamp duty come with no such tax credits.

The development comes amid a debate in the Indian markets whether government should scrap long-term capital gains (LTCG) tax on equities, Late last year, the government streamlined the tax rates by bringing a single rate of 12.5 percent across all asset classes for long-term capital gains. The short-term capital gains tax is 20 percent for all asset classes.

According to NSDL data, sovereign wealth funds held equity assets worth Rs 4.87 lakh crore as on January 31, while pension funds held shares worth Rs 5.86 lakh crore. FPIs' total share holding was worth Rs 67.7 lakh crore.