Capital gains tax structure changes will help IFSC

The proposals seek to increase the capital gains tax rates on listed equity shares.

The union budget’s proposals on capital gains tax structure has potentially a significant impact on foreign portfolio investors and the attractiveness of India’s international financial services centre (IFSC). The likely fallout are as follows.

FPIs

The proposals seek to increase the capital gains tax rates on listed equity shares from 10 percent to 12.5 percent and from 15 percent to 20 percent for long term capital gains and short term capital gains, respectively. The higher rates are applicable for all transfers of listed shares from today onwards. The increase in tax rates could potentially impact NAVs of offshore FPIs that provide for tax on accrued gains.

IFSC

IFSC is emerging as an important destination for Fund Managers to set up funds, especially to raise monies from offshore investors for investing in capital markets. Currently, there is a separate tax regime for Category III Alternative Investment Funds set up in IFSC which is broadly comparable to taxation regime for offshore Funds set up in jurisdictions such as Singapore and Mauritius. To provide further impetus to Funds in IFSC, it is proposed to extend the same regime to retail schemes and ETFs set up in IFSC (currently, there is no separate tax regime for such Funds in IFSC). With this announcement, Fund Managers may want to explore the setting up of retail schemes and ETFs in IFSC.

The reduction in the long term capital gains tax rates from 20 percent to 12.5 percent and the period of holding to qualify as "long term" to twenty four months would help outbound Funds set up in IFSC which are raising monies from resident investors for investing outside India.

Finance companies/global treasury centres set up in IFSC are eligible for a 10-year "tax holiday" (to be availed within 15 years from their date of registration with the IFSCA). There are "thin capitalisation" norms in the tax law that restrict the deduction of interest paid to 30 percent of EBIDTA. Domestic NBFCs were excluded from these norms. It is proposed to extend the benefit to finance companies (subject to conditions to be prescribed) set up in IFSC (relevant for non-"tax holiday" period). This will encourage setting up of finance companies in IFSC for cross-border funding.