The globe has been in turmoil ever since the outbreak of the pandemic but the Indian Government has endeavored hard to prioritise not just the wellbeing of individuals but also to keep the economic growth of the country on track. With many of the citizens now being vaccinated and amid concerns over the third wave, the economy is gearing up to receive the Union Budget 2022 in about two months.
While the stakeholders lay out blueprint of their expectations from the upcoming Budget, it’s worth reflecting on the recent tax changes that the economy has witnessed in the financial services space.
Tax developments in 2021
International Financial Services Centre (‘IFSC’) developments
It was not long back that India introduced the concept of IFSC with the objective that someday it will be considered as a financial hub and be on the same footing with the likes of financial centers in Hong Kong, Singapore and London. To display its commitment, a lot of policy initiatives and tax reforms have been taken to promote IFSC.
The Government in September 2020 introduced sweeping changes to the tax treatment of Category III Alternative Investment Funds (‘AIF’) based in IFSC wherein income on transfer of securities is exempt (except for shares of an Indian company) in the hands of such AIF. Further, income on securities is taxable at the concessional tax rate of 10 per cent in the hands of such AIFs as against the rate of 20 per cent prescribed for foreign portfolio investors (‘FPIs’).
From unitholders’ standpoint, income from Category III AIF in IFSC and from transfer of units of such AIFs is exempt from tax.
In order to aid fund pooling activities in India and as a means to incentivise the existing offshore funds to relocate to IFSC, the Government has brought about tax amendments to help ensure that no adverse tax consequences arise on either the investors of the offshore fund or the offshore fund on account of the relocation of the offshore fund to IFSC.
The investment division of offshore banking unit in IFSC is granted tax benefits similar to tax benefits as granted to Category III AIF for investments made in India under FPI route.
The Government has attempted to attract aircraft leasing activity which was historically carried out from Ireland to IFSC. Aircraft leasing companies operating out of the IFSC are eligible to claim income-tax exemption in respect of business income (including capital gains arising from transfer of aircraft) for a consecutive period of 10 years out of block of 15 years.
Additionally, rentals in respect of lease of aircraft (including interest in case of finance lease) received by a non-resident entity from aircraft leasing unit in IFSC (set up on or before 31 March 2024) are fully exempt from income-tax.
Other developments impacting foreign investors
Besides IFSC, another area that remained in focus in year 2021 is tax exemption provided to sovereign wealth funds (‘SWF’) and pension funds (‘PF’) for investments into infrastructure companies. The Government relaxed some of the onerous conditions as SWF/PF have been provided operational flexibility to invest through holding company, AIF and infrastructure Non-Banking Financial Companies.
Lastly, the Government permitted the FPIs to avail tax treaty benefits for withholding tax on dividend.
Expectations from Budget 2022
With the above being said, there are expectations from the foreign investors to resolve some of the matters.
Streamlining dividend withholding tax process for FPIs
There is lack of clarity amongst the Indian companies as to what kind of documentation should be obtained from FPIs for permitting lower withholding tax on dividend since tax treaty benefits come with riders. In practice, each company calls for different set of information and documents from FPIs for extending tax treaty benefits for withholding tax on dividend. Towards this, the industry expects that if standard set of documents can be prescribed by the Government, it will lead to reduction of administrative efforts at both ends.
5 per cent tax rate on interest from business trust by FPIs
Another issue that requires clarification relates to taxability of interest received by FPIs on securities issued by business trusts. The Budget 2021 led to taxability of interest from business trust at the rate of 20 per cent instead of 5 per cent [this was an unintended consequence due to amendment to the definition of the term ‘securities’ under Securities Contract (Regulations) Act, 1956]. From regulatory perspective, FPIs have been recently enabled to subscribe to debt securities issued by business trusts.
This positive regulatory amendment needs to be accompanied with a clarification on applicability of concessional tax rate of 5 per cent on the interest arising on such debt instruments.
While a lot has been done on IFSC front, the Government is expected to keep the ball rolling and make IFSC further attractive for investors.
On SWF/PF front, it is expected that the Government would further relax the conditions inter alia including providing pass through status to domestic holding company created for investments into infrastructure companies and provide clarity on computation of investment limit at AIF level.
To conclude, tax and regulatory incentives provided by the Government have seen a widely positive response from the stakeholders involved. IFSC has led to set up of activities such as aircraft leasing, fund pooling, banking, etc. which were previously done offshore, in India. Further, the investments in infrastructure companies are picking up given the tax exemptions provided to SWFs and PFs. It would be interesting to see which all expectations of the industry are addressed by the Finance Minister in the upcoming Budget.
Views expressed in this article are the personal opinion of Sunil Badala, Partner and Head, Financial Services, Tax, KPMG in India.