Foreign institutional investors (FIIs) can breathe easy with the Direct Taxes Code (DTC) Bill, 2010 proposing that their income be taxed as capital gains rather than business income. Opinion is divided on whether this will end the uncertainty over FII taxation.
A number of tax experts have said that the categorisation of income as capital gains and not as business income would remove existing uncertainty on FII taxation. However, there are some who feel that this proposal will only partly address the issue, as the taxman could still reject concessional treaty benefits under the proposed General Anti Avoidance Rules (GAAR).
The DTC Bill has made it clear that any security including derivatives held by an FII would be considered an “investment asset”. The income arising from the transfer of such investment assets will be income chargeable under the head “capital gains”, the DTC has said.
There is no special regime proposed for taxation of FIIs under the DTC 2010. It will be on a par with the taxation of other non-residents. Also, the DTC seeks to do away with the usage of expressions long term and short term, but maintains the distinction in terms of time period of 12 months for an investment asset.
The Code also specifies that capital losses can be offset only against capital gains. It proposes to permit capital losses to be carried forward indefinitely.
Under the DTC, where the investment assets (shares or units of an equity oriented fund where the transaction is chargeable to STT) are held for more than one year, capital gains will effectively be exempt from tax as there will be 100 per cent deduction available on the gains. Where the investment asset is held for less than one year, capital gains will be effectively taxed at 15 per cent.
“The DTC seeks to remove the uncertainty on income characterisation. The income of FIIs will be treated as capital gains. If we come from a view that the RBI had permitted FIIs to only invest in Indian securities market and not be involved in trading activities, then the profits should only be treated as capital gains,” Mr Nihar Jambusaria, National Head, Tax Advisory Services, BDO, told Business Line.
Under the proposed DTC, it would not make a difference if the FII had a permanent establishment in India or not, he noted. “While the Code has clarified the characterisation, the availability of treaty benefits will be seen on a case-to-case basis and depend on how GAAR will be applied. One can only say that the DTC has partly removed the uncertainty on the FII taxation issue,” said Mr Prashant Khatore, Partner, Ernst & Young Mr Aseem Chawla, Partner, Amarchand & Mangaldas, said that the legislative prescription suggests that the income earned by FIIs should be characterised as capital gains.