Offshore funds: Foreign investors get a much-needed tax clarity

This could boost investments in the capital market

The move to treat income generated by foreign asset managers residing in India as capital gains, as proposed in the Budget 2014-15, could provide a boost to foreign investments into the capital market.

Experts said the move  could have a significant impact on how the almost $130-billion (Rs 8 lakh crore) worth of foreign portfolio investments’, or FPIs (erstwhile foreign institutional investors, or FIIs), Indian assets are managed.

"The finance minister's recommendation to characterise gains of FPIs as capital gains (against business income) will provide the much-needed certainty to these. This would not only boost the capital markets but also rest tax litigations. It would encourage fund managers relying on this characterisation to return to India for conducting such trading activities," said Bijal Ajinkya, partner at Khaitan & Co.

Currently, the Income Tax (IT) Act does not incorporate express provisions to characterise gains earned by offshore funds, leading to uncertainty on tax treatment.

Legal tax experts said as the gains earned by an offshore fund were regarded as business income, these were subject to a tax rate of up to 40 per cent. This was driving a lot of foreign institutional investors (FIIs) to set up trading teams in Hong Kong and Singapore.

India's capital markets regulator Securities and Exchange Board of India (Sebi) had written to the finance ministry over FPI taxation. Sebi had said the inclusion of 'safe harbour' provisions would prevent the drain of India's asset management sector to offshore markets.

Experts said some indirect benefits of the move could be a rise in employment generation in the asset management sector.

"It is not as if an FII would suddenly decide to relocate its whole trading team to India. But this will help Indian mutual funds managing offshore funds. Fund houses will now be able make a pitch to manage FIIs’ Indian assets," said Gautam Mehra, executive director at PricewaterhouseCoopers.