Relief for FPIs: Capital gains on debt securities now exempt from surcharge

The government on Friday exempted foreign portfolio investors (FPIs) that make capital gains on debt securities from the higher surcharge that was introduced in the Budget. This will bring relief to scores of funds.

“The enhanced surcharge shall also not apply to capital gains arising from the sale of any security, including derivatives, in the hands of FPIs,” observed a note by the finance ministry.

The announcement comes a month after the surcharge on income earned from equities and derivatives was scrapped. Debt funds, which make capital gains from trading in government or corporate bonds, will be the beneficiaries. 

“The government has made it clear that capital gains for FPIs from all securities, including debt, will not be subject to the increased surcharge. This is a big positive for debt FPIs,” said Tejas Desai, partner (financial services), EY India. As of August, the total assets under custody of FPIs investing in debt stood at Rs 4.34 trillion, or 13.5 per cent of the overall FPI assets. “Interest income on debt will continue to suffer a higher surcharge,” added Rajesh Gandhi, partner at Deloitte India.

The earlier note by the government, on August 24, had stated that the enhanced surcharge would be withdrawn for capital assets mentioned in sections 111A and 112A of the Income Tax Act. 

This included equity shares, units of equity-oriented mutual funds, and units of a business trust. For FPIs, gains arising from the transfer of derivatives were exempted too. Non-corporate FPIs, structured as trusts or association of persons, were hit by the higher surcharge.

Ordinance relief

Following the announcement on Friday, the government placed an amended Ordinance. The August 24 announcement was not accompanied by any Ordinance, and a number of chartered accountants (CAs) and tax consultants were undecided on levying a higher surcharge.

FPIs selling shares are issued tax certificates by their consultants and CAs, indicating the quantum of tax to be withheld. The same is withheld by banks and paid to the I-T department. “Legally, there was a dilemma. Most of the big accounting firms didn’t want clients to pay a higher surcharge as it had not materialised into law,” said a tax consultant who deals with FPIs. The top tax firms were also grappling with changing their systems to enable a different tax treatment for gains on equities and derivatives, and that for debt instruments. 

Friday’s announcement will help do away with this differential tax treatment.