Tax cloud over indirect transfer provisions for foreign portfolio investors

There is lack of clarity in the manner in which indirect transfer provisions (ITP) would apply to foreign portfolio investors (FPIs) after their re-categorisation into two segments. They are currently divided into three categories at present.

A circular put out by the market regulator, the Securities and Exchange Board of India (Sebi), last Wednesday had stated that FPIs will be re-categorised into categories I and II.

According to the current regulations, investments held by category I and category II FPIs are excluded from indirect transfer provisions. Category III FPIs, however, are subject to these provisions and it remains to be seen if these would be done away with after category III FPIs are moved into category II.

“Now that three categories have become two, what does that mean from an income tax perspective? Does that mean that the transfer provisions won’t apply to FPIs at all? One will have to wait and watch for clarity on the matter,” said Punit Shah, partner, Dhruva Advisors. In 2012, the government had amended the domestic law retroactively to provide that gains from transfer of shares or interest in an entity outside India would be taxable in India if such shares or interest derive their value (directly or indirectly) substantially from assets located in India. These provisions were referred to as the indirect transfer provisions.

The provisions have undergone changes and exemptions were introduced in subsequent years. The 2017 Budget, for instance, granted an exemption to category I and category II FPIs from the indirect transfer provisions, with effect from April 1, 2015.

“It would appear that the indirect transfer provisions will no longer apply to FPIs. However, one does not know whether the changes will impact the exemption enjoyed by category II FPIs at present, and a clarification to this effect by the CBDT will be appreciated,” said Abhay Sharma, partner, Shardul Amarchand Mangaldas & Co.