No targeting of FPIs; higher tax on all super-rich: Finance Ministry

Sitharaman had in the Budget proposed to increase the surcharge, charged on top of the applicable income tax rate for the super-rich

Amid a backlash from foreign portfolio investors over the new tax, the government Tuesday said it is not targeting FPIs by raising tax on super-rich individuals, and foreign investors have an option to convert into a corporate entity to avail of lower rates available to such category.

Finance Minister Nirmala Sitharaman in her maiden budget hiked the surcharge on income tax paid by super-rich individuals.

However, some 40 per cent of the FPIs automatically come under the higher tax rate as they have been investing as a non-corporate entity such as trust or association of persons (AOPs), which in the Income Tax law are classified as an individual for the purpose of taxation.

"A picture is being painted that Government has targeted FPIs by increasing surcharge over FPIs only. It is totally false. The surcharge has been increased for all super-rich individuals and non-corporate entities regardless of whether they are domestic investors or foreigner, FPI, FII. The surcharge has not been increased for companies again regardless whether it is domestic or foreign," a top government source said.

Sitharaman had in the Budget proposed to increase the surcharge, charged on top of the applicable income tax rate, from 15 per cent to 25 per cent for those with taxable incomes of between Rs 2 crore and Rs 5 crore, and to 37 per cent for those earning more than Rs 5 crore. This takes the effective tax rate for those two groups to 39 per cent and 42.74 per cent respectively.

The source said the surcharge has been increased on all income, be it from salary, saving, interest, mutual funds, stock market or trade in the futures and options (F&O) markets, LTCG, STCG, or other means and is applicable to all individuals and those who choose to be counted as an individual be it through funds, Association of Persons (AOPs) or Trusts.

"FPI is not FDI. Any foreign investor has two options - it can come as a non-corporate entity such as trust, Association of Persons, etc or as a corporate company. The non-corporate entities get taxed as individuals in India. Since the FPIs who are making transactions through stock/F&O markets have chosen to come from trust route instead of company route, so they will be taxed automatically as an individual," the source said.

Surcharge on capital gain on companies is lesser and therefore these FPIs could choose to come as a company, if they wanted to pay a lesser surcharge, he said adding about 60 per cent of FPIs/FIIs have come by adopting company route and paying a lesser surcharge.

However, they can't opt for both -- the benefits as an individual person and benefits as a company.

For an individual earning total income of more than Rs 5 crore, the long-term capital gains tax rate would go up from 12 per cent to 14.25 per cent, while short-term capital gains rate would increase from 17.9 per cent to 21.4 per cent. For companies, the surcharge rate has not been changed.

Even though option to invest as company is available, many FPIs have chosen trust route to enjoy less tax or zero tax through tax havens like the Cayman Islands and Luxemburg, where numerous global funds do create corporate entities to set up a separate structure for each class of fund to be invested, the source said adding through trust structure they enjoy tax avoidance in their countries.

"Giving them (FPIs) further lower surcharge rate as compared to our domestic investors would be discriminatory to the domestic investors and would not be a level playing field as for as the tax structure is concerned. This would amount distorting our tax structure and allow them to chose to eat their cake and have it too," he said.

Sources said that the proposal to extend the tax surcharge to foreign entities was in parity with the increase in the income tax for rich Indians whose total income is more than Rs 5 crore a year. "Therefore, the FPIs demand which is being projected through various sources in media is unjustified."

Also, domestic investors should not be discriminated and put to disadvantage.

"FPI is not targeted discriminately. The tax structure for individual, HUF, and AoPs is same. FPI is investment by foreign entities for quick gains in stocks, bonds, and other such instruments and can be sold off quickly to make money with short-term attempts and do not create not the long-term investment in the economy," the source added.