Tax benefits to help FPIs adopt algo-trading in big way

Algo Trading refers to the automated execution of trades on stock markets through pre-programmed software platforms installed on servers

As a liberal tax regime kicks in for overseas investors from next fiscal, the FPIs (Foreign Portfolio Investors) are expected to expand their activities in Indian markets by using the high-frequency trading technology, experts say.

High frequency trading, also known as Algorithmic Trading (Algo Trading), refers to the automated execution of trades on the stock markets through pre-programmed software platforms installed on servers. The same is becoming popular in India.

While presently only a few Foreign Portfolio Investors (FPIs) have adopted algo-trading, many more a expected to take it up, leading consultancy PwC said.

To improve ease of doing business and for better regulatory oversight, the Indian capital markets regulator Sebi created a new FPI category after pooling together different categories of overseas investors such as FIIs, their sub-accounts and Qualified Foreign Investors (QFIs).

According to PwC, there has been low FPI participation in algo trades so far, mainly because of the ambiguity related to characterisation of their income as 'business income' or 'capital gains'.

"If their income is treated as business income, FPIs could have been taxable at 40% on a net income basis," PwC Executive Director Suresh Swamy said.

"Due to high volume of transactions usually carried on by algo-funds, there was a possibility of that their income would be characterised as business income," Swamy added.

However, with government announcement in budget 2014-15 that the income arising from transactions conducted by FPIs would be classified as capital gains with effect from April 1, 2015, many more investors are likely to take to algo-trading.

"This means FPI's long term capital gains earned on transfer of securities on which securities transaction tax is paid will be exempt from tax," Swamy said.

"While short term capital gains are taxable at 15%," he added.

As per Sebi's latest data there are nearly 8,400 registered FPIs in the country. The FPIs have poured in a total of USD 204.64 billion so far into the economy and are one of the largest drivers of Indian stock markets.

According to the government, necessary amendments to the norms for treating FPI income as capital gains would be made with effect from April 1, 2015.

Under the proposed amendments, any security held by FPI which would be treated as capital asset only so that any income arising from transfer of such security by FPI would be in the nature of capital gain. There is no tax on long term capital gains while short term capital gains are taxable at the rate of 15%.