Two-way fungibility might have boosted the price of Standard Chartered’s Indian depository receipts (IDR). However, tax provisions, or rather the absence of these, could prove to be an impediment for investors.
While the Securities and Exchange Board of India (Sebi) had, in August, allowed partial fungibility for such instruments, at present there are no specific tax provisions under the Income Tax Act, 1961, with respect to tax implications at the time of redemption of IDRs into underlying equity shares. This, experts say, would make it unattractive for investors to convert IDRs into shares due to risk of tax liability.
“While Sebi and the Reserve Bank of India have provided for limited two-way fungibility, there exists no provision providing incentives under the tax laws to make the IDR regime attractive,” leading tax law firm Nishith Desai Associates said in a note. “Any gains arising on redemptions of IDR into the underlying equity shares if not specifically exempt would lead to a situation of the holder being subjected to tax in the absence of any realised gains and, hence, making a redemption unattractive.”
| GOING CHEAP Standard Chartered IDRs are trading at a sharp discount to their underlying shares | |||
| Date | London | India | Discount |
| Aug 1,’12 | 1,320.16 | 1,030.00 | -21.98 |
| Aug 2,’12 | 1,306.63 | 1,020.50 | -21.90 |
| Aug 3,’12 | 1,358.67 | 1,031.50 | -24.08 |
| Aug 6,’12 | 1,268.81 | 1,036.50 | -18.31 |
| Aug 7,’12 | 1,056.23 | 829.50 | -21.47 |
| Aug 8,’12 | 1,135.35 | 857.50 | -24.47 |
| Aug 9,’12 | 1,174.02 | 891.00 | -24.11 |
| Aug 10,’12 | 1,147.31 | 882.00 | -23.12 |
| Aug 13,’12 | 1,162.59 | 886.50 | -23.75 |
| Aug 14,’12 | 1,200.39 | 900.00 | -25.02 |
| Aug 16,’12 | 1,241.27 | 950.00 | -23.47 |
| Aug 17,’12 | 1,240.89 | 945.50 | -23.80 |
| Aug 21,’12 | 1,251.62 | 946.00 | -24.42 |
| Aug 22,’12 | 1,226.75 | 953.00 | -22.32 |
| Aug 23,’12 | 1,220.71 | 953.00 | -21.93 |
| Aug 24,’12 | 1,238.77 | 973.00 | -21.45 |
| Aug 28,’12 | 1,248.78 | 960.50 | -23.08 |
| Aug 29,’12 | 1,238.20 | 1,013.00 | -18.19 |
| Aug 30,’12 | 1,233.69 | 1,023.00 | -17.08 |
| Aug 31,’12 | 1,223.27 | 1,015.00 | -17.03 |
| Sep 3,’12 | 1,224.61 | 1,029.00 | -15.97 |
| Sep 4,’12 | 1,206.88 | 1,017.50 | -15.69 |
| Sep 5,’12 | 1,221.22 | 997.50 | -18.32 |
| Sep 6,’12 | 1,259.22 | 1,010.00 | -19.79 |
| Sep 7,’12 | 1,259.18 | 1,025.50 | -18.56 |
| Sep 10,’12 | 1,262.95 | 1,025.00 | -18.84 |
| Sep 11,’12 | 1,266.84 | 1,027.50 | -18.89 |
| Sep 12,’12 | 1,273.84 | 1,035.00 | -18.75 |
| Sep 13,’12 | 1,288.64 | 1,040.50 | -19.26 |
| Sep 14,’12 | 1,320.04 | 1,056.00 | -20.00 |
| Note: Prices (Rs ) adjusted for comparison Source: Bloomberg | |||
An IDR is a security of a foreign incorporated entity listed on an Indian stock exchange and its underlying is a listed security abroad. At present, Standard Chartered Plc, which listed in June 2010, is the sole IDR listed in the Indian market and its underlying trade on the London Stock Exchange. Two-way fungibility refers to the ability of an IDR holder to convert such instrument into the underlying equity security and vice versa.
To give a push to such instruments and encourage more foreign entities to list their securities in India, market regulator Sebi, following a Budget announcement, has allowed conversion of IDRs into underlying equity shares to the extent of 25 per cent in a single year of the IDRs originally issued, subject to fulfilment of certain conditions.
Following Sebi’s go-ahead, Standard Chartered IDR's discount, to its underlying shares in London, has narrowed to about 20 per cent from 25 per cent levels last month.
Experts said it would be an attractive proposition for an IDR holder to convert it into underlying shares, as they are better valued abroad. However, they say a specific provision in the IT Act is needed for investors to understand the proper tax implications better, while redeeming or converting shares into IDRs.
IDR holders are also subject to tax on dividends received as income from other sources and is taxed at the regular tax rates. Such dividends from Indian companies are exempt from tax in the hands of the shareholder.
Investors could still remain wary of investing in such instruments due to some structural issues like, dividend distribution tax and insurance companies not being permitted to invest.
“The regulatory change brought about to allow limited two-way fungibility is a step in the right direction, and it should make IDRs relatively more marketable. However, the results are more likely to be visible only when the other challenges faced by the Indian capital market are addressed,” says the note by Nishith Desai.
