DTC: Concern for FIIs

In the economic times there is an interesting article carrying the title DTC: Cause of Worry for FIIs. Some aspects relating to the taxability of FIIs has been a matter of previous discussions on this blog. Here are some of the excerpts of the article in the economic times:

"The Bill provides that the income earned by FIIs will be deemed as capital gains. This would not have much impact on the FIIs as most FIIs at present offer their income to tax as capital gains. The deemed characterisation under the Bill implies that income from derivative transactions, which are currently treated as business income, will now be taxed as capital gains. Considering that most derivative contracts have a maturity period of between 30-90 days, the income from the derivative transactions will be subject to tax at 15%. "

"For FIIs investing from favourable treaty jurisdictions, all capital gains will be tax exempt. Though, structures without much commercial substance are likely to face challenges with the advent of general anti-avoidance rule ('GAAR'). As per the proposed GAAR, if the structure has been set up to obtain an unintended 'tax benefit' or involves treaty shopping, the Indian tax authorities will have the ability to lift the corporate veil or deny the treaty benefits. While the detailed rules and safe harbours are still to be announced, it is apprehended that holding structures set up in tax favourable jurisdictions such as Mauritius and Cyprus will be presumed to be set up for tax avoidance and the onus to prove otherwise will be on the taxpayers. This uncertainty might tilt the balance in favour of certain well established jurisdictions such as Singapore, which already have an objective substance test built into their tax treaty with India. For those FIIs who have traders based in jurisdictions from where they invest, it may be easier to meet the commercial substance test."


"The significant impact on the FIIs will be as regards the taxation of their investors. The Bill deviates from the current law and has sought to tax offshore transfer of shares in companies which hold at least 50% or more investment in the form of Indian assets. As a consequence, non-residents investing in an open-ended offshore fund set up as a company may be subject to Indian tax upon redemption of offshore shares. This might create unintended cascading tax burden on the investors in the offshore funds set up as collective investment vehicles, and which have more than 50% asset allocation to India."



I shall explore some of the points in detail at a latter point.