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Foreign Funds In India Hit By Tax Ruling

by Lorys Charalambous,, Cyprus

10 January 2007

In a stunning blow for foreign investors India's Authority on Advance Rulings (AAR) on income tax ruled on Monday that profits from management of portfolio investment are subject to short term capital gains tax and cannot be exempted as business income.

Fidelity Group had sought advance rulings in respect of 40 of its funds after the AAR had previously ruled in its favour in a test case. Its Fidelity Advisor Series VIII fund was exempted from short term capital gains tax (10% on profits from holdings held for less than one year) in India. Share traders are exempted from long term capital gains tax because they pay the Securities Transaction Tax.

The AAR took the view that Fidelity Series VIII does not have a fixed place of business (permanent establishment) in India. Taking into account the frequency of purchase and sale of shares, the AAR said that the gains from trading in shares were in the nature of business income.

Fidelity can appeal the new ruling to the Supreme Court. If it stands, it will act as a precedent for all other similar FIIs (Foreign Institutional Investors) whose home countries apply capital gains tax, regardless of whether there is a double tax treaty with an FII's home country. FIIs from Mauritius and Singapore would escape since these two countries do not have capital gains taxes, yet do have tax treaties with India.

The Indian government has however included wording in a new version of its tax treaty with Singapore in order to prevent 'round-tripping' by Indian investors, and is trying to persuade the Mauritius government to agree to similar terms. Fidelity cannot be accused of round-tripping, at least. The AAR's ruling would seen to be favourable for Mauritius and Singapore as entrepot bases for FIIs involved in India.

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