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India Proposes CGT On Overseas Investors

by Mary Swire,, Hong Kong

17 June 2010

The Indian Central Board of Direct Taxes has revised its draft Direct Tax Code (DTC) on capital gains tax but it is controversial for foreign institutional investors. Consultations on the modified proposals only lasted until June 30, 2010.

The new draft DTC provides that gains (losses) arising from the transfer of investment assets will be treated as capital gains (losses). These gains (losses) will be included in the total income of the financial year in which the investment asset is transferred. The capital gains will be subjected to tax at the rate of 30% in the case of non-residents and in the case of residents at the applicable marginal rate.

If the result of the aggregation of gains and losses over the tax year year is a loss, then the total amount of capital gains will be treated as 'nil' and the loss will be treated as unabsorbed current capital loss at the end of the financial year.

The current distinction between short-term investment assets and long-term investment assets on the basis of the length of holding of the asset will be eliminated. However, in the case of a capital asset which is transferred anytime after one year from the end of the financial year in which it is acquired, the cost of acquisition and cost of improvement will be indexed to reduce the inflationary gains.

A new Capital Gains Savings Scheme should be framed by the Central Government. Capital Gains deposited under this scheme would not be subject to tax until their withdrawal from the scheme.

According to the Discussion Paper, the following major issues and concerns have been raised regarding the taxation of capital gains:

  • Currently, short-term capital gains arising on transfer of listed equity shares or units of equity oriented funds are being taxed at 15% and long term capital gain arising on transfer of such assets is exempt from tax. The withdrawal of this regime would raise the tax liability and may cause fluctuations in the capital market;
  • The rate of 30% for taxation of capital gains in the hands of non-residents is very high as in the case of listed equity shares they are currently being taxed at nil rate if held for more than one year;
  • Foreign Institutional Investors (FIIs) play a significant role in the Indian capital market. Various countries, including emerging markets, offer non-residents a special tax regime to attract investments and promote depth of capital markets; and
  • FII should not be liable to Tax Deducted at Source (TDS) on capital gains as this may cause undue hardship to them. The current provisions relating to payment of the liability as advance tax should be continued.

According to the Discussion Paper, a major area of dispute is whether the income from transactions in the capital market should be characterized as business income or as capital gains.

The majority of Foreign Institutional Investors (FII) are reporting their income from investments as capital gains, but some class such income as “business income” and claim total exemption from taxation in the absence of a Permanent Establishment in India.

It is proposed that the income arising on purchase and sale of securities by an FII shall be deemed to be income chargeable under the head "capital gains‟. The Discussion Paper says this would simplify the system of taxation, bring certainty, eliminate litigation and be easy to administer.

TAGS: capital gains tax (CGT) | tax | investment | business | India | mining | law | capital markets | investment funds | equity investment | stock exchanges | inflation

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