A government clarification on indirect transfer of shares seems to have unnerved foreign portfolio investors as they could end up paying up to 40% tax on their investments in the country’s capital markets.

As per the clarification issued on last Wednesday, if the shares of an Indian company held by a fund constitute more than 50% of its total assets, and the value of the holding exceeds.`10 crore, indirect transfer of these shares abroad would be taxed in India.

Since then, many foreign portfolio investors (FPIs) and their custodians have been trying to gauge the exact impact of the government’s clarification on their returns even as government officials chose to shrug it off as unnecessary fears. Industry experts are of the view that investors will have to start paying the tax in a year or two when revenue officials make the demand.

“Investors in FPIs can face 10%-20% tax on long-term capital gains and higher tax of 30%-40% on short-term capital gains as per the current law,” said Rajesh H Gandhi, partner at Deloitte Haskins & Sells.

FPIs may face up to 40% tax on Indian investments

“This is because the concessional rate of 0-15% is available only for sale of securities listed in India and not foreign securities,” he said.

While Wednesday’s clarification is around an earlier regulation, FPIs so far had assumed this rule covered only M&A (mergers and acquisitions) situations and that indirect transfer of shares was exempt. Senior government officials played down the development.

“The clarification was issued only to address queries and if anyone wants to have a legally binding opinion they can go to AAR (Authority of Advanced Ruling),” a senior tax official said.

While theoretically the government can also levy tax retrospectively for the last seven years, a tax official said that is unlikely.

“As per the current law, tax department can go back till seven years but these issues are only theoretical in nature. In case of such demand (retrospective) the tax official will have to go through a high-level committee,” the person said.

The official pointed out that there were only two such tax claims in the last couple of years. Amit Singhania, partner at Shardul Amarchand Mangaldas, said finance minister Arun Jaitley had constituted a high level committee to examine any fresh cases for scrutiny under retrospective taxation, “Accordingly, this is not left to discretion of tax officer alone. However, this makes it clear that tax department (after seeking approval of the committee) can legally still make such an adjustment,” he said.

In some cases, tax officials can theoretically even go 14 years retrospectively and demand tax from India-focused FPIs, experts said. “There is argument that such reassessment could be done for the past 14 years though it is unlikely that authorities would want to go that far,” said Gandhi of Deloitte Haskins & Sells.

However, there is a view in the industry that while the revenue officials may not demand tax retrospectively, prospective adjustments could start happening soon. “You could see some adjustments where tax officials scrutinise last two years of transactions and demand a tax on that,” a person in the know said.