Here’s some great news for all foreign portfolio investors! The CBDT has finally provided clarity on how investments by FIIs and QFIs- categories that constitute India’s new Foreign Portfolio Investment regime- will be taxed. Just this month, SEBI notified its FPI regulations; repealed its extant FII regulations and left it up to the tax department to clarify the modalities of taxation. The tax department has now clarified that the tax procedures for FPIs will be similar to that for FIIs. That brings in clarity not just for FIIs who will now have to migrate to the FPI regime but also for Qualified Foreign Investors or QFIs- an investor category that was introduced last year but did not take off as it placed onerous requirements of withholding on Qualified Depository Participants. Here’s Tax consultant Ameet Patel on the impact of CBDT’s Circular Ameet Patel, Partner, Sudit K Parekh & Co.
As you are aware, SEBI had been very proactive in setting up a committee and verbatim accepting the committee report and forwarding it to the government to implement it. While SEBI was proactive, the problems that were faced were with reference to taxation because everyone felt that unless necessary notification was issued or necessary amendments were passed in the Income Tax Act, the FPI scheme would not really kick off & as we saw - based on the experience of the QFI scheme- the tax related issues really bogged down that scheme. So when the FPI regulations were notified by SEBI, everyone was awaiting the necessary amendments or clarifications on the income tax side. As you are aware, the IT Act refers to the term FII and in the last budget we had a couple of amendments whereby the concept of QFI was brought into the IT Act. So the IT Act was nowhere talking about FPI & therefore it was obviously the expectation that the Act would be amended so as to bring clarity on FPIs.
Now with this notification that seems to have been issued by the CBDT, it appears that the notification talks about Section 115AD of the IT Act. This Section refers to the taxation of FIIs & in that the term FII is defined to be 'any foreign investor as may be notified by the Government from time to time' and using those powers vested in the government, under the particular Section, the new notification seems to have been issued. And the notification says that for the purpose of Section 115AD, the term FII would mean or include FPIs and therefore all the tax related Sections or provisions in the IT Act applicable to an FII would going forward apply to an FPI. Clearly this notification is aimed at allaying all the fears that the foreign investors and the custodian industry had on the taxation front on FPIs and hopefully we should now see the foreign investors getting more confidence and all those investors who had held back their applications hopefully would now go forward with their plans of entering India in the context of investment in Indian securities.
As you are aware, in the context of QFIs, the biggest stumbling block was the provision whereby QDPs were required to take care of withholding tax provisions and they were forced to ensure that anytime money is going into the bank account of a QFI, the QDP was to ensure that tax was deducted and paid to the government. In the context of FII, that requirement was not there. Most of the income of the FIIs is either exempt or is deducted by someone else. Since the regulations relating to FPI- on taxation- are identical to the ones relating to FII, I feel that the QDPs or the DDPs - the custodians basically- they would certainly heave a sigh of relief and they would no longer be required to take care of the withholding tax provisions.
The only thing that is a curious point is that in the operational guidelines for DDPs, issued by SEBI, para 6 mentions that the DDP will need to set in place a mechanism to ensure that tax is deducted and paid over from any payments made to the FPIs and of course at that place they mentioned that as maybe prescribed by the CBDT or the IT Department or the Finance Ministry from time to time. So there was a reference again to the withholding tax provisions and not to the advance tax mechanism which is what is now in place in light of the latest notification.