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Low long-term gains tax for FIIs may continue
February, 19th 2007

The government is set to continue the concessional long-term capital gains tax regime for foreign institutional investors investing in private placements in unlisted securities. FIIs pay a 10% long-term capital gains tax on profits from the sale of unlisted securities. Short-term capital gains are taxed at 30%. These shares are not traded on the stock exchange and hence do not attract the securities transaction tax (STT). Domestic investors, on the other hand, pay a 20% long-term capital gains tax on profits from sale of unlisted securities.

The finance ministry is in favour of retaining the concessional tax rate on long-term capital gains from the sale of unlisted securities in order to lend certainty to the tax treatment of foreign institutional investors. According to official sources, the ministry has rejected the recommendation made by the task force on non-resident taxation (2003) to usher in equality in the tax treatment between residents and non-residents.

Currently, FIIs and domestic investors who invest listed securities have to pay STT. If these investors offload the shares before one year, they have to pay a 10% short-term capital gains tax. If the shares are sold after one year of acquisition, they are exempt from paying long-term capital gains tax.

Mauritius-based FIIs do not pay even the 10% short-term capital gains tax from transactions which attracts STT. This is because Mauritius does not tax capital gains. Whereas FIIs from destinations such as the US have to pay the 10% short-term capital gains tax.

The task force on non-resident taxation, in fact, recommended omitting the provisions under Sections 115 AB, 115 AC and 115 AD of the Income-Tax Act. Under Section 115 AB, offshore funds are taxed on income from units purchased in foreign currency and long-term gains from transfer of such units are taxed at a concessional rate of 10%. Currently, this section effectively provides a concessional rate only on long-term capital gains from sale of non-STT bearing units.

Under 115 AC, income from bonds and GDR bought in foreign currency and long-term capital gains from the transfer of such securities are taxed at a concessional rate of 10%. Under 115 AD, FIIs are taxed at flat rates on income from securities and capital gains from sale of shares. The provision is, therefore, relevant only for interest income and capital gains from unlisted shares for which STT has not been paid.

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