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How will new IDRs be taxed in India?
May, 27th 2010

It is only for the convenience of listing in India that the issuing foreign company does not issue shares directly to the Indian public, but issues IDRs instead, which represent entitlement to a certain number of shares.

The first-ever issue of Indian depository receipts (IDRs) by a foreign company is now available in India with Standard Chartered Plc offering them. IDRs are similar to sharesthe receipts represent and entitle you to a particular number of shares of the issuing company (in the case of Standard Chartered, 10 receipts represent one share of the bank).

It is only for the convenience of listing in India that the issuing foreign company does not issue shares directly to the Indian public, but issues IDRs instead, which represent entitlement to a certain number of shares. IDRs would be traded on the Indian stock exchanges in the same manner as shares are traded. However, since the issuing firm is a foreign entity, there is a significant difference in the taxation of income in respect of such IDRs, which you need to keep in mind as an investor.

Normally, in the case of sale of shares of an Indian company on a stock exchange, if the shares have been held for at least 12 months, long-term capital gains that accrue to you are totally exempt. If such shares have been held by you for a lesser period, your gains are taxed at a concessional rate of 15%.

This exemption is available only to equity shares of a company on the sale of which securities transaction tax (STT) has been paid. The benefit would not extend to any capital gains that you may make on the sale of IDRs of a foreign company since transactions in such IDRs are not subject to STT, nor are IDRs the same as equity shares (though they may entitle you to the same benefits as equity shares).

If you have held IDRs for at least 12 months, since IDRs are listed securities (though not equity shares), you would get the benefit of the concessional rate of long-term capital gains tax at the lower of 20% of the gains computed with indexation of cost, or 10% of the gains computed without indexation of cost.

For instance, if you acquired IDRs for Rs110, sold them after a year on the stock market for Rs160, and the indexed cost is Rs125, your capital gains tax would be the lower of 20% of Rs35 (Rs160 minus Rs125), which comes to Rs7, or 10% of Rs50 (Rs160 minus Rs110), which is Rs5. Your tax liability would, therefore, be Rs5. In other words, your maximum tax liability would be 10% of your gains. Of course, your short-term capital gains on sale of IDRs would be taxed at your tax slab rates, the highest being 30%.

The other important difference is in relation to taxation of dividends. Dividends received in respect of equity shares of an Indian company are not taxable at all since the Indian company pays dividend distribution tax (DDT) on the dividend distributed by it. In case of IDRs, the foreign company does not pay DDT, and the dividend received by you in respect of such IDRs is, therefore, not exempt from tax. It is taxable at normal tax slab rates applicable to you.

An interesting point is that in respect of companies which are tax residents of the UK (such as Standard Chartered), though there is no tax payable in the UK on the dividends you get as a foreign shareholder, a tax credit may be available to you. Under the Double Taxation Avoidance Agreement between India and the UK, an Indian shareholder of a UK company receiving dividends from that company would be entitled to the same tax credit that a UK shareholder of the company would have obtained on those dividends. Under UK law, if a shareholder receives a dividend of Rs90, a tax credit of Rs10 is available, with dividends being taxed at Rs100. Therefore, you may also get the same benefit (which can be claimed by you as a relief under section 90), thereby reducing your income tax liability. Of course, such relief is subject to fulfilment of certain conditions.

The point that you, therefore, need to understand is that as an Indian resident taxpayer, income from IDRs is normally taxable in India. You may get certain tax concessions, but for that you need to understand the tax laws of the specific country of which the issuing company is a tax resident. You will also have to understand the provisions of any double taxation avoidance agreement with that country. A difficult proposition for most small taxpayers indeed!

 
 
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