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India hasnt thought through its tax on foreign funds
May, 31st 2016

Are you an American investor in an India fund? Call up the manager and ask three questions: what part of your profit might you have to share with the government; how will you settle your dues; and what must you do to receive an offset against US taxes. Good luck getting straight answers.

No, your manager is not being evasive. It’s just that India’s resolve to collect capital-gains taxes from foreign investors, while laudable in its motivation, stands on wobbly operational legs.

The key idea is for India to stop discriminating between local investors, who must hand over 15% of their short-term profits to the authorities, and foreigners who enter the country via funds typically domiciled in Mauritius or Singapore. Since neither nation imposes capital-gains taxes on securities, and India has tax treaties with both, those investing through offshore funds can keep all they make.

That’s now changing. Mauritius-based funds will be subject to taxes from next year. The deal with Singapore is also up for renegotiation.

Considering just how hard it is to tax internationally mobile capital, full marks to a developing country with yawning public-investment gaps for taking the bold step. If only somebody had thought through the mechanics.

How will an American investor who buys into a Mauritius-domiciled India fund in, say, October, and books a profit in December, get a tax certificate from the Indian government in time for the mid-April deadline of the US Internal Revenue Service? India’s tax year ends 31 March. Besides, the Indian tax department will at best issue a blanket certificate to the fund. It won’t know the identities of the ultimate beneficiaries, let alone print individual tax-paid receipts. So investors might pay twice—once in India and once in the US—on the same income.

The Indian government says it’s setting up a working group to ease foreign investors into its new tax regime from April 2017. Currently, the global fund industry—at least the part that’s not entering India via Mauritius or Singapore—seems to be coping by subsuming India’s short-term capital-gains tax into its costs. Some offshore mutual and exchange-traded funds pay taxes when they sell Indian shares held for less than a year. Never mind that funds should be pass-through vehicles, which shouldn’t be taxed.

When a fund takes on a burden that only some investors ought to bear, the result is reduced net asset values. Even if it’s a minor erosion, why penalize patient foreign investors who hold fund units for years and years together with speculators? That runs counter to India’s desire to encourage long-term money into the stock market. But a weak-kneed tax can support only so much idealism.

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