Foreign institutional investors will have to classify income from capital market transactions as capital gains and not as business income, the revised discussion paper of the Direct Tax Code (DTC) says.

This move would check hot money flow into Indian markets, say analysts.

The revised paper of the DTC has retained the clause directing foreign institutional investors to classify income from investments as capital gains and pay tax on it.

The majority of FIIs are reporting their income from such investments as capital gains. However, some of them are characterizing such income as business income and consequently claiming total exemption from taxation in the absence of a Permanent Establishment in India.

It is therefore, proposed that the income arising on purchase and sale of securities by an FII shall be deemed to be income chargeable under the head capital gains, the revised discussion paper said.

This would simplify the system of taxation, bring certainty, eliminate litigation and is easy to administer, the paper said. The capital gains arising to foreign institutional investors will not be subjected to TDS and they will be required to pay tax by way of advance tax on such gains.

The revised discussion paper is open for public comments till June 30. The Government hopes to introduce a Bill on the proposed DTC in the Monsoon session of Parliament.

Income earned by the appreciation or depreciation of an asset class cannot be classified as business income. It was therefore logical that this was classified as capital gains, said Mr J. Moses Harding, Head, Global Markets Group, IndusInd Bank.

This would definitely be a burden on the hot money investor'. With this, only investments that are strategic in intent would come in and all fleet-footed speculative trades would come down, he said.

This would result in stability of both capital inflows and reverse flows. For instance, the rupee fluctuated from 39 to the dollar to 52 and then to 48 through 44 in the recent past. Such instances would be minimised, he added.