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No capital gains tax exemption
September, 09th 2009

The plan to encourage overseas firms to raise capital in India through Indian Depository Receipts, or IDRs, as they are popularly known, appears to have hit a road block, with the revenue department not in favour of granting long-term capital gains tax benefits for such issues.

IDRs are derivative instruments like Global Depository Receipts (GDRs) and American Depository Receipts (ADRs) which have shares as the underlying asset and denominated in the local currency the rupee. These instruments will help foreign companies raise capital in India by listing IDRs on local exchanges.

Standard Chartered, which has been working on an IDR issuance, could have raised close to $700 million. A host of institutions and corporates are also said to be watching the developments on this front, given their interest in raising money from the local capital market.

StanChart has sought a clarification from the finance ministry on the taxation of this instrument. The revenue department and the department of economic affairs two separate wings of the finance ministry handling policy issues and taxation, respectively, hold different views on taxation of these instruments.

A clarification from the finance ministry was expected in this years Budget, providing capital gains tax exemption for IDRs on par with shares of listed companies if held by an investor for a year or more.

However, a senior official in the revenue department who does not wish to be identified says "no clarification will be issued because the law is very clear. IDRs would not be exempted from long-term capital gains tax. The direct tax code comes into effect from 2011 and it does not exempt securities from capital gains tax. So, there is no reason to exempt IDRs from capital gains tax."

Finance ministry officials said they have communicated these views to Standard Chartered Bank. According to investment bankers, one of the major problems in promoting IDRs was the lack of capital gains tax benefit for investors. Merchant bankers and Standard Chartered Bank officials are said to have spoken to the finance ministry and CBDT officials.

Now, Income Tax laws, in vogue, provide for a capital gains tax exemption for securities which are held for over an year. For less than a year, capital gain tax will be levied at 15%.

However, bankers say they are just seeking tax parity for IDRs with local shares till the new tax code comes into
effect. "IDRs should be treated like other shares. Currently, both insurance companies and banks cannot invest in an IDRs. This leaves only domestic institutions, retail investors and foreign institutions which can invest in these issues. If the government is serious about promoting IDRs, they need to put it on par with local shares," said a senior investment banking official.

StanChart is likely to take a final decision on raising money through IDRs this month. If the decision is approved, the bank is likely to go ahead with the issue towards the end of the year.

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