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Foreign portfolio funds may get tax waiver

Rakesh P Sharma & Janaki Krishnan in Mumbai

The task force on direct tax, headed by former finance secretary Vijay Kelkar, is likely to recommended the removal of the 10 per cent long-term capital gains tax.

In case the government accepts the recommendation, foreign institutional investors would be exempted from paying capital gains tax in the country. However, the short-term capital tax of 30 per cent is likely to continue. The task force will present its report to the finance ministry on Friday.

Further, exemption of long-term capital gain tax is also expected to solve FIIs' problems relating to the Mauritius route. It is expected that the government may introduce an alternative entry tax at the time of transaction, which would be similar to a turnover tax paid by brokers.

Moreover, the revenues from long-term capital gains tax have been marginal, estimated at around Rs 125 crore in the current fiscal. Moreover, the move is expected to give a big boost to the capital markets.

The recommendation is aimed at encouraging the investing community to look at a longer term view rather than a short-term approach.

Typically, most FIIs take a short-term view especially when they invest in emerging markets such as India. The total abolition of the tax on long-term capital gains for investments of more than a year is expected to give a fillip to such long-term investments.

Analysts, however, said that it remained to be seen whether removing the long-term capital gains tax of 10 per cent would really be of any significant impact to the FIIs.

On July 5, the Delhi High Court had ruled that FIIs should be taxed even if they route their transactions through Mauritius under the double taxation treaty.

The two-member bench had ruled that avoidance of double taxation would not mean that a person do not have to pay tax in any country whatsoever.

In Mauritius, in terms of statute, a foreign company is not entitled to own any property, open any bank account, or do any business. Several restrictions have been imposed in that country as a result whereof no income may be generated in Mauritius and thus no income-tax may be payable.

FIIs have been increasing their investments in India over the years and the government has bent over backwards in order to accommodate FII inflows.

While FIIs and foreign direct investment have been made fungible (in most of the sectors), the limit for FII investments (which are portfolio investments as opposed to strategic investments which would be categorised as FDI) in Indian equities has been steadily going up.

The fungibility ensures that portfolio investments by FIIs can go up to as high as 100 per cent in some cases. Recently, the government also allowed two-way fungibility between Indian shares, American depositary receipts and global depository receipts.

Last year, though FIIs were found to have predominant presence in the market crises which erupted in March, the authorities chose to crack down on entities operating in India as overseas corporate bodies, while FIIs were let off relatively scot-free.

The market needs some big ticket players and those with some 'stickiness' factor in them. The idea behind abolishing long-term capital gains is to discourage short-term momentum games by the FIIs.

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