FPIs press the panic button on tax surcharge

The government may well have targeted high-income individuals while proposing a tax surcharge but that has taken a toll on foreign investors in the Indian capital market.

According to experts, a large number of foreign portfolio investors (FPIs) in India operate through a trust or a limited liability partnership (LLP) structure that are not recognised as a corporate entity by the Income Tax Act and hence, are taxed as per the individual tax slabs based on their earnings. While presenting her maiden Budget on Friday, Finance Minister Nirmala Sitharaman said that the effective tax rate for individuals having taxable income between Rs 2 crore and Rs 5 crore would increase by around 3%.

Those earning above Rs 5 crore would see an increase of 7% due to the surcharge. Experts believe that the surcharge would see the effective tax rate go up by 3.2 percentage points for those earning between Rs 2 crore and Rs 5 crore, and by 6.9 percentage points for those earning more than Rs 5 crore.

“The surcharge is applicable to non-corporate entities but a significant number of foreign portfolio investors are organised as a trust and they will have an impact in terms of additional tax,” said Riaz Thingna, director, Grant Thornton Advisory.

“Most of these funds would have an income of more than Rs 5 crore and their tax burden would go up from the current 35.8% to 42.7%. For those entities, that earn more than Rs 2 crore but less than Rs 5 crore would see their tax outgo increase from 35.8% to 39%,” explained Mr. Thingna. Incidentally, the impact of the surcharge was clearly visible in the stock markets on Monday as the benchmark Sensex and Nifty plunged by over 2% with participants attributing the increased tax burden as one of the factors for the fall.“The proposed tax regime will hurt non-corporate FPIs as well as several domestic funds, particularly open-ended Category III AIFs (Alternate Investment Funds),” said Tejesh Chitlangi, senior partner, IC Universal Legal.

“This will not only exert a lot of pressure on their fund managers to perform extra by taking higher risks to make up for the lost fund returns on account of additional taxes but also discourage investors from putting in the money as post-tax and post-ee returns may not remain lucrative anymore in an already sluggish market,” he added.

The current calendar year has seen FPIs put in Rs 75,537 crore in the equity market apart from Rs 14,284 crore in the debt segment.