Transaction cost for dealing with Indian shares is already one of the highest worldwide.
The recent policy measures taken by the government
such as tweaks to the tax agreement with Mauritius and additional curbs on participatory notes (p-notes) have increased both the cost and the compliance burden on FPIs.
Experts say any further tweak could put India in a disadvantageous position compared to other emerging markets (EMs).
“FPIs are concerned about any tweak to the current long-term capital gains tax framework. It could also lead to a significant drop in FPI flows and lower the revenue for the government
arising out of securities transaction tax (STT). Hence, we met the government officials to explain our apprehensions,” said a source.
According to the current rules, any investments held in listed equities for more than one year are exempt from capital gains tax. These relaxations were provided by the government to encourage the stock market investment culture and attract more flows from both foreign and domestic investors.
Experts say computation of capital gains would also be a key challenge to some of the big-ticket FPIs who are pool of funds.
However, current taxation laws treat FPIs as a single taxpayer as all their trades are done through a single demat account. But a majority of FPIs are not funds themselves but asset managers or pooling vehicles for numerous investors. Hence, transferring the tax liability to end-beneficiary also becomes complicated for foreign institutional investors (FIIs).
“Currently, there is a lot of buzz in the market that the capital gains tax structure would be altered in the Union Budget.
Any such tweak could have repercussions from FPIs and could also dampen the current market rally. There are also administrative challenges associated with such a move. The government should keep the capital gains tax as it is and to mop up additional tax from the markets, they could consider increasing the STT,” said Amit Singhania, partner, Shardul Amarchand Mangaldas.
Tax experts say increasing the period to avail capital gains exemption might not essentially lead to a significant increase in tax collection for the government. Also, the capital gains tax would depend largely on when an investor wants to sell a stock. They say investors could re-evaluate their strategies in such a situation and in cases where they want to avail capital gains exemption they could hold the stocks for more than two years. This could also squeeze some of the liquidity in the markets.
“It is difficult to predict how much additional revenue would the government get by altering the LTCG period as it depends not only on the direction of the market, but also on an individual deciding to sell or not,” said Bank of America Merrill Lynch in a note.
Equities in India get a preferential treatment compared to other asset classes when it comes to capital gains tax. While the minimum holding period to avail capital gains tax exemption is one year for equities, it is three years for all the other asset classes such as real estate. However, in case of listed equities, an investor has to pay STT and dividend distribution tax. Both these channels provide a steady revenue streams for the government.