The Finance Minister has brought some sunlight for capital markets in India. For players in the securities market, the highlights of the Finance Bill, 2014 are as follows:

Characterisation of income of fund managers of FPIs: One of the major issues plaguing investments into India was tax uncertainty in relation to characterisation of income for managers of FPIs residing in India. Despite huge investments being made, fund managers preferred residing overseas due to the question whether double taxation treaty benefits would be accorded to such entities.

This led to substantial tax leakages from investments made in Indian securities and loss of employment opportunities. However, from now on, securities held by an FPI will be considered “capital assets”, and gains derived from their transfer will be considered capital gains and thus the income arising out of such transfers will be eligible for treaty benefits. This would incentivise fund managers to shift to India, which in turn is expected to increase inflows of investments along with additional improvements in employment opportunities and reduction of tax disputes.

Depositary Receipts: It has been seen that capital raising through IDRs has been abysmally low. In order to revamp the regulatory framework for IDRs and based on the recommendations of the Sahoo Committee Report, the government has proposed to launch a more liberal regime - Bharat Depository Receipt (BhDR). BhDRs would have a wider range of securities such as debentures, bonds and mutual funds as underlying securities as opposed to equity alone. In addition, requirements in relation to taxation have been simplified to facilitate fund raising. In addition, it has been proposed to liberalize the norms for ADRs and GDRs by expanding the list of underlying securities to include all securities of public and private companies.

Mutual funds: The mutual fund industry is one which has been adversely affected. Fixed Maturity Plans (especially those with a tenor of 1-3 years) and debt funds would become less lucrative owing to higher taxes on all non-equity linked mutual funds. Presently, for the units of mutual funds with the exemption of equity oriented funds, the capital gains arising on transfer of units held for over a year are taxed at a rate of 10%. This rate is proposed to be increased to 20%. Additionally, until now 12 months was the threshold for categorising an asset as a long term asset however this has been stretched to 36 months. Although, some relief comes in the form of retirement mutual funds being afforded a tax treatment similar to regular pension funds, that might not be sufficient to undo the damage.

Tax Pass Through for REITS and InvITs: The Finance Bill has proposed a tax pass-through regime for real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). This means that income received by the REIT would be exempt from taxation. Tax clarity has made these new investment vehicles lucrative investment options while ensuring that funds are directed towards infrastructural growth in the country. However, a much awaited and a logically consistent announcement regarding a pass-through status for all categories of alternative investment funds, which have already raised substantial amounts of funds, was missing from the budget. On the contrary, a CBDT circular on the nature of a fund being closed to new investors to avail of pass through benefits has wreaked havoc in the beneficial alternate fund industry.

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Date:September 29, 2015