India - Taxation

India - Taxation

International funds and fund management survey

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1.1 Taxation of funds

Resident Funds

The Indian income-tax law specifically recognizes the following tax exempt funds1:

Alternate Investment Funds (AIF)

As per the Finance Act, 2013, income of a Venture capital Fund (VCF), registered under the Securities and Exchange Board of India (SEBI) (AIF) Regulations 2012, shall be exempt from tax. Pass through status has been provided to these funds, i.e., the income will be taxed in the hands of the investors, as and when accrued or received by them.

Mutual Funds

Under Indian income-tax law, the entire income earned by any mutual fund registered with the SEBI (Mutual Funds) Regulations, 19962 is exempt from tax in India.

The mutual fund will receive all income without any withholding tax.

Income distributed by a mutual fund is exempt in the hands of the unit holders; however, income distribution tax (IDT) must be paid by the mutual fund at the following rates:

For income distributed to any persons being individuals or Hindu Undivided Family:

  • by a money market mutual fund or a liquid fund – 28.325 percent (inclusive of surcharge and education cess)
  • by a debt fund other than money market mutual fund or a liquid fund – 14.1625 percent (inclusive of surcharge and education cess) upto 31 May 2013 and 28.325 from 1 June 2013 onwards.

For income distributed to any other person:

  • By a money market mutual fund or a liquid fund – 33.99 percent (inclusive of surcharge and education cess);
  • By a debt fund other than money market mutual fund or a liquid fund – 33.99 percent (inclusive of surcharge and education cess).

To avoid double taxation, IDT is not paid when distributing income to a unitholder of equity-oriented funds.

STT is charged on transactions entered into a recognized stock exchange, at varying rates on the value of specified taxable securities.

The recent changes to STT rates are as under:

Nature of transaction Payable by Value on which tax shall be levied Rate of tax (%)
  Up to 31 May 2013 1 June 2013 and onwards
Delivery-based purchase/ sale transaction in equity shares entered in a recognized stock exchange Purchaser/ Seller Value at which shares are bought/ sold 0.1 0.1
Delivery-based purchase transaction in units of equity-oriented fund entered in a recognized stock exchange Purchaser Value at which units are bought 0.1 NIL
Delivery-based sale transaction in units of equity-oriented fund entered in a recognized stock exchange Seller Value at which units are sold 0.1 0.001
Non-delivery-based sale transaction in equity shares or units of equity-oriented fund entered in a recognized stock exchange Seller Value at which shares/units are sold 0.025 0.025
Sale of a futures in securities Seller Futures: The value at which futures are traded 0.017 0.01
Sale of an option in securities Seller Options: The option premium 0.017 0.017
Sale of an option where the option is exercised Seller Value at which the units are sold 0.25 0.001
Sale of unlisted equity shares under an offer for sale to the public included in an in initial public offer and subsequently listed on a recognized stock exchange. Seller Value at which shares are sold 0.2 0.2
Sale of an option where the option is exercised Purchaser Settlement price 0.125 0.125

 

Value of taxable securities transaction in case of:

  • option in securities – such as, the option premium in case of sale of an option in securities and the settlement price of such option in case where the option is exercised
  • futures – at the price at which such futures are traded
  • any other security – at the price at which such securities are purchased or sold.

Equity-oriented fund means a fund:

  • where the investible funds are invested by way of equity shares in domestic companies to the extent of more than 65 percent of the total proceeds of such fund
  • which has been set-up under a scheme of a mutual fund;
  • provided that the percentage of equity share holding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures.

STT applicable on Equity-oriented schemes:

  • Not allowed as a deduction in computing capital gains
  • Allowed as deduction in computing business income from transactions in securities.

Foreign funds

Foreign funds may invest in Indian markets through the following alternate modes:

  • as Foreign Institutional Investors (FIIs) registered with SEBI; or
  • as Qualified Foreign Investors (QFIs).

FII – It is an entity established or incorporated outside India, which proposes to make investment in India. An FII is registered under and governed by the SEBI (FII) Regulations, 1995.

QFI – Specified class3 of foreign investors allowed to invest in Indian Mutual Funds through SEBI registered qualified depository participants (QDP’s) in listed securities such as listed non-convertible debentures, listed bonds of Indian Companies, listed units of mutual funds and corporate bonds that are to be listed within 15 days. To facilitate such investment, SEBI and RBI4 have laid down the regulatory procedural guidelines and conditions, one of the conditions being that the redemption proceeds would be subject to withholding at applicable rates.

Income of such Foreign funds (FIIs and QFIs), are subject to tax in India.

Under the Indian income-tax laws, a specific tax regime is in existence to tax FIIs in India. However, in case of QFIs, clarification with regard to specific tax regime (especially withholding regime) is awaited. In the absence of such clarification, we understand that this route of investment has not been practically implemented. Hence, the general taxes as applicable to non residents also apply to QFIs.

FII Taxation

FII Taxation

The domestic tax law provides concessions to FIIs as regards taxation of income from dividend (that is, dividends which are not exempt), interest on securities and capital gains arising on alienation of Indian securities. Income from dividends (other than exempt dividend) and interest on securities of FIIs is taxed at a concessional rate of 20 percent plus applicable surcharge and education cess thereon.

Capital gains tax rates*

Income Type Corporate/ Non Corporate
Short Term Capital Gain (%) Long Term Capital Gain (%)
Sale of listed securities (STT paid) 15 NIL
Sale of listed securities (STT not paid) 30 108
Sale of unlisted securities 30 108

 

*Surcharge, as relevant, and cess would apply in addition.

QFI Taxation

In case of QFIs, income from dividends (other than exempt dividend) and interest on securities5 will be taxed at the rates, as applicable to non residents.

In absence of a specific tax regime for QFI’s, the tax rates below shall apply:

Capital gains tax rates*

 

Income Type Corporate Non Corporate
Short Term Capital Gain (%) Long Term Capital Gain (%) Short Term Capital Gain (%) Long Term Capital Gain (%)
Sale of listed securities (STT paid)6 15 NIL 15 NIL
Sale of listed securities (STT not paid)6 40 207 (10% - without indexation) 30 207 (10% - without indexation)
Sale of unlisted securities6 40 108 30 108

 

*Surcharge, as relevant, and cess would apply in addition.

Applicable surcharge rates as amended by the Finance Act 2013 are:

For Corporate entities

  • NIL, where the income does not exceed INR 10 million;
  • 2 percent on the amount of tax payable where the income exceeds INR 10 million but up to INR 100 million; and
  • 5 percent on the amount of tax payable where the income exceeds INR 100 million.

For Non- Corporates

  • NIL, where the income does not exceed INR 10 million; and
  • 10 percent is levied on the amount of tax payable where the income exceeds 10 million.

In all cases, education cess of 3 percent is leviable on tax plus surcharge.

In the case of a remittance to a country with which a double taxation Avoidance agreement (DTAA) is in force, the tax ought to be deducted at the rate specified in the Finance Act of the relevant year or at the rate provided in the DTAA, whichever is more beneficial to the taxpayer. However, the applicability of beneficial rate will be subject to fulfillment of PAN8 and TRC9 conditions. (Also refer to para 1.7 on TRC)

1.2 Taxation of resident investors in a resident fund

The taxation of resident investors is as follows.

Income distributed by a mutual fund is exempt from tax in the hands of the recipient.

Capital gains tax

Period of holding - A unit of a mutual fund, shares of a company and listed securities held by the investor as a capital asset, is considered to be a short-term capital asset, if it is held for 12 months or less from the date of its acquisition by the investor. Accordingly, if the unit of a mutual fund, shares of a company, and listed securities is held for a period of more than 12 months, it is treated as a long-term capital asset. In case of unlisted securities, the period of 12 months should be read as 36 months.

In this context, the definitions of “capital asset” and “transfer” have been widened with retro-effect from 1 April 1961 specifically with a view to tax in the hands of non-residents, gains from direct or indirect transfer of assets in India.

In the context of units of a registered mutual fund:

  • Where sale/repurchase transaction of units (other than equity-oriented fund) is not chargeable to STT:

    Long-term capital gains tax on the transfer of units other than equity-oriented fund is levied at the rate of 20 percent, subject to an upper limit of 10 percent of the gains computed without the benefit of cost indexation. Short-term capital gains tax would apply at normal rates depending on the type of entity. The tax liability is further increased by surcharge and education cess.

Where sale/repurchase transaction of units of equity-oriented fund is chargeable to STT:

As tabulated in point 1.1 above, STT is chargeable on transactions of purchase or sale of units of equity-oriented mutual fund on the recognized stock exchange and sale of equity-oriented mutual fund to the mutual fund.

  • Long-term capital gains arising from sale of units of equity-oriented mutual fund on a recognized stock exchange or a unit of an equity-oriented fund to the mutual fund are not subject to income-tax;
  • Short-term capital gains arising from sale, of units of an equity-oriented fund on a recognized stock exchange or a unit of an equity-oriented fund to the mutual fund are subject to tax at 15 percent plus applicable surcharge and education cess on tax plus surcharge.
  • The applicable rates of surcharge (amended in the Finance Act 2013) and cess are as under:

Corporate entities

  • NIL, where the income does not exceed INR 10 million;
  • 5 percent is levied on the amount of tax payable where the income exceeds INR 10 million but up to INR 100 million; and
  • 10 percent is levied on the amount of tax payable where the income exceeds INR 100 million.

Non-corporates

  • NIL, where the income does not exceed INR 10 Million; and
  • 10 percent is levied on the amount of tax payable where the income exceeds INR 10 million

Education cess of 3 percent is levied on tax plus surcharge (if any) in all cases

Long-term capital gains are exempt from tax if the capital gains are invested within six months from the transfer of the units in certain bonds issued by specified institutions.

1.3 Taxation of resident investors in a non-resident fund

The worldwide income of an Indian resident is taxable in India. Benefits under India’s double taxation agreements with the country involved can be availed of.

Income of a mutual fund registered with SEBI is exempt from income-tax. Thus, there are no Indian income-tax implications for registered mutual funds who invest in units of non-resident funds.

1.4 Taxation of non-resident investors in a resident fund

The taxation of non-resident investors is as follows:

Income distributed by a mutual fund registered with SEBI is not liable to tax in the hands of the unitholder. The tax treatment is the same as in the case of a resident unitholder.

Capital gains tax

Period of holding – as explained in Para 1.2 above.

  • Where sale/repurchase transaction of units of equity-oriented fund is chargeable to STT at rates applicable to resident unitholders.
  • Where sale/repurchase transaction of units (other than equity-oriented fund) is not chargeable to STT:
    1. FIIs: long-term capital gains are subject to income-tax at the rate of 10 percent plus applicable surcharge and education cess thereon. Short-term capital gains are subject to tax at the rate of 30 percent plus applicable surcharge and education cess thereon.
    2. Overseas financial organizations (being any fund, institution, association or body established outside India, which has entered into an arrangement for investment in India with an approved mutual fund, public sector bank or a public financial institution with the approval of the government): Long-term capital gains on units are taxable at 10 percent plus applicable surcharge and education cess while short-term capital gains are taxable at the rates prescribed on normal income.
    3. Other non-resident investors, including QFIs: Long-term capital gains tax on the transfer of listed units (other than equity-oriented fund) is levied at the rate of 20 percent (plus applicable surcharge and education cess) subject to an upper limit of 10 percent (plus applicable surcharge and education cess) of the gains computed without the benefit of cost indexation. However, long term capital gains on transfer of unlisted units will be levied at 10 percent (plus surcharge and education cess) without the benefit of cost indexation or currency fluctuation protection. Further, short-term capital gains tax would apply at normal rates depending on the type of entity.
  • Withholding of tax at source by the mutual fund towards payment on redemption/repurchase of units to/from non-resident investor:
    1. Tax is not required to be deducted at source in respect of capital gains arising to FIIs on transfer of Indian securities. However, the FII is required to compute and pay advance tax on such capital gains.
    2. In respect of transaction in equity-oriented fund, the mutual fund is not required to deduct tax at source on long-term capital gains and is required to withhold tax at source at the rate of 15 percent (plus surcharge and education cess) on short-term capital gains.
    3. In respect of transaction in units (other than equity-oriented fund), the mutual fund is required to deduct tax at source at the rate of 20 percent (plus surcharge and education cess) on long-term capital gains on listed units and 10 percent (plus surcharge and education cess) on long term capital gains on unlisted units. Tax at source at the rate of 30 percent (plus surcharge and education cess) will be deducted on short-term capital gains
  • Applicable Ssurcharge rates and cess have been mentioned in para 'Foreign funds'.

In the case of a remittance to a country with which a double taxation Avoidance agreement (DTAA) is in force, the tax ought to be deducted at the rate specified in the Finance Act of the relevant year or at the rate provided in the DTAA, whichever is more beneficial to the taxpayer. (Also refer to para 1.7 on tax residency certificate)

Mutual Funds would be obliged to withhold tax at penal rates of TDS in case of payments to investors who have not furnished their PAN. The penal rate of TDS is 20 per cent or any higher rate of TDS, as may be applicable.

1.5 Taxation of fund management/custodian companies

Asset management companies (AMCs), by way of domestic companies, are taxed on their worldwide income, in accordance with the provisions of the Income-tax Act, 1961. The income of an AMC from managing the fund is taxed as profits and gains of a business. The currently applicable income tax rate for a domestic company is 30 percent plus a NIL surcharge where the income does not exceed INR 10 million. A surcharge of 5 percent of the tax where the income exceeds INR 10 million but up to INR 100 million or 10 percent where the income exceeds INR 100 million and education cess at 3 percent on tax plus surcharge, if applicable, resulting in an effective tax rate of 30.90 percent or 32.445 percent or 33.99 percent, as the case may be.

Custodian companies are taxed in the same manner as other companies.

1.6 Entitlement to income

Under the domestic law, income generally arises to the unitholder only when it is distributed by the fund.

1.7 Double tax agreements

All funds, which are tax resident either in India or in another country with which India has a treaty, have access to India’s double taxation treaty network. Entitlement to the benefits under a treaty depends upon the provisions of the applicable treaty.

For non-residents claiming tax treaty benefits, it is mandatory to obtain from the home country tax authority a tax residency certificate (‘TRC’) of his being a resident. The non-resident may also be required to provide such other documents and information as may be prescribed.

The Act states that the government may by notification; assign meanings to any term used in any tax treaties but not defined in the domestic tax law or in such treaty. Such definition shall be effective from the date of coming into force of the tax treaty.

India has a wide international tax treaty network having signed tax treaties for avoidance of double taxation with more than 85 countries (including 17 countries with which it has signed limited tax treaties).

1.8 Other tax-favored vehicles

Generally, none.

1.9 Transfer taxes, stamp duty, and capital duty

At the time of incorporation, companies are required to pay stamp duty on their authorized capital to the stamp authorities of the state concerned and registration fees to the registrar of companies. Stamp duties vary from state to state. Registration fees are payable on a sliding scale based on the nominal share capital.

Allotment and transfer of shares or securities is generally subject to stamp duty in India. However, allotment and transfer of units in a mutual fund is not subject to stamp duty.

There are no capital duties and transfer taxes in India.

Service tax

Services of AMCs are liable to service tax.

Mutual funds/AMCs are also liable to pay service tax as recipient of services, under the reverse charge mechanism for specified services received by them, including in particular, the following:

  • Taxable services provided from outside India and received in India with effect from 18 April 2006 pursuant to specific amendments made by Finance Act, 2006 and notification of Taxation of Services (provided from outside India and received in India) Rules, 2006. With effect from 1 July 2012, these rules have been superseded by Place of Provision Service Tax Rules, 2012.
  • Specified services received from domestic service providers with effect from 1 July 2012, including legal consultancy services, security agency’s services etc and subject to certain specified conditions.

Services rendered by mutual funds/AMCs from agents/ distributors of mutual funds are exempted from the levy of the service tax with effect from 1 July 2012. Consequently, mutual funds/AMCs are not liable to pay service tax on such services under the reverse charge mechanism.

The current standard rate of service tax is 12 percent plus education cess at the rate of 3 percent. The effective tax rate is, therefore, 12.36 percent.

1.10 Other Provisions

Existing Special Anti Avoidance Rule (SAAR)

Dividend stripping (shares): If shares are purchased within a period of three months prior to the record date of declaration of dividend on shares and are sold within three months after the record date, the loss, if any, arising is ignored to the extent of the dividend on shares which is exempt from tax.

Dividend stripping (units): If units are purchased within a period of three months prior to the record date of declaration of income on units and are sold within nine months after the record date, the loss, if any, arising is ignored to the extent of the income on units, which is exempt from tax.

Bonus stripping: In case of units purchased within a period of three months prior to the record date for entitlement of bonus and sold within nine months after the record date, the loss arising on transfer of original units shall be ignored for the purpose of computing the income chargeable to tax. The loss so ignored shall be treated as cost of acquisition of such bonus units.

General Anti Avoidance Rule (GAAR)

The Finance Act 2013 has postponed the implementation of GAAR to be effective from 1 April 2015, where the tax authorities will have the power to invoke GAAR in cases where an arrangement is entered into for obtaining tax benefit being the primary purpose and hence, can be declared as an “impermissible avoidance agreement”.

The GAAR provisions seek to confer on the tax officer extensive powers, to disregard/ combine/ recharacterise transactions/ persons in situations where there is a tax avoidance motive or where such motive is presumed to exist in law.

Invoking the GAAR provisions may also lead to denial of tax treaty benefits . There are no specific tax provisions governing other collective investment schemes.

Alternate Minimum Tax (AMT)

The Act extends the levy of AMT to tax unit holders (other than companies) to pay AMT at the rate of 18.5 percent (plus applicable surcharge and cess) on the adjusted total income. In a situation where the income-tax computed as per normal provisions of the Act is less than the AMT on “adjusted total income”, the unit holder shall be liable to pay tax as per AMT. “Adjusted total income” for this purpose is the total income before giving effect to the deductions under any section (except section 80P) included in chapter VIA under heading C - Deduction in respect of certain income and section 10AA. AMT will not apply to an Individual, HUF, AOP, BOI or any Artificial Juridical Person if the adjusted total income of such person does not exceed INR 20 lakhs. Further, the credit of AMT which can be further carried forward to ten subsequent years and set off in the year(s) where regular income tax exceeds the AMT.

Permanent Account Number (PAN)

In order to claim benefit of lower tax rates under the domestic law or treaty, as the case may be, the investors will have to obtain an Indian tax registration number/ PAN. In a situation where such PAN is not obtained, a penal withholding tax rate will apply at the higher of:

  • applicable rates under domestic law, or
  • rate or rates in force, or
  • rate of 20 percent.

An investor is required to quote and attach a copy of the permanent account number on the application for purchase of units of a mutual Fund. The Trustee of a mutual fund or a person managing the affairs of the mutual fund on the authority of the trustee is required file an Annual Information Return (AIR) for receipt of INR 200,000 or more from a person for purchase of units of a mutual fund. This return is required to be filed on or before 31 August following the financial year in which the specified transactions have been registered or recorded with them.

India does not levy any inheritance tax at present.

Units of mutual funds do not attract wealth tax.

1 This document takes into account the provisions of the Income Tax Act, 1961, as amended by the Finance Act, 2013.

2 SEBI is the regulator of the capital markets in India.

3 Any person resident in a country that is a member of Financial Action Task Force (FATF) or a member of a group which is a member of FATF and which is a signatory to International Organization of Securities Commission (IOSCO’s) Multilateral Memorandum of Understanding (MMOU) or a signatory of a bilateral MOU with SEBI, and not a resident of a specifically debarred country. Further, such person should not be a SEBI registered FII, sub-account or FVCI.

4 The RBI is the central bank of India which manages the foreign exchange law.

5 As per the Finance Act 2013, interest earned by a FII/ QFI from investments in rupee denominated bonds of an Indian Company or Government security will be subject to lower withholding rate of 5%, subject to the following:

  • interest is payable on or after 1 June 2013 but before 1 June 2015; and
  • rate of interest on the rupee denominated bonds of Indian Company shall not exceed the Government notified rate.

6 Where shares/ debentures are purchased in foreign currency, capital gains shall be computed by converting full value of consideration, cost of acquisition and cost of improvement in the foreign currency in which shares/debentures were purchased. Capital gains so computed shall be reconverted to Indian currency.

7 Subject to an upper limit of 10 percent of the gains computed without the benefit of applicable cost indexation in case of listed shares and units.

8 Without giving benefit of indexation/currency fluctuation protection.

9 Permanent Account Number

10 Tax Residency Certificate

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