FPIs’ tax outgo on bonds may go down by 2-7% on surcharge rollback

Mumbai: Foreign portfolio investors (FPIs) dealing in India’s bond markets are set to benefit after finance minister Nirmala Sitharaman said on Friday that FPIs need not pay higher surcharge on capital gains if they have paid the securities transaction tax.

FPIs have been provided relief from the tax surcharge for transactions in all asset classes – equities, mutual funds, debt and derivatives. But wealthy investors who are residents of India and family trusts, on the other hand, will have to continue paying higher surcharge on gains made from derivative and bond market trades.

After the rollback of the enhanced surcharge, the tax outgo on FPIs dealing in bonds will come down in the range of 2-7%, depending on the income slab and holding period of securities.

For instance, if an FPI has taxable income of over Rs 5 crore and has held the bonds for over three years, the effective tax rate will come down by 2.5%. However, if the same FPI has held the security for less than three years, the tax rate will go down by 3.5%. If the investments are in derivative markets, including currency derivatives, the tax outgo would reduce by 7%.

However, exemption from the enhanced surcharge will be applicable only in those cases where the investor sells the bonds in the market and doesn’t hold them until maturity. This is because if the bonds are held until maturity, the income arising would be deemed as interest income and not capital gains tax.

“The announcement will provide a huge relief to FPIs that trade in debt markets. Effectively, the government has now withdrawn the tax surcharge hike on almost all the FPI transactions,” said Rajesh Gandhi, partner, Deloitte India. “However, domestic investors will continue to be subject to the enhanced surcharge on their derivative trades.”

In the Union Budget for FY20, the government had increased the tax surcharge applicable on wealthy non-corporates (both domestic and foreign). However, following a backlash from FPIs, the government partially rolled back the tax surcharge in August. The surcharge applicable on capital gains made on the sale of listed shares was already waived last month.