What caused the market crash? Big tax hit sends FPIs running for cover

NEW DELHI: Amid a host of Budget proposals that Finance Minister Nirmala Sitharaman tabled in Parliament on Friday, the increase in surcharge on income-tax hit foreign portfolio investors (FPIs) hard, leading to Monday’s big selloff.

FPIs rushed to book profit after Budget fine print showed the hike in I-T surcharge will lead to a spike in long-term capital gains tax for overseas investors.

On Monday, CBDT Chairman Pramod Chandra Mody said the board was examining FPIs' concern on tax surcharge and would issue a clarification on the issue soon. Later the FM said no fresh clarification is needed on FPI taxation.

"I do not think any clarification on tax surcharge on FPIs is needed for now," she said at a press conference following RBI board meeting.

Monday's jitters cost equity investors in excess of Rs 3 lakh crore on Monday.

Under the tax laws, equity investors need to pay a 10 per cent (11.96 per cent effective) tax on long-term capital gains in the case of selling of shares of listed securities, when the gains are in excess of Rs 1 lakh. A 15 per cent tax (17.94 per cent effective) is levied, if such capital gains are short term in nature (less than 1 year).

If one sells shares of unlisted securities on a long-term basis, LTCG tax rises to 20 per cent and STCG levy to 30 per cent. On derivative trades, the levy on short-term capital gains is 30 per cent. Besides, selling of immovable property attracts 20 per cent short-term capital gains. None of these rates have changed in the Sitharaman’s Budget.

What has changed is the surcharge in the Rs 2-5 crore income group from 15 per cent to 25 per cent, and for Rs 5 crore-plus income group from 15 per cent to 37 per cent. Earlier, a 15 per cent surcharge was levied on annual income of over Rs 1 crore.

Overseas funds, especially mutual funds, have in the past preferred to be structured as AOP (Association of Persons) or trusts to avoid Minimum Alternative Tax (MAT).

This means if such FPIs accumulate income of over Rs 2 crore entirely from listed equities, they will now attract 25 per cent surcharge over their capital gains tax, short or long. In the case of income of Rs 5 crore and above, the same will go up to 37 per cent.

“While one would continue to pay 10 per cent LTCG on income over Rs 1 lakh on listed shares, if the capital gains along with the other income heads exceeds Rs 2 crore, then one has to pay the higher surcharge,” Chairman at JMP Advisors. Accordingly, the net tax rate increase for the two income groups will be 3 per cent and 7 per cent, respectively, said Jairaj Purandare.

FPIs would thus bear effective peak LTCG and STCG rates of 14.25 per cent and 21.37 per cent, respectively.

Bhavin Shah, partner at PwC India, said for the Rs 2-5 crore income group, the effective LTCG and STCG would now be 13 per cent and 19.50 per cent, respectively. For those in the Rs 5 crore bracket, which most FPI would likely be in, LTCG and STCG will go up to 14.25 per cent and 21.37 per cent.

In case of gains from unlisted securities and derivatives trade, STCG for the Rs 2-5 crore group will be 39 per cent, while it will be as high as 42.74 per cent for the Rs 5 crore-plus group.


“The increase in surcharge has not gone down well, as it will increase effective tax rates of higher income groups. The dilution that we may see due to a proposal to increase in minimum public shareholding is another worry,” said Sanjay Sanghvi of Khaitan & Company.

Analysts said the Rs 5 crore threshold is too small for FPIs since foreign institutions are known for taking large positions in the Indian market.

"The increased surcharge has a bearing on FPIs coming in through the Trust route and taxation of Cat-3 AIFs. This potentially reduces the post-tax attractiveness of India, vis-à-vis other markets, where such a high rate doesn’t exist," said Amar Ambani of YES Securities.

The effective tax rate for the highest bracket is now highest since 1992, Edelweiss Securities said in a note.