What are FPIs?
Foreign Portfolio Investment (FPI) is holding financial assets from a country other than the investor's own. FPI holdings can include stocks, ADRs, bonds, mutual funds, and exchange-traded funds. While Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) are the two most common ways for an investor to participate in an overseas economy, FPI is passive ownership where investors do not have direct control, ownership, or stake in the company and its ventures. Due to this reason, FPIs are more liquid and volatile than FDIs.
How does Budget 2019 affect FPIs in India?
In her maiden budget presentation on Friday, finance minister Nirmala Sitharaman proposed to levy a higher surcharge on the super-rich. The surcharge will be raised from 15 percent to 25 percent for incomes between Rs 2 crore and Rs 5 crore and to 37 percent for incomes above Rs 5 crore.
Tax experts say several foreign portfolio investors (FPI) in India are under either as trusts or Association of Persons (AOPs) to avoid Minimum Alternate Tax (MAT). However, the category of AOPs falls under the mandate of the new tax proposals and it is estimated that 1,500 to 2,000 FPIs will be affected by these surcharges.
What will be the new tax rates on FPIs?
According to the new budget, the tax on funds that earn an income of more than Rs 5 crore in a year and structured as AOPs will increase to 42.7 percent from the current 35.8 percent. For funds earning an income between Rs 2 crore and Rs 5 crore, the tax rate will surge to 39 percent from the existing 35.8 percent. The change will also partially impact FPIs dealing in the cash markets. For instance, for an FPI earning more than Rs 5 crore income, the long-term capital gains tax rate would go up from 12 percent to 14.25 percent, while short-term capital gains rate would increase from 18 percent to 21.4 percent.
It is believed that the new surcharges proposed in the Union Budget 2019 were presented with the sole objective to increase taxes on the super-rich individuals in India and the higher tax rates on FPIs are an unintentional consequence. Many were expecting a lower capital gains tax, heavily contrasting what the new budget has proposed. The new proposal, if implemented, will have an adverse impact on FPIs because it will raise long-term and short-term tax rates. Besides the tax on capital gains, other taxes such as transaction tax and stamp duty are also levied on FPIs.
How is the government responding?
Finance minister Nirmala Sitharaman refused to provide an immediate clarification on the FPI issue at a press conference after the customary post-budget board meeting of the Reserve Bank of India in New Delhi.
“I don’t think clarification at the moment is all that required. Let’s see as it goes. You think it is required? Will take it as it comes,” she said, when asked about the FPI issue. Sitharaman added that this is a question she would rather answer in the Parliament. Sitharaman's ambiguous response came hours after Central Board of Direct Taxes chairman PC Mody said at an Assocham conference that the matter has been brought to the government's notice and a clarification would be issued soon.
How are FPIs reacting?
Arvind Sanger, managing partner of Geosphere Capital Management, told CNBC-TV18 that the move is "unplanned'' and ''arbitrary''. ''I suspect that this was never the intention of the government as I don't believe that the government is trying to punish equity investors. The need of the hour is a quick clarification from the government that this move was meant for high-income individuals and not pooled assets,'' Sanger added.
In a similar sentiment, Vaibhav Sanghavi, Co-CEO of Avendus Capital, said, “We hope to hear a clarification soon from the government that investment vehicles registered under the SEBI regime should be exempt from the surcharge increase.”