Mumbai: To encourage the local incorporation of foreign banks, the Indian Banks Association, or IBA, the national lobby of lenders, has pitched for an exemption of capital gains tax on foreign banks that wish to convert their branch operations in the country into wholly owned subsidiaries.
Existing tax rules discourage foreign banks from doing this as their local branches are treated as foreign companies. This implies that if a foreign bank wishes to set up a wholly owned subsidiary for local incorporation, which the Reserve Bank of India (RBI) favours, it has to transfer its assets to the new unit. However, it cannot dilute its stake in the subsidiary for eight years after the transfer of assets, failing which it will end up paying a capital gains tax of about 22%.
IBA also reasoned that the global economic environment requires governments around the world to increase capital in banks or have stronger banks acquire weaker ones. But in India, if a foreign bank does so, it will trigger a capital gains tax.
To resolve the bottleneck, IBA, in its budget recommendation, has proposed that the government dispense with the eight-year time limit. “It should be provided that the exemption would apply in respect of any transfer in the course of conversion of an Indian branch of a foreign bank into an Indian subsidiary in accordance with specific guidelines prescribed by RBI,” IBA said.
Finance minister Pranab Mukherjee will announce the budget for 2012-13 on 16 March.
In January last year, RBI published a discussion paper that favoured the subsidiary route for foreign banks to operate in India, saying that local incorporation will enhance the commitment of foreign lenders to the country. The discussion paper also suggested almost doubling the role of foreign banks in the Indian banking system. India has 33 foreign banks, including large lenders such as Citibank, The Hongkong and Shanghai Banking Corporation Ltd and Standard Chartered Plc. Foreign banks together control at least 10% of the total assets in the system.
According to the RBI paper, all new overseas banks in India will have to locally incorporate themselves, and existing players, particularly the systemically important ones, will be encouraged to opt for local incorporation and act as subsidiaries of foreign parents. But the apex bank is yet to announce its guidelines.
According to tax experts and bankers, foreign banks are unlikely to convert their branches in to subsidiaries unless the huge tax burden is removed.
Senior executives of foreign banks agreed the huge tax liability is a discouraging factor. “It is reasonable to presume that foreign banks will expect an exemption from the capital gains implications (on conversion of assets) should they proceed to adopt the wholly owned subsidiary route,” said Sanjiv Bhasin, general manager and chief executive officer, DBS Bank Ltd, India. “If the exemption is not there all foreign banks will revisit their whole strategy on the matter.”
According to Bhasin, banks that have ownership in real estate will evaluate the implication of the stamp duty that will be levied on transfer of assets.
The industry lobby has also highlighted a range of other issues including reducing the lock-in period for term deposits with tax exemption to three years from five years to make the product more attractive and giving exemption to banks from tax deducted at source on their incomes.
Standard Chartered is the only foreign bank that has listed its shares in the Indian stock markets through Indian Depository Receipts. The IDRs have fallen 40.15% since they hit a peak of Rs134.5 on 3 March 2011. On Friday, Standard Chartered IDRs ended at Rs80.50 on BSE, down 1.65%, while the Sensex rose 0.75% to 18,289.35 points.
Sudhir Kapadia, tax market leader, Ernst and Young India Pvt. Ltd, said an amendment in the Income Tax Act is critical to enable foreign banks to migrate to the subsidiary route. “Nobody will be willing to pay the high capital gains tax,” Kapadia said. “Besides, the same norms require the ban to dilute holding over a period of time and doing so, the bank, in effect, will have to pay to comply with the norm as any dilution will trigger capital gains tax within a period of eight years,” Kapadia said.