The Reserve Bank of India (RBI) on Tuesday said foreign banks will not have to pay stamp duty and capital gains tax if they convert their branch operations into a wholly owned subsidiary.
The government has modified the relevant laws to allow this, RBI said in a statement on Tuesday. The exemption from capital gains tax is effective from 1 April 2013.
Foreign banks have been hesitant of local incorporation fearing tax and stamp duty liabilities. The central bank has been encouraging foreign lenders in India to operate through wholly owned units rather than branches so that the domestic banking system is insulated from any turmoil in overseas financial markets.
If there is a financial crisis abroad, foreign banks typically tend to withdraw capital from their branches to their parent entities to safeguard their position, which could disturb the local banking system in the countries where they operate. Creating subsidiaries lessens such risks as it increases the commitment of banks to the local markets they operate.
On 6 November, RBI had outlined a framework for setting up of wholly owned subsidiaries by foreign banks in India. It said foreign banks with “complex structures” and banks that do not provide “adequate disclosure” in their home jurisdiction will have to compulsorily convert themselves into wholly owned subsidiaries of their parents in India.
Complex structure here refers to the opaqueness of a bank’s shareholding. For example, many European banks, especially those in the wealth management business, are owned by companies and individuals with a complex chain of holding companies and cross-holdings. In many cases, the owners of the banks are hidden under several layers.
Like local banks, foreign banks will have to lend 40% of their deposits to the so-called priority sector that includes loans to farmers, small enterprises, homes loans below a certain threshold, and minorities, RBI had said.
However, foreign banks that set up local units will be given an “adequate transition period” to achieve their priority sector targets, the central bank said, without specifying the time frame.
Foreign banks’ subsidiaries in India will need to have a minimum paid-up equity capital of Rs500 crore, while existing branches of foreign banks will have to have a minimum net worth of a similar amount if they want to incorporate locally. The parent will be then required to issue a letter of comfort to RBI for meeting the liabilities of the domestic unit.
On 31 March, foreign banks accounted for about 15.2% of the Rs.7.09 trillion capital, reserves and surplus of all scheduled commercial banks, RBI data shows.
Detailing the guidelines for foreign banks, RBI had said it will treat them on nearly equal terms with local lenders if they converted into subsidiary structure.