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The government may consider a proposal to offer foreign banks with local branches tax parity with their Indian counterparts, a move that will reduce their tax rates by as much as 15 percentage points to 22%, two government officials said.

“We are examining the issue. An announcement to this effect can find mention in the upcoming budget," one of the two officials said, requesting anonymity. The finance ministry is looking at a representation made by some foreign lenders, the person said.

Foreign banks pay significantly higher taxes than domestic lenders as corporate tax rate cuts in the past years did not apply to them. While they can be taxed at a lower rate if they convert their operations into subsidiaries, few have chosen to do so, given the operational complexities and regulatory challenges involved.

The banks asked the government to treat them on a par with Indian banks as they are subject to the same regulations and norms and practise the same method for computation of profits and taxable income.

“While domestic banks have opted for a lower rate option at 22% (plus surcharge and cess) under the tax laws, a similar tax rate option is not available to foreign companies, creating significant disparity," said a second official aware of the development. Branches of foreign banks are taxed at the base rate of 40% plus surcharge and cess.

“There should be parity in corporate tax rates for branches of foreign companies with domestic companies, in line with global practice of corporate tax parity," the official said, adding that all BRIC countries, except India, and a majority of OECD countries, treat local and foreign entities equally.

A spokesperson for the finance ministry did not respond to a query on the issue.

“The tax structure in India has widened the level playing field for foreign banks, with differential ranging between 12-15 % or more. So if the government lowers the taxes for foreign banks, it will help them consolidate their operations here," said Keyur Shah, partner and tax financial services leader, EY India. “The option for overseas banks is to convert their operations into subsidiary operations to get taxed at lower rates. But that has regulatory challenges and operational complexity ties including bringing changes in lending norms, priority sector lending, etc."

If the government accepts the proposal, it will run counter to the Reserve Bank of India’s (RBI) policy of encouraging foreign banks to set up wholly owned subsidiaries in the country.

“Instead of bringing tax parity between domestic and foreign banks having branch operations, a better solution could be to maintain the tax differential between the two while lowering taxes on both. In any case, the government has mandated all banks starting operations after 2010 to set up wholly owned subsidiaries. So the taxation should promote the idea but with lower rates all across," said Rajesh Gandhi, partner, Deloitte India.

Under current tax laws, the branch of a foreign bank in India is treated as a foreign company. To set up a wholly owned subsidiary for local incorporation, a foreign bank will have to acquire the business of the branches, requiring the parent to pay capital gains tax for the transaction.

Currently, there are 46 foreign banks in India, who collectively operate more than 300 branches. According to RBI data, the share of foreign banks in the banking system’s total assets is in the single digit, and an expansion in their operations could push up their share to close to 10%.

Traditionally, foreign banks have focused on trade finance, wealth management, mergers and acquisition advisory, besides funding large companies that do not require an extensive branch network. Several foreign banks operate in the country with just a single branch, and their participation in retail banking services is limited.

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