Finance minister Nirmala Sitharaman took several measures to woo foreign portfolio investors (FPIs) after the misstep last year on imposing a surcharge on investors which were registered as a trust. The steps showcase how the government is seeking to tap private capital, especially foreign funds, to revive economic growth at a time when the government’s balance sheet is stretched.
These include a withholding tax rate of 5% for FPIs investing in the bond market, eliminating the dividend distribution tax (DDT), letting them claim credit in home jurisdiction, almost a total exemption for sovereign wealth funds if they invest in infrastructure and other notified priority sectors.
“Expectations were very high and therefore market is a bit disappointed but there are a lot of incentives for foreign investors," Nirmal Jain, founder and chairman, IIFL, said in a statement on Saturday. The Centre tried to pull all stops in reaching out to foreign investors in the budget, it added.
The finance minister also announced full tax exemption to sovereign wealth funds on their interest, dividend and capital gains income for investments in infrastructure and other notified sectors before 31 March 2024 and with a minimum lock-in period of three years. This would mostly eradicate their tax liability. The sectors include roads, highway projects, ports and water supply projects.
“We might see interest from sovereign wealth funds as these tax incentives reduces their tax outgo substantially when compared with other jurisdiction," said Rajesh Gandhi, partner, Deloitte India.
Sovereign wealth funds such as Abu Dhabi Investment Authority and Singapore’s GIC have invested billions of dollars in India, especially in infrastructure and energy sectors. They are considered as patient investors with extremely deep pockets and very long-term investment horizons.
While foreign investors welcomed the latest measures, they sounded a note of caution. “Government seems to be mindful of the fact that the way out of economic slowdown is attracting foreign capital. These are positive steps. But not a complete opening up. We would like to see the fine print before we commit more capital," said a foreign fund manager, declining to be named. “Investing in infra is a risky bet considering India’s land and environmental laws. As a policy, we look at long term investment opportunities so tax incentives are good but not enough."
For investments made by FPIs in bond market instruments such as government securities, corporate bonds, municipal bonds, the government has set the withholding tax rate at 5%. In its absence, the tax would have depended on double taxation avoidance agreement or tax treaties so could go up to 15%. Under the treaty, the tax outgo is capped at 15% for the US.
Withholding tax is deducted at source, and is levied by some countries on interest or dividends paid to a person residing outside that country. The withholding tax was so far allowed only until July 2020, which has been extended to July 2023. The amendments are effective from the next fiscal.
“The extension or elimination altogether of the sunset date for the concessional rate are recommendations that Asia Securities Industry and Financial Markets (Asifma) has been making and it’s positive that the status quo has been maintained to provide stability," said Patrick Pang, managing director and head of compliance and tax at Asifma, an industry body for foreign funds.
The biggest beneficiary of eliminating DDT are foreign funds, as they won’t just pay tax as per rates negotiated under various treaties but can also claim credit in their home jurisdictions on tax outgo in India.