(Photo: Mint)
(Photo: Mint)

Higher FPI tax not the only reason to worry for markets

  • The Sensex plunged to its biggest single-day decline in nine months on 8 July, the first full trading day after the 2019-20 Union budget was announced on 5 July
  • Mint explores whether there was more to the fall in the indices than just the higher tax on foreign portfolio investors

The Sensex plunged to its biggest single-day decline in nine months on 8 July, the first full trading day after the 2019-20 Union budget was announced on 5 July. Mint explores whether there was more to the fall in the indices than just the higher tax on foreign portfolio investors.

Who are foreign portfolio investors?

Non-resident investors putting their money in instruments such as shares, convertible securities, government and corporate bonds, are known as a foreign portfolio investors (FPIs). They include foreign institutional investors (FIIs) and qualified foreign investors (QFIs). The investments made by them are termed foreign portfolio investments. In India, FPIs are allowed to invest in government securities, real estate and infrastructure investment trusts (ReITs and InvITs), corporate bonds, and listed firms. Each of these instruments has a cap on the investment that can be made in it by FPIs.

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What did the budget do?

The budget raised the surcharge on tax paid by the super rich. This will hit FPIs, too. Earlier, a surcharge of 15% on a tax of 30% was levied on those earning more than 1 crore. The budget proposed to increase the surcharge to 25% for those with taxable income from 2-5 crore and to 37% for those earning more than 5 crore. This makes the effective tax rate for the two groups 39% and 42.74%, respectively. About 40% of FPIs will be hit by the hike in surcharge as they invest as non-corporate entities, which are classified as regular individuals for taxation purposes. They will thus have to pay more income tax.

What options do the FPIs have to keep investing?

FPIs may get into a corporate structure to lessen their tax. But it may attract penal laws of General Anti-Avoidance Rules since an existing structure can’t be changed due to tax reasons.

Will a higher surcharge hurt investment?

The BSE Sensex has shed nearly 1,100 points between 4 July, the day before the budget, and the end of trading session on Thursday. Though the common refrain has been that investments will take a hit, it may not be wise to blame the fall in indices on FPI outflows alone. A faltering economy, lack of direction in the budget and a poor monsoon could have had an even bigger impact on markets than a higher surcharge on FPIs. Sentiment has also been hit as the government is perceived to be anti-rich.

What are the other provisions on FPIs?

The budget proposes to ease ‘know your client’ norms for FPIs. It took the statutory limit for foreign portfolio investment in a company from 24% to a higher sectoral limit. FPIs will be permitted to subscribe to listed debt securities issued by ReITs and InvITs. So far, foreign investment came broadly through three routes—foreign direct investment, FPIs, and NRIs. A merger of the NRI-portfolio investment scheme route with the foreign portfolio investment route has also been mooted to ease investment by NRIs in equities.

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