FPIs press the panic button on tax surcharge

In News:

  • The Union Budget has proposed to raise the surcharge on taxable incomes above Rs 2 crore targeting high-income individuals.
  • However, the increase in surcharge will also apply to a large number of foreign portfolio investors (FPIs), which has led to panic in the investors, leading to fall in the stock markets.

 

News Summary:

  • The 2019-20 Budget tabled in Parliament, has proposed to increase surcharge from 15 per cent to 25 per cent on taxable income between Rs 2-5 crore, and from 15 per cent to 37 per cent for income above Rs 5 crore.
  • Following the increase in surcharge, the effective income tax rate for individuals with taxable income of Rs 2-5 crore will go up to 39 per cent, and for those above Rs 5 crore it would go up to 42.7 per cent.
  • There were concerns that the increased surcharge on super-rich could also affect foreign funds investing in India, including FPIs as well as several domestic funds, particularly open-ended Category III AIFs (Alternate Investment Funds).

Why will it apply to FPIs?

  • A large number of foreign portfolio investors (FPIs) in India operate through a trust or a limited liability partnership (LLP) structure.
  • These structures are not recognised as a corporate entity by the Income Tax Act and hence, are taxed as per the individual tax slabs based on their earnings.
  • So now the surcharge which is applicable to non-corporate entities (about 50 per cent of FPIs are registered as non-corporates) will also be applicable to these FPIs.
  • Most of these funds would have an income of more than Rs 2 crore and Rs 5 crore and their tax burden would go up.

Impact of the increased surcharge

  • The impact of the surcharge was clearly visible in the stock markets as the benchmark Sensex and Nifty plunged by over 2%.
  • The proposed tax regime will discourage investors from putting-in the money as post-tax returns may not remain lucrative anymore in an already sluggish market.

 

About Foreign Portfolio Investment (FPI):

  • Foreign Portfolio Investment (FPI) is investment by non-residents in Indian securities including shares, government bonds, corporate bonds, convertible securities, infrastructure securities etc.
  • The class of investors who make investment in these securities are known as Foreign Portfolio Investors.
  • FPI is induced by bond yields, growth prospects, interest rate, dividends or rate of return on capital in India’s financial assets etc.

Categories of FPI:

As part of Risk based approach towards customer identity verification (KYC), FPIs have been categorized into three major categories:

  • Category I (Low Risk) which would include Government and entities like Foreign Central banks, Sovereign wealth Funds, Multilateral Organizations, etc
  • Category II (Moderate Risk) which would include Regulated entities such as banks, Pension Funds, Insurance Companies, Mutual Funds, Investment Trusts, Asset Management Companies, University related endowments (already registered with SEBI)
  • Category III (High Risk) which would include all other FPIs not eligible to be included in the above two categories

Note: FPIs are currently not permitted to invest in liquid and money market mutual fund schemes.

 

What is a Surcharge?

  • ‘Surcharge’ is an additional charge or tax levied on an existing tax.
  • Surcharge is levied as a percentage on the income tax payable as per normal rates.
  • The revenue earned via surcharge is solely retained by the Centre and, unlike other tax revenues, is not shared with States. Collections from surcharge flow into the Consolidated Fund of India.

Note:   Unlike a cess, which is meant to raise revenue for a temporary need, surcharge is usually permanent in nature.

Significance

  • Surcharges, in India, are used to make the taxation system more ‘progressive’.
  • They are used to ensure that the rich contribute more to the tax kitty than the poor.
  • Traditionally, the assumption has been that companies can pay higher taxes than individuals and corporate taxes have been subject to surcharge.
  • Increases in surcharge are usually easy to push through than across-the-board increases in tax rates, as they only impact a small, more affluent segment.
  • Note: Levying surcharge on the wealthy seems right b they must not be so high that super-rich find ways to skip taxes altogether.
Image result for impact of surcharge on fpi
Notional Image 

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