Portfolio

Why did FPIs spook market on additional surcharge?

Vivek Ananth BL Research Bureau | Updated on July 08, 2019 Published on July 08, 2019

Will issue a clarification soon on the issue, says government

The benchmark indices fell by record numbers on Monday. The Nifty 50 lost the most in about eight months, while the Sensex 30 lost the most in four years. An amendment to the surcharge slabs, which would directly impact foreign portfolio investors or FPIs and domestic individual investors, seems to have pulled the rug from under the feet of market participants.

But this isn’t a new tax provision that has been introduced in this Budget to specifically tax market participants such as domestic individual investors or FPIs. The additional surcharge on high-income earners has also become applicable on investors using the Trust route into the stock market. Trusts are taxed at the rates applicable to individual taxpayers. So, the slab-rates and the additional surcharge for Trusts are similar to that of individuals.

Most FPIs use this route to invest in India, and don’t incorporate companies because they are tax residents in countries with low- or no-income taxes. This structure is used because of the opacity it offers in hiding the identity of the ultimate beneficiaries.

LTCG, STCG taxes

The panic that has set into the market is also because of the anticipation that the surcharge will impact domestic investors as well. Individual investors who trade in the stock market, unless it’s a business operation, must pay long-term capital gain (LTCG) or short-term capital gain (STCG) tax. These gains are taxable at a special rate of tax — 10 per cent for LTCG and 15 per cent for STCG. The gains are then added to the total income of the taxpayer who are referred to as individuals, association of persons, body of individuals or artificial person under the Income Tax Act 1961. If the income exceeds the thresholds for surcharge, then surcharge is leviable on the aggregate tax that includes taxes at special rates such as LTCG and STCG.

FPIs and other investors who use structures such as a trust have been paying lesser taxes to the exchequer, using the tax rates applicable to individuals. Now, with an additional surcharge that can push up the total tax rate on such investments in the stock market up to the peak rate of 42 per cent, there was a market sell-off that dragged the Nifty by over 2 per cent to 11,558.60, while the Sensex ended down 2 per cent 38,720.57.

The government says it will issue a clarification soon on the issue, but Finance Minister Nirmala Sitharaman refused to comment in a press conference since Parliament is currently in session.

With FPIs being a huge source of foreign exchange into India, it is unlikely that the Centre would like to spook the market by increasing their tax outgo by up to 8 per cent. However, if the government does stand its ground and refuses to amend the Finance Bill before it is passed into law, the market will see far more volatility in the coming days.

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