Daily Stock Market Reports

Budget 2023: Foreign portfolio investors seeking clarity & parity on tax


Foreign Portfolio Investors (FPIs) were allowed entry into the Indian capital market at the beginning of 1993, and the FPI policy has been progressively liberalised thereafter. As per the stock exchange data, FPIs have accounted for more than 1/5th of the market cap of the listed companies over the past few years. FPI inflows have not been a phenomenon specific to the Indian economy but have also been witnessed in other emerging economies.

Over the years, several tax and regulatory changes have been made to ensure a smooth functioning of the FPIs. Lately, a couple of issues which require the attention of the tax regulators is a) taxability of interest income from Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs) and b) withholding tax on dividend income.

Clarity on taxability of interest income from InvITs and REITs

REITs and InvITs are investment vehicles which have been introduced by the Indian Government in 2014 (vide SEBI Regulations) to increase private participation in infrastructure and real estate sectors. The number of such investment vehicles has been increasing over the years and as of today, there are five REITs and 19 InvITs which are registered with SEBI.


Recognizing their role, the Indian government decided to permit FPI investment in InvITs and REITs (referred to as ‘business trusts’) in 2016. This was aimed at increasing liquidity and attracting capital for InvITs and REITS, leading to wider participation by global investors.

From an Indian taxation perspective, section 115A of the Income-tax Act, 1961 (‘Act’) covers taxability of income earned by non-residents. Further, section 115AD of the Act specifically covers taxability of income earned by FPIs from securities [as defined in the Securities Contracts (Regulation) Act, 1956 (‘SCRA’)] issued in India.

In light of the introduction of REITs and InvITs in India, in the year 2014, an amendment was made in section 115A of the Act to provide a concessional tax rate of 5% for interest income earned by non-resident unitholders from business trust. In 2021, the definition of “securities” under SCRA was amended to inter alia include units of REITs and InvITs. The amendment was made to bring these units under the purview of stamp duty. However, the consequences of such an amendment has exceeded the underlying intention.

The amendment in the SCRA has led to an ambiguity under the Act viz. whether interest income received by FPIs from business trusts could be taxable @20% as income received from securities as per section 115AD of the Act instead of the concessional tax rate of 5% specifically provided for interest income received by any non-resident from business trusts as per section 115A of the Act.

The government’s intention does not seem to be to tax FPIs at a rate higher than other non-residents who continue to be taxed at 5%. The conflict between two independent provisions of the Act must be clarified.

Parity on taxability of dividend income

With effect from 1 April 2020, dividend income was made taxable in the hands of the investor. Consequently, dividend income was taxable in the hands of the FPIs at the rate of 20% under the Act and tax was required to be deducted at source by the Indian company at the said rate.

Subsequently, vide an amendment to the provisions of the Act, tax in case of dividend income to FPI is required to be withheld at source at 20% or as per the rate available under the relevant tax treaty, whichever is beneficial.

Substantial portion of the FPI investment in India is from countries such as USA, Mauritius and Singapore and India’s tax treaty with such countries provide for a lower tax rate (i.e., 5%/ 10%/ 15%) on dividend income earned from India company, subject to certain conditions.

The Indian companies, often, adopt a conservative approach and withhold tax at 20% (plus applicable surcharge and cess) under the Act, on the dividend income paid to FPIs. In other words, the FPIs are not able to get the benefit of the lower withholding tax rate under the tax treaty.

While the Act provides for a mechanism to claim a refund of the additional taxes withheld by filing the return of income, the same does have an impact on the cash flows.

The Act provides for a framework under section 197 of the Act to enable payees to approach the tax authorities and obtain a lower withholding tax certificate. The said framework covers inter alia dividend payment/ other payments to non-residents (other than FPIs) and dividend payment to residents. However, such framework does not cover the dividend payment to FPIs. This appears to be unintended.

A suitable amendment in section 197 of the Act to cover dividend payments to FPI would provide the necessary parity and would encourage more inflow of FPI investments in India.

Generally, the Government has been forthcoming in resolving stakeholder issues through tax and regulatory amendments/ clarifications. Especially, situations which have resulted in unintended consequences have been addressed promptly. Given the proposed Budget on 1 February 2023, the Government should provide the necessary clarity and parity as discussed above.

(The author is Partner, Dhruva Advisors and Vishal Lohia – Principal, Dhruva Advisors)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)



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