Why FPIs may not form a company to escape the super-rich surcharge?

The foreign portfolio investors’ (FPI) net outflow was ₹9,761 crore from the equity market since the Union Budget in July. The net outflow was the highest in a single day this calendar at ₹2,746 crore on Wednesday. The higher surcharge on the super-rich announced by Finance Minister Nirmala Sitharaman in Budget 2019 has been the primary reason behind the sell-off.

Sitharaman suggested that the FPIs who are now registered as trusts should convert themselves into companies to avoid higher surcharge. But FPIs may not be ready to change their structure to a company just to lower their tax burden in India as registration as a company will entail more compliance requirements, additional tax liability and invocation of anti-avoidance tax laws. FPIs can avoid these through the trust structure.

The Budget announced higher surcharge for those earning more than ₹2 crore.

This provision is applicable even to association of persons or body of individuals under which trusts — domestic or foreign — are also covered.

Thus, most of the FPIs, which are formed as trusts, now have to pay higher taxes of about 21.3 per cent on short-term capital gains, up from about 18 per cent earlier. Taxes on long-term capital gains on FPIs registered as trusts have similarly increased to 14.2 per cent from 10.92 per cent earlier. However, if the FPIs are converted as corporates, the applicable tax rate would be only 16.4 and 10.92 per cent, respectively, for short- and long-term capital gains, the rate applicable before the Budget.

There’s more to it

Most of the FPIs are registered as trusts because of the opacity it offers to the identity of the ultimate beneficiaries.

Sunil Gidwani, Partner, Nangia Advisors, believes that several FPIs are global funds that are formed as trusts for ease of operations, ease of redemptions, home country regulatory requirements, etc, while corporates call for higher compliance procedures and don’t meet the fund industry’s needs.

Further, companies also attract Minimum Alternate Tax (MAT) if tax payable by it on income computed according to normal provisions of the Income Tax Act is less than 18.5 per cent of book profits. Provisions of MAT are applicable to all types of companies, whether foreign company or domestic company.

Naveen Wadhwa, DGM, Taxmann.com, says that the possibility of invoking the provisions of General Anti-Avoidance Rule (GAAR) that targets arrangements or transactions made specifically to avoid taxes, by the revenue department cannot be ruled out, if FPIs are formed as corporates

Extra taxes on conversion

The other unfavourable situation for FPIs that would arise on converting trusts to a company is that the conversion would be treated as transfer according to the Income Tax Act, and would be chargeable to capital gains. Wadhwa adds, “Indirect transfer provisions apply when a person transfers shares of a foreign entity which derive their value substantially from the assets located in India. In such a case, any income arising on transfer of said shares shall be deemed to accrue or arise in India, except for few category-I and category-II investors.”

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