Taxation, a key issue that has vexed foreign portfolio investors for the most part of a decade and dampened participation in Indian equity markets, has now been addressed by policymakers in India. In fact, unfavourable tax policies have been a key determinant of the cost of investing in India. The current tax regime promotes inefficiency in tax collection and provides a great incentive for treaty shopping. In a recent bid to absolve India of its unfavourable tax policies, the finance minister has approved much-needed changes in offshore funds taxation in India. According to media reports, the residence of fund managers in India will no longer constitute a permanent establishment and the location of fund managers will not determine business income.
It has been our view that billions of dollars have been waiting on the sidelines to be invested in India and large institutions would allocate funds to the country if they could open offices in India and bring decision-making closer to the ground. The finance minister’s move brings India’s tax regime in line with global norms and would give a tremendous fillip to the industry.
Tax regime uncertainty
At the moment, India is losing both high-paying jobs and tax revenues at a critical time when economic growth is sputtering, the rupee is in a free-fall and global investors have lost confidence in the Indian economy. The other consequence of the current tax regime is that we have actually exported the market for offshore derivatives, with underlying assets in India, to financial centres in Singapore, Dubai and Hong Kong. Even our currency markets are getting exported along with this. There is an easy answer. FIIs invest through countries like Mauritius because their gains through sale of investments, both short-term and long-term in India, are exempt from tax. Long-term capital gains are exempt in India but short-term gains are taxable. By making offshore funds exempt from taxation, India will bring an estimated 20,000 high-paying jobs back to India’s shores from offshore financial centres and solve the Mauritius issue in one stroke, at least from an FII perspective! (Foreign investments account for roughly 20% or $200 billion of India’s $1 trillion market cap. A 2% management fee is charged on this. Assuming 1% is spent in India, it translates to $2 billion, out of which nearly 50% or $1 billion is distributed as compensation for employees. Assuming that the talent pool has an average salary of