India’s ‘Clarification’ on Foreign Investments Under Fire

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By Siri Bulusu

Tax professionals criticized the Indian government’s attempt to clarify the taxation of foreign investments that derive a major part of their value from Indian assets.

The Dec. 21 circular from the Central Board of Direct Taxes relates to a controversial 2012 amendment to the Income Tax Act of 1961, which states that any indirect transaction of India-focused funds would be subject to taxation in India.

Tax professionals said the circular targets tax evasion accomplished through complex offshore structures, but that it, as confirmed by the circular, encompasses most foreign portfolio investments. Approximately 9,000 foreign portfolio investors trade on the Indian stock exchange.

Rajesh Gandhi, a tax partner at Deloitte in Mumbai, told Bloomberg BNA Jan. 5 that the guidance can result in multiple layers of tax depending on the number of layers in the overall structure of the foreign portfolio investments.

Double taxation of foreign portfolio investments occurs when an investor first pays a transfer tax upon purchase of Indian assets and then again when those assets are redeemed. Withholding tax is required by foreign funds upon redemption of Indian assets and buyers who purchase shares on the Indian stock exchange.

“A lot of people are looking to make representations to the Central Board of Direct Taxation regarding foreign portfolio exemptions,” Gandhi said, adding that he will also be making a case for exemption of foreign portfolios to the tax authority.

Further, the provision is considered regressive, he said, and discriminatory against India-dedicated funds that “should in fact be getting a preferential treatment for their contribution.”

Vodafone Provision

The 2012 amendment is widely referred to as the Vodafone provision due to the tax dispute between the Indian government and the telecommunications giant.

The Indian government added the provision to its domestic tax law to encompass indirect offshore transactions after a massive transaction of Indian assets passed to Vodafone Group from India-based telecommunications company Hutchinson Essar Ltd. through a Cayman Islands-based subsidiary. The transaction didn’t technically fall under India’s tax jurisdiction because all the transactions took place outside of India.

India argued that the transaction should have been taxed since its purpose was to transfer Indian assets, but Vodafone challenged the government and won its case before the Supreme Court. The ruling maintained that Vodafone Group operated within legal bounds and if India wanted to tax such transactions, the tax law would need to be amended—which India did. The dispute is ongoing.

Unintended Investments

Gandhi said the provision wasn’t meant to punish investors, and tax officers have taken a lax view of foreign portfolio investments up to the point the clarification was issued.

“No one has been paying the tax because they didn’t think it applied to them,” Gandhi said. “It wasn’t taken seriously because many feel their portfolios are well diversified, albeit made up primarily of Indian shares. They feel different to Vodafone who brought about the tax in the first place.”

Russell Gaitonde, partner at Mumbai-based legal firm BMR and Associates LLP, told Bloomberg BNA in an e-mail Jan. 6 that the provision “has created a lot of confusion, especially for foreign portfolio investors” whose facts are very different from Vodafone.

“Such portfolio investors requested the government to clarify its position on the applicability of the indirect transfer provisions to their cases.”

Gaitonde said instead of putting investors’ fears to rest, the circular merely reiterated what was already in the law. Instead of offering relief to those unsure of their taxability, it did “just the opposite” by standing by its all-encompassing nature.

“The law was very widely worded and seemed to cover many unintended situations under its dragnet,” Gaitonde, told Bloomberg BNA Jan. 6. “It was so simplistically written that it’s drawn in a lot of different funds.”

Gaitonde said the clarification is technically binding to tax officers, not taxpayers, who appreciate the “spirit” of the law in cracking down on tax evasion, but said now with the newly issued circular “their hands could be tied.”

Union Budget

Consideration of exemption of foreign portfolio investments will be a closely watched topic in the upcoming Union Budget announcement in early February, at a date yet to be confirmed, given the government’s desire to increase the ease of doing business in India.

A failing tax dispute resolution scheme will likely increase the government’s incentive to do away with the tax.

Gaitonde added that the taxability of foreign portfolio investments has been a highly contested issue for many years and could “die a natural death” in the upcoming 2017-18 Union Budget next month.

To contact the reporter on this story: Siri Bulusu in New Delhi at

To contact the editor responsible for this story: Penny Sukhraj at

For More Information

The government's clarification is at

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