On 1 February 2020, India’s Finance Minister, Nirmala Sitharaman, presented the Union Budget 2020 with a number of tax proposals for the Financial Year 2020-21, including notably important changes such as the taxability of dividends, alleviation of conditions related to offshore funds, exemption from indirect transfer to Foreign Portfolio Investors (FPIs) and simplified tax process.

The proposed changes have been incorporated into the Finance Act 2020 (which amends the Indian Income Tax Act), which was enacted in Parliament on 27 March 2020 with effect from 1 April 2020.

An overview of the key changes that are relevant for the fund industry are set out below.

Taxation of dividends – New system

Until 31 March 2020, Indian companies were subject to a Dividend Distribution Tax (DDT) at the effective rate of 20.56% on distributions of dividends to their shareholders, while the shareholders were exempt from taxation in India on such dividends. In the light of the number of challenges which arose from this imposition system, the DDT has been abolished with effect from 1 April 2020. On the other hand, in line with the  classical system of dividend taxation and current international practices, taxation of dividends has been introduced at the level of the investor, with the following rates applicable on distributions to FPIs:

• 20% on dividend income and income on units of mutual funds;
• 10% on dividends relating to GDRs;
• 10% on dividends distributed by business trusts.

It should be noted that a surcharge (depending on the type of legal entity and net annual taxable income) and health and education cess (4% applied on the base rate plus surcharge) are applicable in addition to the abovementioned base rates, with the result that the maximum rate of WHT for corporate entities (e.g. SICAVs) will be 21.84% and for non-corporate entities (e.g. FCPs) it will be 23.42%.

Impact on India’s tax treaties

In light of the aforementioned amendments, the tax implications for foreign investors investing in India also need to be considered. Prior to these amendments, foreign investors were not entitled to claim any tax credit in their country of residence or apply reduced withholding tax rates under the applicable tax treaty, as they were not considered as being liable to pay the DDT. Based on the new system, since the tax would now be considered to be borne by the foreign investors, FPIs will now be able to benefit from any reduced withholding tax rates under the applicable tax treaty. It should be noted that the rate of dividend tax under India’s DTTs ranges from 5% to 25%.

Offshore Funds – Exemption from PE in India

Since 2015, foreign funds which appoint an Indian fund manager would not, under certain conditions, be treated as having a business connection / place of effective management in India. To further strengthen the onshoring of fund management activity in India, the Finance Minister has relaxed the following conditions:

• The foreign fund would need to maintain a monthly corpus of at least INR 1 billion (approximately EUR 12 million) within a period of 12 months from the date of its establishment or incorporation, an extension from a period of 6 months to meet this threshold;
• Based on applicable regulations, the aggregate participation by Indian tax residents in foreign funds may not exceed 5% of the corpus of such funds. In relation to this, it has been clarified that the contribution made by the Indian fund manager of up to INR 250 million (approximately EUR 3 million) in the first three years will not be taken into consideration in determining the total participation by Indian tax residents in the fund.

This amendment applies retroactively from 1^st April 2019, i.e. from financial year 2019-2020.

Exemption from indirect transfer to FPIs

As a result of amendments to the Indian tax laws effected in 2012, the Indian tax authorities have the right to tax an indirect transfer of assets located in India, i.e. a transfer of shares or rights in a foreign company or entity, whose value is derived substantially from assets located in India. Nevertheless, an exclusion to this provision had been carved out in relation to investments held by Category I & II FPIs registered under the Securities and Exchange Board of India (SEBI) regulations, 2014.

On 23^rd September 2019, SEBI published the SEBI (Foreign Portfolio Investor) Regulations, 2019 (FPI Regulations 2019), as a result of which, the existing three categories of FPIs were re-categorised into two categories: Category I & II FPIs.

In the light of these changes, the corresponding provisions of the (Indian) Income Tax Act have been amended to reflect the revised categories of FPIs in terms of the FPI Regulations, such that all Category I FPIs (based on the revised FPI Regulations) will be entitled to the exemption from the indirect transfer tax provisions. The exemption will continue to apply to existing investments by FPIs that previously qualified as either Category I or Category II FPIs but which are now classified as Category II FPIs.

Common Application Form (CAF) for FPIs

In order to enhance the operation flexibility and ease of access to Indian capital markets, the Finance Ministry has notified a common application form for registration of Foreign Portfolio Investors.

While this amendment does not fall squarely within the scope of the Indian tax laws, it is a welcome change which should ease the administrative burden for FPIs as it includes the registration with SEBI, allotment of a tax Permanent Account Number (PAN) and carrying out Know You Customer (KYC) for opening of a bank & custodian demat account.

KPMG Luxembourg comments

From a Luxembourg tax perspective, these amendments to the Indian tax laws would have a significant impact on Luxembourg funds investing in India.  

Without a doubt, the most critical amendment to the Indian tax laws is the new dividend taxation system. As stated above, the abolishment of the DDT and implementation of a WHT on dividends, coupled with the fact that Luxembourg funds currently do not have access to the DTT between India and Luxembourg, would result in a substantially greater taxation of dividends, whether for SICAVs or for FCPs. It becomes even more important that the Luxembourg tax authorities issue certificates of tax residence to Luxembourg based on the said DTT.

The impact of these changes on each fund’s investments should be carefully analysed, which is something that KPMG Luxembourg, together with KPMG India, would be able to assist you with.

In addition, for asset managers who plan to launch new funds / sub-funds to invest in India, KPMG Luxembourg and KPMG India would be happy to work with you for the entire fund lifecycle, from registration to the taxation of investment income.

Kadambari Chari
Assistant Manager
E-mail: kadambari.chari@kpmg.lu
Phone: +352 22 51 51 5355