Foreign Portfolio Investors (FPIs) Taxation on Equity Derivatives
Two FPIs from Mauritius are now required to pay tax on earnings from equity derivatives. This change arises because although international investors from places like Mauritius and Singapore pay capital gains tax on stock sales, they traditionally haven't been taxed on derivative trades.
Reason for Tax Demand
- The taxing authority argues that since equity derivatives derive their value from underlying stocks, they should be taxed similarly to stock trades.
- The Dispute Resolution Panel, a body of three income tax commissioners, has supported this viewpoint, highlighting the similarity between stocks and derivatives.
- A new clause, Clause (3A) of Article 13 in the Double Taxation Avoidance Agreement (DTAA) between India and Mauritius, is being cited to justify this taxation.
Current Treaty Implications
- FPIs from Mauritius currently do not incur tax on derivative gains and pay capital gains tax only on stocks bought after March 2017.
- Derivatives earnings for resident Indians are taxed at a rate of 30% or more.
- FPIs from Mauritius also enjoy a reduced tax rate of 10% on interest earnings from Indian-listed debt securities.
Rights Entitlement and Derivatives
- Tax has also been demanded on the transfer of entitlement to equity rights, though the sale does not involve physical stock transfer.
- Both rights entitlements and derivatives are considered separate asset classes despite their valuation being tied to underlying stocks.
- Currently, income from these assets remains exempt under treaties with several countries, including Singapore, Mauritius, and others.
Implications of Taxation Changes
- The stance on taxing derivatives may lead to broader implications for FPIs from all treaty jurisdictions if upheld by courts.
- India and Mauritius signed a protocol to amend the treaty, which might require FPIs to meet the 'principal purpose test' (PPT) for tax benefits, emphasizing a need for commercial rationale.
- The General Anti-Avoidance Rule (GAAR) already mandates FPIs to have substantial presence in Mauritius for tax benefits.