Companies
Budget 2024: 3.5x surge in capital gains tax on CCDs stuns foreign investors
Summary
Apart from gains on unlisted compulsorily convertible debentures, foreign investors also face a higher tax burden on share buybacks.
Mumbai: India’s latest Union budget had a rude shock for foreign investors—their tax liability on capital gains in the country will surge across asset classes, experts said, which is likely to make them weigh the impact before investing in the country.
The biggest hit will be on foreign direct investments (FDI) in compulsorily convertible debentures (CCDs), where the income tax rate on capital gains has gone up to 35% from 10%.
Earlier, gains on unlisted CCDs held directly by foreign companies for more than three years were treated as long-term capital gains (LTCG) and taxed at 10%. Now, these gains will be treated as short-term capital gains (STCG), regardless of the holding period.
The increased taxation rate arises as the latest Union budget changed the characterisation of these assets by amending Section 50AA of the Income Tax Act.
Capital gains on CCDs will now be taxed at the maximum marginal rate, which is 35% for foreign companies. The corporate tax rate on foreign companies was lowered to 35% in the budget on Tuesday. It was 40% earlier.
CCDs are bonds that must be converted into equity by a specified date. Issuance of CCDs is one of the most popular ways of raising FDI by Indian companies.
Lightning blow
“The amended section 50AA covers any gains on transfer or redemption of unlisted debentures as short-term capital gains, which will be taxed at the maximum marginal rate," said Vaibhav Gupta, a partner at Dhruva Advisors. “Taking positions on taxability of CCD capital gains under the tax treaties will now need to be considered in light of the impact of the tax rate going up 3.5 times in India."
To be sure, unlisted CCDs held for less than three years were already taxed at the maximum marginal rate.
The latest amendment will also affect domestic investors in unlisted CCDs. But CCDs are largely issued for the purpose of FDI.
Also Read: Budget deals capital gains tax blow to investors
“The change in characterisation of CCDs is a lightning blow to FDI. It will lead to a significant increase in tax outflows on unlisted CCDs held by foreign entities," said Amit Singhania, founder of Areete Law Offices.
Foreign investors will also weigh the impact of the increase in the LTCG and STCG tax rates before investing in India, experts said. The budget increased LTCG from 10% to 12.5% and STCG from 15% to 20%.
Overseas investors will also have to weigh the impact of share buybacks now being treated as dividend, which could increase their tax outgo, according to the experts.
This is because, in the absence of a provision treating buyback proceeds as dividend only to the extent of accumulated profits of the investor, the entire buyback proceeds will now be taxed as dividend, Gupta said.
This means that the entire amount received from the buyback of shares will be taxed, and investors will not get a chance to offset the initial investment cost. Earlier, the buyback proceeds were taxed in the hands of the company, net of the amount received against the shares, effectively only taxing the gains.
“The investment cost will only be available as a capital loss for the investors, which can be offset against any other capital gains income," said Gupta, adding that not allowing the investment to be offset was “a bit surprising".
Silver lining
However, there is a silver lining for foreign investors as they will now get the benefit of currency fluctuations when computing their LTCG, experts said.
“While the tax rate on LTCG has gone up to 12.5%, this may not be as adversarial as it looks. The higher taxes for foreign investors will be offset by exempting the gains attributable to foreign exchange fluctuation benefits, which are now allowed," Singhania said.
Also Read: Budget 2024: What changes in capital gains taxes mean for investors
Section 112 of the Income Tax Act governs LTCG. Following the amendment in the latest budget, the section does not contain a clause that does not allow foreign exchange fluctuation benefits when computing LTCG for foreign investors. A clause to this effect was present before the amendment.
However, some experts said this could be an omission.
“This looks inadvertent since no inflation adjustments are available for resident investors. It will be interesting to see if this is plugged in at the time of the final approval to the Finance Bill," Gupta said.
