A Tax Question Stands Between India And Its Long-Sought After Global Bond Index Listing

First, India had too many restrictions on overseas flows into local bonds. There were caps on overall inflows and separate limits across different categories. The RBI, not willing to lift the overall cap, found a work-around and opened up certain securities fully to foreign investors. That earned India a more favourable view from the FTSE Russell Index—one of three large global bond indices—which put India on the watch list for possible inclusion earlier this year.

But before Indian bonds can make it to any of these indices, a crucial bridge remains to be crossed—Indian bonds have to become eligible for settlement via Euroclear, an international securities settlement platform.

These issues stand in the way of Euroclear allowing settlement of Indian bonds, two people familiar with the matter told BloombergQuint on condition of anonymity.

The Finance Ministry’s Department of Revenue is currently studying the issue of the applicability of capital gains tax in a scenario where a non-resident sells bonds to another non-resident once Indian securities are listed on global indices, one of the two people quoted above said.

When a bond is sold within India between residents, a capital gains tax is applicable. The long term capital gains tax is set at 10% flat or 20% with indexation.

But what happens when a non-resident sells to another non-resident? The applicability of capital gains tax in such a scenario is an issue, the person said.

The issue of a sale between a non-resident and a resident is also being discussed.

Euroclear is of the view that there cannot be different laws for different scenarios in terms of capital gains tax. However, the tax department is not in favour of the idea of entirely exempting non-residents from the capital gains tax, the person said.

There are pending issues that have to be resolved before we can start clearing on Euroclear, said the second person cited earlier. The Department of Revenue is working on it since there are some legitimate concerns that need to be addressed, the second person said.

A third person familiar with the matter, while acknowledging that taxation related issues have cropped up recently, said these matters can be resolved. Similar issues have been addressed in the case of other nations too, said this person, adding that relevant authorities are in discussions.

An email sent to the Ministry of Finance on Wednesday was not answered. Euroclear declined to comment.

Presently there is no expressed capital gains tax exemption when it comes to transfer from a non-resident to a non-resident of India sovereign bonds, said Pranav Sayta, partner and national tax leader at EY. In such a scenario capital gains may become taxable in the hands of a seller on the grounds that the “situs” of the bonds is in India, he said. The situs of a property is where the property is treated as being located for legal purposes.

In a situation wherein a non-resident is a seller and the buyer is a resident, again there is no exemption from capital gains tax under the domestic Income Tax Act, Sayta said. For such transfers outside India an exemption may be considered.

“One has to also look at the relevant Double Taxation Avoidance Agreement/treaty with the relevant country which, in many cases, may grant exemption to the non-resident from Indian capital gains taxes,” Satya said.

According to Bhavin Shah, leader for financial services tax at PwC India, certain transactions executed on overseas exchanges have been exempted from Indian tax. “If you look at American depository receipts and global depository receipts or Foreign Currency Convertible Bonds, which are traded on overseas exchanges, law provides for specific tax exemption and that exemption was introduced a long time back in the law,” he said.

To garner the interest of international investors, India may have to provide tax exemption on capital gains for debt traded on overseas platforms as well, Shah said.