Surcharge Rollback Boosts Market Sentiment But Fineprint Awaited

Finance Minister Nirmala Sitharaman today announced the rollback of the enhanced surcharge levied on long- and short-term gains arising from transfer of equity and shares to boost economic growth from a five-year low.

That comes after foreigners sold nearly $3.3 billion in equities in the Indian markets since Sitharaman introduced the surcharge on foreign investors and the super-rich in her maiden Budget. The government was also criticised for failing to tackle slowing economic growth, affecting demand for products ranging from consumer goods to automobiles.

The Singapore Nifty (SGX) rose 1.3 percent from the day’s low to breach the 10,900 level after the minister’s early evening announcement. Indian markets had closed higher for the first time this week on anticipation of economy and market boosting measures. The S&P BSE Sensex rose 0.63 percent to 36,701 and the NSE Nifty 50 gained 0.82 percent to 10,829.

Backstory

The surcharge, levied on the applicable tax paid, was hiked in the union budget presented on July 6, from 15 percent to 25 percent for those with taxable income of Rs 2-5 crore, and to 37 percent for those earning more than Rs 5 crore. This increased the effective tax rate for these two groups by 3.12 percent and 7 percent to 39 percent and 42.74 percent, respectively.

Many FPIs automatically came under the higher tax rate as they have been investing as a non-corporate entity such as trust or association of persons, which in the income tax law are classified as an individual for purpose of taxation. They had protested against this sudden increase in tax.

Once today’s announcements are notified in law they, and surprisingly domestic investors too, will be spared the additional surcharge on transfer of equity shares in -

• a company
• unit of an equity oriented fund
• and unit of a business trust

This is a very positive development which would give a fillip to the capital markets, said Rajesh Gandhi, partner at Deloitte India, commenting on the surcharge rollback. “Post the rollback, tax rates for FPIs (foreign portfolio investors) will come down by 4-7 percent,” he said. “This removes the anomaly created by the Budget 2019.”

Today’s move, according to Gandhi, also benefits domestic investors like individuals and alternative investment funds. “It seems that the relaxation has been announced for all capital gains earned on listed investments. It remains to be seen whether the benefit will be extended to derivative income if that’s treated as capital gain.” He also questioned whether the surcharge will continue to be applied to interest income.

Derivatives Clarification

Late night Friday, the Finance Ministry issued a note clarifying the position on derivative trades. It said “derivatives (futures and options) are not treated as capital asset and the income arising from the transfer of the derivatives is treated as business income and liable for normal rate of tax”.

But for FPIs derivatives are treated as capital assets and the gains arising from their transfer is treated as capital gains.

What that means is domestic investors will continue to pay enhanced surcharge on the business income arising from transfer of derivatives.

Other Fineprint

A few experts are waiting for the notification fineprint before fully applauding the move. Bhavin Shah, leader of financial services tax at PwC India, pointed out that the section determining FPI taxation was not explicitly mention by the minister in her announcements.

“The removal of higher surcharge on capital gains will not apply to Alternate Investment Funds (AIFs) where the characterisation of income is business income,” Shah added.

Vaibhav Sanghvi, co-chief executive officer at Avendus Capital, echoed that. “We have seen that the surcharge is out from the capital gains perspective and not from all category III AIFs”. Sanghvi is referring to the business income of funds - that will continue to bear the additional surcharge.

“So all the long-short funds and all the hedge funds would still be charged at a higher surcharge,” he added

Glass Half Full

Market veteran Ajay Bagga expressed how for a revenue of Rs 1,400 crore (on account of this surcharge on equity capital gains) the government had allowed for an erosion of Rs 17 lakh crore in market capitalisation.

“It’s sentimentally very good somebody has finally understood the gains were very little and losses for the nation were too huge,” he said, adding there remains hope. “There is hope for more decisions to come through... I look at the glass as half full.”