Budget 2019: The Impact Of Surcharge And Buyback Tax On Equity Investors
In levying a much higher surcharge on those in the higher income brackets, the government’s Budget proposal has also anguished non-resident and foreign investors.
Presented on Friday by Finance Minister Nirmala Sitharaman, the Budget proposes to increase the surcharge from 15 percent to 25 percent for those with a taxable income of between Rs 2 and 5 crore, and to 37 percent for those with a taxable income of Rs 5 crore and above. This takes the effective tax rate for those two categories to 39 percent and 42.74 percent respectively.
These changes apply not just to individual taxpayers but also to Hindu undivided family or association of persons or body of individuals, whether incorporated or not, or every artificial juridical person. This provision also includes trusts, which is how several foreign investors route their investments in India’s capital markets. While the exact scope of impact is tough to identify, it is widespread and encompasses non-resident Indian investors too.
The use of trusts is very common among foreign investors, said Siddharth Shah, partner at Khaitan & Co. “Especially globally, when there are succession and estate planning taxes, people do use trust to make sure they address some of those succession issues. This (Budget provision) will also apply to all NRIs and those investing under Portfolio Investment Scheme route. That’s a very large segment.”
There are many foreign fund vehicles which are established and operated as trusts and many of them will be investing in India and have been doing for number of years, concurred veteran tax and regulatory expert Bobby Parikh.
If you go back to history, most of these structures were availing treaty benefits. In order to avail treaty benefits they were primarily organised under a corporate structure. It is the last two years where people were starting to disband (treaty structures) and investing directly. If you look at structures which were set up earlier, a lot them could be using a corporate vehicle. But in last 2-3 years, we have seen large institutional names which have started to come in directly. A lot of them are organised as business trust and trust globally and they will be impacted by it.Siddharth Shah, Partner, Khaitan & Co
The levy of surcharge did hurt market sentiment on Monday, two days after the Budget was presented on July 5. When asked if the tax department would review it, PC Modi, chairman of the Central Board of Direct Taxes, said the matter would be examined. Both Shah and Parikh are hopeful of a review that at least spares foreign investors investing via trusts.
(The Budget proposal) is essentially directed at individuals—that if you want substantial amount of income then you should be subject to higher amount of tax. I don’t know whether that logic holds for entities which—if the fund is investing via a company then it pays lower surcharge and if it invests as a fund (trust) then it pay higher surcharge on the same kind of income. There cannot be a policy objective to structure things in that manner.Bobby Parikh, Founder, Bobby Parikh Associates
The Buyback Tax Impact
Dividend payments by companies are taxed at 15 percent plus the applicable surcharge and cess, totaling an effective rate of 20.56 percent, according to a report by law firm ELP. If dividend revenue in the hands of the shareholder exceeds Rs 10 lakh, it is further subject to a 10 percent tax plus surcharge and cess.
To equalise the treatment of share buybacks with that of dividend, as well as with buyback of unlisted shares, the Budget has proposed a buyback tax of 20 percent plus surcharge and cess on buyback of listed shares, totaling 23.3 percent. But it has spared the shareholder from paying long-term capital gains tax on a sale of shares via buyback, which was so far applicable.
Once the company has paid tax and whatever surcharge, then there will be no tax further at the hands of the shareholder, said Shah.
Parikh pointed out that the tax levy is “somewhat asymmetric” as the buyback tax would apply on the difference between the buyback price and issue price not the price at which the shareholder acquired it.
Suppose you have a 100 rupee share (buying price) and that one share you tendered it for buyback and the company did the buyback for let’s say Rs 90 per share. So, you have now added a capital loss of Rs 10 (Rs 100-90) however the share was issued originally by the company at Rs 10. So, there is a buyback distribution tax which will apply on the difference between the Rs 90 that the company is paying you and the Rs 10 that the company issued the share for. Which is 80 bucks, less tax of Rs 16. Which means you will only get Rs 64 in hand for a share which cost you Rs 100.Bobby Parikh, Founder, Bobby Parikh Associates
Shah noted that the buyback tax will be tough to implement, especially in the case of market buybacks, where the company repurchases its shares from the open market.
“How will the administration of this be done? Especially when you are doing a buyback on the market. You don’t even know if the company is buying it or any other shareholder (is the buyer). It is actually undertaken on the screen. From a shareholder perspective whether this gain is pursuant to a buyback by the company or through purchase by any other shareholder, how do you really decide, especially when it is a market-based buyback?”
Tax Benefits For AIFs
Alternate Investment Funds are of three types, as per categorisation norms of market regulator Securities and Exchange Board of India.
- Category I: SME Funds, infrastructure funds, social welfare funds, venture capital funds.
- Category II: Private equity funds or debt funds.
- Category III: Hedge funds or funds which trade with a view to make short-term returns or such other funds which are open ended.
Tax law allows for pass through status to category I and II funds such that investors in the fund are liable to tax on the income earned by the AIF, other than business income. But the same provision was not available for losses. The Budget has proposed to change that. A note by consultancy KPMG details the new proposals...
- Business loss shall be carried forward and set off at the AIF level.
- Loss other than business loss shall be allowed to be carried forward and set off in the hands of the unit holder (AIF investor) where the unit holder has held the unit for at least 12 months.
These changes will enable AIF investors to set off losses incurred at the fund level.
Another Budget proposal involves extending to category II AIFs the exemption available to category I funds that allows for investment in companies (not public) at a price higher than fair market value. This amendment will take effect on April 1, 2020, said the Finance Bill.
Watch the full discussion with Bobby Parikh and Siddharth Shah here.