Tax implications of offshore derivative instruments

Mr. PURNA P , Last updated: 26 October 2007 Share Follow on Google News

Will the proposed review of foreign institutional investor (FII) regulations about issuance of ODIs (offshore derivative instruments) have any income-tax implications in India for the foreign investors? The answer appears to be in the affirmative. "The proposals may lead to tax cost for the overseas investors and these investors will have to take a re-look at their India investment strategy," cautions Mr Naresh Makhijani, Executive Director, KPMG. As you may be aware, the market regulator SEBI (the Securities and Exchange Board of India) recently clarified that it will allow only proprietary sub-accounts of FIIs to issue participatory notes (PNs) till such time these sub-accounts get themselves re gistered as full-fledged FIIs. The regulator is also set to undertake a full review of regulations relating to the foreign portfolio investors with the "ultimate objective to have a cleaner market where everyone knows the identity of all investors", reminds Mr Makhijani, during the co urse of an e-mail interaction with Business Line. "As per the latest press reports, SEBI is expected to issue a notification to allow foreign nationals with a minimum net worth of $50 million to invest through sub-accounts. " Excerpts from the interview: Why control ODIs? The potential exponential returns from investments in the Indian stocks have led to considerable interest by overseas investors, particularly the FIIs. To regulate the same, SEBI has issued a draft discussion paper on the issue of ODIs. These proposals, if carried out, may cause restructuring of investments by FIIs with the resultant tax consequences. How do these ODIs work? Simply stated, overseas investors subscribe to ODIs such as PNs for an exposure in Indian equities or equity derivatives. These investors are unregistered with SEBI. These ODIs are issued by a FII (or its sub-account) registered with SEBI. What are the tax implications of the proposed regulation? SEBI has proposed that there should be no further issuance of ODIs by sub-accounts of FlIs. So, investment in Indian securities that underlie the ODIs will now have to be traded by the FII itself and may cause a taxable event in India. An example? For instance, a corporate FII in Luxembourg may have a sub-account in Mauritius, a country with which India has a tax treaty, whilst Luxembourg has yet to have a tax treaty. If the Mauritius sub-account is barred from issuing ODIs, the only option before the FII is to issue the ODIs from Luxembourg to the investors. This would hurt the FII in Luxembourg by way of income-tax, as the gain realised from sale of securities would suffer income-tax as per the domestic tax law, i.e., at the rate of 10.56 per cent or 42.23 per cent including surcharge and education cess (fo r short-term capital gains from sale of listed and unlisted shares respectively) or at the rate of 21.12 per cent including surcharge and education cess (for long-term capital gains from sale of unlisted shares) against total capital gains tax exemption in Mauritius. This could eventually force the FII in Luxembourg to stop issuing ODIs.

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About the Author

Mr. PURNA P

CA Final Student & Tax n Law Consultant

TAXnLAW I am Mr. Purna Chandra Rao P simply you can call me asPURNA P I am a student of CA Final and preparing for CA Final and working as Asst Manager [F A], Jasper Industries Pvt Ltd, Hyderabad, Andhra Pradesh,a native of Vijayawada I created Website for CA, CS, CW and other professionals please c ... Read more

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