The taxation of Foreign Institutional Investors (FIIs) and specified funds plays a significant role in attracting foreign investment into India. Section 115AD of the Income Tax Act specifically deals with the tax implications for FIIs and specified funds on income generated from securities and capital gains arising from the transfer of such securities. This blog aims to provide a comprehensive guide on Section 115AD, covering its scope, tax rates, provisions, and relevant amendments.
Table of Contents:
- Overview of Section 115AD
- Tax Rates Under Section 115AD
- Provisions for Specified Funds
- Deductions and Computation of Capital Gains
- Explanation of Terms Used in Section 115AD
- Legislative Amendments and Notifications
- Impact on Foreign Institutional Investors
- Conclusion
- FAQs
Overview of Section 115AD
Introduced through the Finance Act of 1993, Section 115AD aims to provide a concessional tax regime for FIIs and specified funds investing in India. The section covers the tax treatment of income earned in respect of securities, as well as short-term and long-term capital gains arising from their transfer. The intent behind introducing this section was to promote foreign investment in India’s capital markets by providing favorable tax rates.
Tax Rates Under Section 115AD
Income from Securities
Under Section 115AD, the tax rates for income received from securities, excluding units referred to in Section 115AB, are as follows:
- For Foreign Institutional Investors: The tax rate is 20%.
- For Specified Funds: The tax rate is 10%.
Short-Term Capital Gains (STCG)
Short-term capital gains arising from the transfer of securities are taxed at different rates:
- General Rate: 30%.
- For Short-Term Capital Gains Covered Under Section 111A: The tax rate is reduced to 15%. Section 111A applies to short-term capital gains on the transfer of equity shares or units of equity-oriented funds listed on a recognized stock exchange and subject to Securities Transaction Tax (STT).
Long-Term Capital Gains (LTCG)
For long-term capital gains arising from the transfer of securities, the tax rate is:
- General Rate: 10%.
- For Long-Term Capital Gains Covered Under Section 112A: The tax rate of 10% applies only to gains exceeding one lakh rupees. Section 112A covers gains from the transfer of equity shares or units of equity-oriented funds that are subject to STT.
Interest Income Under Section 194LD
A concessional tax rate of 5% applies to interest income earned on certain bonds and government securities, as specified under Section 194LD. This provision aims to incentivize foreign investment in debt instruments by providing a reduced tax rate on interest income.
Provisions for Specified Funds
The application of Section 115AD to specified funds is subject to certain conditions:
- The provisions apply only to the extent of income attributable to units held by non-residents who do not have a permanent establishment in India.
- In the case of specified funds that are investment divisions of offshore banking units, the section applies to income attributable to the investment division, provided it qualifies as a Category-I portfolio investor under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019.
Deductions and Computation of Capital Gains
Section 115AD imposes specific restrictions on the availability of deductions:
- No Deductions for Certain Income: If the gross total income comprises only income from securities, deductions under sections 28 to 44C, section 57, and Chapter VI-A are not allowed.
- Capital Gains Computation: For calculating capital gains under this section, the first and second provisos to Section 48, which deal with the computation of capital gains in foreign currency for non-residents, do not apply.
These provisions ensure that the concessional tax rates apply strictly to the specified income without any additional deductions.
Explanation of Terms Used in Section 115AD
To understand Section 115AD, it is important to know the following terms:
- Foreign Institutional Investor (FII): An investor specified by the Central Government through a notification in the Official Gazette.
- Specified Fund: Defined under clause (c) of the Explanation to clause (4D) of Section 10 of the Income Tax Act.
- Securities: As per clause (h) of Section 2 of the Securities Contracts (Regulation) Act, 1956, “securities” include shares, bonds, debentures, government securities, and other marketable securities of like nature.
- Permanent Establishment: Defined in clause (iiia) of Section 92F of the Income Tax Act, generally referring to a fixed place of business in India through which the foreign entity carries on its business activities.
Legislative Amendments and Notifications
Section 115AD has undergone several amendments, reflecting changes in tax rates and extending concessions to different types of securities. Here’s a brief overview of significant changes:
- Finance Act, 1997: Extended the tax concession to unlisted securities.
- Finance (No. 2) Act, 2004: Introduced a 10% tax rate for short-term capital gains covered under Section 111A.
- Finance Act, 2018: Made long-term capital gains taxable at 10% for gains exceeding one lakh rupees under Section 112A, aligning with the removal of the exemption under Section 10(38).
- Finance Act, 2020: Amended provisions concerning specified funds and offshore banking units.
Notifications have also been issued to specify the list of eligible FIIs and to clarify the applicability of different provisions under the section.
Impact on Foreign Institutional Investors
Section 115AD has been instrumental in attracting foreign investment by providing a tax-friendly environment for FIIs and specified funds. The concessional tax rates and exemptions encourage investment in India’s equity and debt markets. However, FIIs must ensure compliance with the provisions to benefit from the favorable tax regime. Non-compliance or misinterpretation of the eligibility criteria could result in higher tax liabilities.
FAQs
Q1. What is the tax rate for long-term capital gains under Section 115AD?
A1. Long-term capital gains are taxed at 10%. However, for gains covered under Section 112A, the 10% rate applies only on gains exceeding one lakh rupees.
Q2. Are specified funds eligible for the reduced 5% tax rate on interest income?
A2. Yes, specified funds can benefit from the 5% concessional tax rate on interest income under Section 194LD.
Q3. Can FIIs claim deductions under Chapter VI-A if they have income from securities?
A3. No, deductions under Chapter VI-A are not allowed if the gross total income consists solely of income from securities.
Q4. What are the conditions for specified funds to benefit from Section 115AD?
A4. The provisions apply to income attributable to units held by non-residents who do not have a permanent establishment in India, or to the investment division of offshore banking units classified as Category-I portfolio investors.
Q5. Does Section 115AD apply to dividend income?
A5. No, dividend income is excluded from the scope of Section 115AD as per the amendments made to align with Section 115-O.
Conclusion
Section 115AD serves as a vital provision for promoting foreign investment in India’s capital markets by offering concessional tax rates for FIIs and specified funds. With favorable rates on income from securities and capital gains, it creates an attractive environment for foreign investors. As the section continues to evolve through legislative amendments, FIIs and specified funds must stay updated on the changes to maximize the benefits and ensure compliance.
By understanding the nuances of Section 115AD, FIIs and specified funds can better navigate the Indian tax landscape and optimize their investment strategies. For more detailed tax guidance, feel free to contact us at SmartTaxSaver.
