Tax and Regulatory update on Foreign Portfolio Investors (FPIs) in India – January to March 2024

Taxation Updates

Ministry of Finance invokes MFN (Most Favoured Nation) clause, notifies lower tax rate for Royalty and Fees for Technical Services (FTS) under India-Spain Double Taxation Avoidance Agreement (DTAA)

Government of India vide notificatio¹ dated 19 March 2024 has notified a significant amendment to paragraph 2 of Article 13 of the India-Spain DTAA, affecting the taxation of royalties and FTS.

Due to the Protocol to the DTAA in place, any future reduction in taxation on royalties or FTS by India with an OECD member country will also apply to the India-Spain DTAA automatically. Accordingly, Germany being an OECD member at the time of entering into the treaty with India, the 10% of the gross amount of royalties or fees for technical services for beneficial owners shall be applicable to India-Spain DTAA instead of 10% for equipment royalty and 20% for all other royalty and FTS payments. Thus, India and Spain have now amended their DTAA to provide clarity and consistency in the taxation of royalties and FTS between the two countries.

Regulatory Updates

Securities and Exchange Board of India (SEBI) issues framework for short-selling

SEBI vide circular² dated 5 January 2024 introduces additional conditions for short selling. The institutional investors are required to disclose, at the time of placement of order whether the transaction under question constitutes a short sale, while the retail investors must disclose about the same by the end of the trading day.

Moreover, brokers are now under a mandate to collect and submit the details pertaining to scrip-wise short-sell positions to the respective stock exchanges before the next trading day. The stock exchanges are required to consolidate and disseminate on a weekly basis.
The circular reiterates that all classes of investors are permitted to short sell however naked short selling is not permissible. Institutional investors are barred from day trading. Securities traded in the Futures and Options segment are within the list of securities which are eligible for short selling.

SEBI modifies the underlying investor to a beneficial owner

SEBI's recent circular³ dated 11 January 2024 directs the Alternative Investment Funds (AIFs) managers to ensure that investors or their beneficial owners are not listed in the UN Security Council sanctions list during onboarding.

Furthermore, the investors should not reside in countries identified by the Financial Action Task Force (FATF) with strategic anti-money laundering or terrorism financing deficiencies, subject to countermeasures, or jurisdictions showing inadequate progress in addressing these issues. For an existing AIF, the manager also has to ensure that existing underlying investors who now do not meet the criteria of the beneficial owner shall not be allowed drawdown of any further capital commitment until such condition is met.

SEBI streamlines the regulatory reporting by Designated Depository Participants (DDPs) and custodians.

SEBI has issued a circular⁴ dated 25 January 2024 wherein SEBI has mandated specific reports to be submitted by DDPs and Custodians on the SEBI Intermediary ('SI') Portal. The reports to be submitted include Annual audit reports, Annual review reports of systems, AI/ML reports and the timeline for submission ranges from monthly to annual. DDPs shall make reporting of changes in material information of FPIs as per the regulation in place, on a monthly basis on the SI portal. However, the DDPs shall continue to submit delay in intimation of certain material changes within 2 working days from the receipts of intimation from FPI. Further, it is instructed to upload the monthly and quarterly reports within 15 calendar days from the end of each month and quarter, respectively. While the other reports shall be uploaded as per timelines specified in the Master Circular for Custodians dated 27 April 2023.

SEBI introduces amendments to additional disclosure by FPIs

SEBI vide circular⁵ dated 20 March 2024 has introduced amendments to the disclosure requirements by FPIs.
The previous SEBI circular⁶ dated 24 August 2023, requires FPIs holding more than 50% of their Indian equity Asset Under Management (AUM) in a corporate group to provide additional disclosures as specified. However, the present circular prescribes a few conditions under which such FPIs with over 50% Indian equity AUM in a corporate group can be exempted from the above-referred additional disclosure requirement.

The circular stipulates conditions with respect to the apex company of such corporate groups, requiring it to have no identified promoter and also stipulates that the aggregate holding of the FPIs in the apex company shall not be more than 3% of the total equity share capital of the apex company. It also mentions that the Custodians and Depositories shall track the utilisation of the said limit for apex companies without identified promoters and require them to take appropriate actions if these limits are met or breached. FPIs which do not meet the criteria must realign their investments below the 50% threshold or make additional disclosures within a specified timeframe. It has further clarified disclosures for FPIs that met specific criteria but have not realigned their portfolios within the prescribed period. Those meeting the conditions specified in the circular are exempted from penalties for non-disclosure.

Procedural Updates

SEBI releases consultation paper on relaxation of timelines for FPIs

SEBI, on 7 February 2024, sought public consultation regarding the relaxation of timelines for FPIs to disclose material changes. This move follows numerous representations from market participants citing challenges, particularly in disclosing changes in Beneficial Owner within the prescribed seven working-day timelines.

In light of the above, SEBI has proposed categorising material changes to be notified by FPIs into specific categories to mandate notification timelines for notification of such changes viz. –

(i) Type I: changes which require FPI to seek fresh registration or which affect any privileges/exemptions available to the FPI, and

(ii) Type II: all other material changes.

Further, it has been clarified that Type I material changes shall be informed by FPIs within 7 working days of the occurrence of the change. However, the supporting documents shall be provided within 30 days of such change. Type II material changes along with the supporting documents (if any) shall be provided by FPIs within 30 days of such change.

SEBI had requested public comments by 28 February 2024.

SEBI proposed a framework for providing flexibility to FPIs while dealing with securities post-expiry of registration

SEBI issued a Consultation Paper on 7 February 2024 pertaining to the framework for providing flexibility to FPIs in dealing with their securities post-expiry of their registration. There have been several instances wherein the FPIs failed to liquidate their holdings within the prescribed timelines for non-compliance which led to securities remaining frozen in the accounts of FPIs. With an objective to facilitate ease of doing business and resolve the aforesaid issue, SEBI now proposes to permit FPIs to regularise their account or dispose of securities lying in their demat accounts, post-expiry of their registration.

The key proposals have been listed as under:

1. SEBI is also contemplating extending the benefit of extending the registration of the regularisation of registration to FPIs as well which is time-bound and includes financial disincentive.

2. SEBI suggests that a liquidation period of 180 days may be given for the other open-ended scenarios as per the current framework. However, the proposed timelines for regularisation and liquidation shall be applicable only for non-compliances that occur in future.

3. It is also proposed that an additional period of 180 days may be provided for the disposal of such securities. Therefore, a period of 360 days (180+180) shall be available for the disposal of securities after the expiry of an FPI’s registration.

4. The consultation paper has also outlined two approaches for the FPIs to liquidate their securities in the additional 180-day time period namely sale of securities by FPI itself and sale of securities through exchange empanelled brokers.

5. With respect to securities held in the accounts of FPIs, where timelines for regularisation and/or timeline for liquidation have already expired as of the date of issuance of this framework, it is proposed to provide a one-time opportunity for disposal of securities blocked in such accounts.

6. Further, FPIs, whose registration has expired, prior to issuance of this framework, shall be provided an opportunity to sell the securities lying in their demat accounts, within 180 days from the date of issuance of this framework. The securities which the FPIs were unable to sell will be compulsorily written off by the FPIs.

7. The securities written off on the date or post the issuance of the framework shall be disposed off by the broker in the manner as may be prescribed and subsequently the proceeds, net of brokerage shall be transferred to IPEF.

SEBI had requested public comments by 28 February 2024.

SEBI Board Meeting

In order to provide flexibility and facilitate ease of doing business, SEBI in its recent Board meeting⁷ on 15 March 2024, has approved certain proposals relevant to FPIs which are as under:

• Sanction of the introduction of the Beta version of the optional T+0 settlement system, restricted to a set of 25 scrips and a limited number of brokers.

• Revision in the timelines for disclosing material changes by FPIs wherein material changes and classification of the same into two categories.

• Proposals relating to measures to deal with securities after the expiration of registration of FPIs, allowing amendments to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 and providing a framework for privately placed InvITs to issue subordinate units, amendments to the SEBI (Infrastructure Investment Trusts) Regulations, 2014 are approved.

International Financial Service Centre (IFSC)

Central Board of Direct Taxes (CBDT) provides exemption to IFSC Units from TDS Requirement on certain Payments

The CBDT notification⁸ dated 7 March 2024 lists specified payments exempt from tax deduction under the Income-tax Act, 1961 (IT Act), on payments made by any 'payer' to a person being a Unit of IFSC. The IFSC unit will be required to submit a statement in Form No. 1 to the payer providing details concerning preceding years pertinent to the ten consecutive assessment years during which the said unit opted for deduction under section 80LA(1A) and 80LA(2) of the IT Act and the exemption shall be available only for such preceding years. After the date of receipt of the said statement, the payer shall not deduct taxes and shall furnish the details in the statement of deduction of tax referred to under section 200(3) of the IT Act.

Accredited Investors in IFSC

The International Financial Services Centres Authority (IFSCA) circular⁹ dated 25 January 2024 provides an extensive framework with respect to the eligibility of Accredited Investors in IFSCs and the modalities related thereto. The circular lays out requirements for Accredited Investors' eligibility and specifies the deemed Accredited Investors. The Regulated Entities are required to ensure that adequate procedures and mechanisms are in place for timely compliance & are directed to take appropriate steps wherever necessary.

Direct Listing of Indian companies on the stock exchanges in IFSC – Monitoring of investments from countries sharing land border with India

To stimulate foreign investment inflows, unlock avenues for growth, and expand the investor base for Indian companies, the CG has permitted direct listing of equity shares of an Indian public company. It will be the responsibility of the permissible holders and its beneficial owner to ensure compliance with this requirement and the same shall be disclosed by the public Indian companies in their offer documents.

In light of the above, IFSCA with immediate effect has specified a mechanism in their recent circular¹⁰ dated 9 February 2024 to ensure compliance by permissible holders as under:

1. All the Broker-dealers, depository participants and custodians in the IFSC are required to conduct Know your Customer (KYC) and Client Due Diligence (CDD).

2. A list of Identified Clients is to be maintained and updated. Further, the list of such existing clients shall be prepared within 30 days from the date of the circular.

3. Broker dealers/depository participants must submit the list prepared to Stock Exchanges in the IFSC/to the depository respectively, who in turn shall then share it with recognised stock exchanges in the IFSC. Moreover, in the event of any update, it shall be informed promptly within one working day of such update.

4. A signed declaration shall be taken from the Identified Clients that they shall not hold equity shares of a public Indian company listed or be listed on a stock exchange in IFSC without CG approval. Similarly, a signed declaration shall also be taken from other clients stating that neither they nor any of its beneficial owners, is situated in or is a citizen of a country sharing land border with India. These declarations must be obtained during initial onboarding and periodically updated during CDD.

5. Stock exchanges are required to submit a monthly report to IFSCA regarding market surveillance conducted to monitor the activities of Identified clients in the secondary market.

6. Stock exchanges, broker-dealers, depository, depository participants and custodians in the IFSC shall have sufficient mechanisms to ensure the necessary compliance.

Recent Jurisprudence

Mumbai Tax Tribunal allows US-based FPI to set off short-term capital loss against Short-Term Capital Gain (STCG) irrespective of different tax rates.

The Mumbai Tax Tribunal (Tribunal) recently held¹¹, that the Short-Term Capital Loss (STCL) can be set off against the STCG even though taxed at different rates. In the present case, the taxpayer was a SEBI-registered FPI based out of the US and earned STCG on the sale of derivatives and incurred Short-Term Capital loss (STCL) on the sale of equity shares (STT paid). The taxpayer had set off its STCL against STCG taxed at 15% and 30% respectively and had carried forward the balance. As per the provisions of the IT Act, STCL can be set off against the gains of any other capital asset. The tax officer and Dispute Resolution Panel (DRP) contended that the STCG earned from derivative instruments constituted speculative gains. Additionally, it was observed that the STCL incurred from equity shares could not be offset against such gains due to disparate tax rates applicable to STCL and STCG for different classes of assets. Consequently, the tax authority disallowed the offset claim referring to the provisions of section 70(2) of the IT Act. The aggrieved taxpayer preferred an appeal before the Tribunal. Basis the facts of the case and the past judicial precedents, the tax tribunal passed a favourable ruling and upheld the taxpayer's right to select the set-off sequence for maximum benefit, allowing STCL from any asset to offset STCG from any other asset.

This ruling reemphasises the comprehensive applicability of Section 70(2) of the IT Act across different asset classes, irrespective of applicable individual tax rates. The ruling further affirms that the calculation of income after setting off the losses occurs before applying the tax rate.

Consequently, this ruling provides a benefit to the taxpayer in exercising its right to select chronology of set-off which is most beneficial to him in the absence of a specific mode of set-off provided under the provisions of the IT Act.

Stay on Delhi High Courts’ (HC) Ruling that deems a Tax Residency Certificate (TRC) sufficient evidence for claiming treaty benefits

The Supreme Court of India (SC) issued a notice¹² in a Special Leave Petition (SLP) filed by the Revenue Authorities against the HC’s decision which ruled that a TRC is sufficient for claiming relief under DTAA and the tax officer cannot challenge/ question the same and declared it as conclusive evidence of residential status and legal ownership.

The SC issued a notice directing to stay the HC ruling and also directed the Revenue not to collect the amount assessed to be collected from the assessee.

The Interim Budget 2024

Budget Highlights

The Hon’ble Finance Minister presented an Interim Union Budget¹³ 2024, highlighting a significant positive transformation in the Indian economy over the past decade. The government prioritises a broader 'GDP' approach, encompassing Governance, Development, and Performance.

This year being a Vote-on-Account budget, there were no major announcements. While no new tax proposals were introduced, to ensure the continuity of a few tax benefits, amendments have been made to extend the sunset clauses by one year till 31 March 2025. These amendments include exemptions for specified incomes/units, such as the Investment Division of Offshore Banking Units, income from leasing aircraft or ships in IFSC units, tax holidays for eligible startups, and exemptions for specified pension funds and sovereign wealth funds.