Section 115AD - Tax Rates for Foreign Institutional Investors

Section 115AD offers concessional tax rates for certain incomes of specified institutions. These institutions are Non-Residents that do not have any permanent establishment in India. This article explains the tax implications of different kinds of income earned by Foreign Institutional Investors in detail.

What is Section 115AD?

• Section 115AD of the Income Tax Act,1961 deals with the taxation of Foreign Institutional Investors. It offers concessional tax rates to the aforesaid investors.
• From an Income tax perspective, Foreign Institutional Investors are those specified by the Central Government for this purpose in an official gazette.
• Usually, FII’s receive capital gains from the transfer of securities, other income from securities and miscellaneous income. 

Who are Foreign Institutional Investors?

• These institutions are regulated by SEBI in India. 
• They are foreign institutions making investments in the economy. Ever heard of Black Rock and Deutsche Bank in India, investing their funds in the Indian economy? They are popular Foreign Institutional Investors in India. 
• More often than not, FIIs are financial and banking institutions.

Can FIIs be Residents Under the Income Tax Law?

We need to diverge and look at SEBI  regulations slightly. 

• As per SEBI regulations about Foreign Portfolio Investors, an FPI cannot be a resident. 
• However, a resident can be a ‘constituent to the fund’ in fulfilment of certain conditions as prescribed, whether an individual or not.

Therefore, though residents cannot be investors, they can contribute to the fund maintained by FIIs upon fulfilling conditions.

What are Specified Funds?

Before going into tax treatment, we must understand the meaning of specified funds. The specified funds are those referred to u/s 10(4D) of the Act. They are:

• Category III AIF under relevant SEBI regulations
• Registered as a Retail Scheme/ Exchange Traded Fund, as regulated under the relevant IFSC regulations
• Units located in any IFSC
• Funds in which Non-Residents hold all the units( Exceptions as specified)
• Investment Division of an Offshore Banking Unit - conditions as prescribed.

What is the Tax Treatment of Income from Specified Funds for Foreign Institutional Investors?

We can classify the income received by the specified funds under two categories:

• Income arising from the Transfer of securities
• Any other income arising from such securities

Tax Treatment on the Transfer

Any income arising for funds specified u/s 10(4D) due to transfer is exempt in the hands of the assessee on the satisfaction of the following conditions:

• The consideration on transfer of units is received in Convertible Foreign Exchange (and)
• The transfer happened on a Recognised Stock Exchange located in an IFSC.

If both of the above conditions are not satisfied, the transfer is taxed as follows:

Transfer of Securities other than Equity Shares of Listed Companies or Equity-Oriented Mutual Fund

• In case of a Long Term Capital Gain - 10% (Without Indexation)
• In case of a Short Term Capital Gain -  30% (Without Indexation)

Transfer of Securities - Equity Shares of Listed Companies or Equity-Oriented Mutual Fund

If the transfer happened before 23rd July 2024,

• In case of a Long Term Capital Gain - 10% (Without Indexation) (Exemption of Rs.1,25,000 is available)
• In case of a Short Term Capital Gain -  15% (Without Indexation)

If the transfer happened on or after 23rd July 2024,

• In case of a Long Term Capital Gain - 12.5% (Without Indexation) (Exemption of Rs.1,25,000 is available)
• In case of a Short Term Capital Gain -  20% (Without Indexation)

Tax Treatment of Any Other Income from Securities

Income arising apart from the transfer for funds specified u/s 10(4D) is exempt in the hands of the assessee on the satisfaction of the following conditions:

• The security is issued by a Non-Resident (and)
• Income from securities does not accrue or arise in India.

If neither of the above two conditions is satisfied, it is taxed as follows:

• 20% in the case of a Foreign Institutional Investor
• 10% in the  case of a specified fund
• Interest on Rupee Denominated Bond or a Government Security or a municipal debt securities - taxed at 5% - (Interest received as mentioned u/s 194LD)

Tax Treatment of Income other than Income From Securities

All the other income, except income from securities, is taxed at normal rates.

• Normal rates for FIIs to the extent that they do not have permanent establishment in India - since they do not have a permanent establishment in India, and the business income arises out of activities outside India, the income is not taxable in India as it is accrued outside India for a Non-Resident.
• Normal rates for FIIs are to the extent that they do not have permanent establishment in India. Since the income arises from business activities in India, it is taxed at a 40% tax rate for foreign companies when the FII is a foreign company.

Summary

Here is a summary of taxation provisions for FIIs in a tabular format:

1. Income Arising from the Transfer of Securities

2. Other Income from Securities (Not Transfer)

3. Income Other than from Securities

Final Word

Section 115AD provides a concessional tax regime to attract foreign capital into Indian markets. It also significantly promotes investments through IFSC stock exchanges by offering full tax exemption on the transfer of specified securities carried out on these exchanges.