Anne Marie Sharkey
Where investors hold securities through a pooled vehicle such as an investment fund, tax leakage or so-called, ‘tax drag’ should be minimised such that an investor is not placed at a disadvantage by investing in a fund rather than investing directly themselves. This past year saw some significant developments in relation to the taxation of foreign investors in both China and India that will be of interest to both Irish asset managers and investors.
China
A foreign investor investing in China A-shares (Renminbi denominated shares of Chinese companies traded on the Shanghai/Shenzen exchanges) will typically invest through a registered Qualified Financial Institutional Investor (QFII) who has been allocated a quota for investment. Following the introduction of the QFII and (Renminbi) QFII schemes, a number of tax circulars were released in China to clarify how foreign investors should be taxed on their investment return. Chinese authorities had historically remained silent on the tax treatment of capital gains derived by foreign investors investing in China A-shares until November 2014. Under existing Chinese tax code, there had always been a technical exposure to capital gains tax (CGT) on a self-assessment basis but there was no practical collection mechanism in relation to this tax in China.
Tax circulars released in conjunction with the StockConnect share trading programme announced a ‘temporary’ exemption from CGT for gains derived by foreign investors on investment in China A-shares. Importantly, a temporary CGT exemption was deemed to apply from 17 November 2014 in relation to transfers and disposals of China A-shares occurring after this date. At the same time it was clear that capital gains realised by foreign investors prior to 17 November 2014 would be subject to Chinese tax at the rate of 10%. Practically speaking Irish funds using a fund plus QFII structure were required to assess their historic tax position in China and calculate and pay over tax to the authorities. It is expected that the Chinese authorities will respect treaty benefits afforded under double tax agreements between China and the fund/QFII.
India
Since their introduction in 1992, Foreign Institutional Investor Programmes have contributed significantly to the growth of the Indian capital markets. “Foreign Portfolio Investors” (FPIs) are permitted to invest in primary and secondary traded securities of Indian companies.
In late 2014 the Indian Revenue began issuing ‘show-cause’ notices to FPIs as part of the tax audit programme for financial years ending in 2012 requesting FPIs to clarify why they should not be subject to ‘Minimum Alternate Tax’ (MAT) on their book profits (which typically applied to Indian resident entities or permanent establishments). The MAT tax came into focus for FPIs following the adverse ruling issued by the Authority for Advance Ruling in the Castleton case, where it was held that MAT applies to foreign companies. Castleton, a Mauritian FPI, has appealed the decision to the Supreme Court.
Following representations by affected parties, the Indian Finance Act 2015 amended the MAT provisions to exclude, among others, capital gains and interest income received by FPIs, effective from 1 April 2015 (and, significantly, did not clarify the historical position). The Indian Revenue took the position that MAT applied up to 31 March 2015, and proceeded to raise assessments, for up to 7 years in some cases.
It was not surprising that major global asset management industry bodies made representations to Indian authorities disputing the position taken by the Indian Revenue. Lobbying efforts sought to underline the negative impact of applying MAT retrospectively to FPIs for inbound investment in India.
On 11 May 2015 the Ministry of Finance said the applicability of MAT to FPIs prior to 1 April 2015 (along with related tax issues) would be referred to a committee to be headed by Justice A.P. Shah, chairman of the Law Commission in India.
The Shah Committee recommendations were released on 25 August last and strongly endorsed the view that FPIs should not be subject to MAT having regard to the fact that the MAT rules were never intended to have been applied to non-domestic companies. The Indian Finance Ministry confirmed on 1 September it would bring forth legislation to give effect to the recommendations and would instruct the Indian Revenue to cease the issue of show-cause notices to FPIs.
As the difficult market conditions in China have shown recently, although investment in Asia represents a significant opportunity, it is not without its complexity and pitfalls. Irish fund promoters and their service providers have been grappling this year with ever increasing complexity, uncertainty and increased tax filing obligations abroad. The sensible outcome in the case of MAT and its applicability to FPIs in India is welcomed but this year has shown that promoters and managers should always fully investigate the tax aspects of investing in such markets prior to entry.