FPIs withdraw over Rs 2,000 cr from equities in July; will proposed tax surcharge hit flows?

Foreign portfolio investors (FPIs) have continued to pull out money from the cash segment in July. In the first 10 days, FPIs and FIIs have withdrawn over Rs 2,000 crore.

The government's proposal to raise the tax burden on them have not helped the cause either as the selling picked up the pace soon after the proposal was made public during the Union Budget July 5.

Finance Minister Nirmala Sitharaman proposes increasing surcharges on super-rich individuals that could impact over 2,000 foreign funds which are equivalent to the association of persons (AOP), according to a media report.

The effective tax on the FPIs (being an AOP or Trust or individual), earning more than Rs 5 crore of income in a financial year, will increase from 5.98 percent to 7.12 percent (on interest income from specified bonds), 23.92 percent to 28.5 per cent (on interest income), 11.96 percent to 14.25 percent (on long term capital gains), 17.94 percent to 21.37 percent (on STT paid short term capital gains), 35.88 percent to 42.74 percent (on non-STT paid short term capital gains).

However, the increases rates are not effective on FPIs constituted as a company, a firm or a limited liability partnership, Punit Shah, Partner, Dhruva Advisors told Moneycontrol.

The budget has soured FII sentiment due to a higher tax liability which will impact flows coming into India especially towards equity markets. However, there could be a higher allocation in the debt segment.

FIIs have poured in more than Rs 6,000 crore in the debt segment so far in July, followed by Rs 7,000 crore net investment in the debt segment in June 2019.

“Higher tax surcharge will make India a less attractive destination and may also lead FIIs to re-visit their positive outlook on India. There will be most certainly a re-think on the vehicle for investing into India which may require more paperwork and additional regulation,” Dipan Mehta, Director at Elixir Equities Pvt. Ltd told Moneycontrol.

“But, FIIs come to India despite higher taxes and increased regulation and scrutiny because of the demographic opportunity that India offers and presence of world-class companies with excellent corporate governance standards and secular high growth businesses that provide compounding returns,” he said.

Amar Ambani. President & Research Head, YES Securities in a note said that hike in surcharge in the Budget will have an adverse impact on high-end consumption, as well as reduce the investible surplus of high-income individuals, whose money was the mainstay of mutual funds, portfolio management services and the midcap segment.

“The increased surcharge also has a bearing on FPIs coming in through the Trust route and Cat-3 AIFs. This potentially reduces the post-tax attractiveness of India, vis-à-vis other markets, where such a high rate doesn’t exist,” he said.