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Bonus stripping: Foreign portfolio investors from Mauritius feel the pinch

By Ashley Coutinho
February 10, 2022 15:55 IST
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Foreign portfolio investors (FPIs) who invest from Mauritius into Indian companies that dole out bonus debentures will get impacted by the tax avoidance provisions on bonus stripping.

FPI

Illustration: Uttam Ghosh/Rediff.com

The FY23 Budget has extended these provisions — applicable only to MFs, so far — to shares and units of REITs, InvITs and AIFs.

The move will especially affect large institutional investors who sell original units within nine months after the record date because the loss arising from sale of original units would have to be ignored for the purposes of computing taxable income and cannot be set off against any other capital gain.

 

For instance, say, an FPI receives a bonus on a share that was acquired within three months prior to the record date.

If the investor sells his/her original holdings within nine months of such record date, the loss on sale would have to be ignored.

Such loss would now have to be considered to be the cost of acquisition of the bonus shares and deduction would be available as and when the bonus shares are sold.

“Bonus stripping is an anti-avoidance provision. So far, the law prohibited bonus stripping in the case of MFs. But with this chan-ge, it is extended to equity shares and other securities.

"Computation of tax on capital gains on shares will become relatively complex and investors will need to maintain their data systematically to consider the effect of these provisions,” said Suresh Swamy, partner, Price Waterhouse & Co.

“Different views are possible on the allocation of cost to bonus shares in a situation where the taxpayer sells part or all of the bonus shares, along with the original shares and whether the proportionate theory can be applied. Arguably, the provision should’nt apply if all securities, including bonus securities, are sold,” said Rajesh Gandhi, partner, Deloitte India.

The new stripping provisions can lead to another scenario. In certain cases, companies have paid dividends to shareholders by way of bonus debentures.

These debentures are allotted to the shareholder without any payment and on the basis of holding his/her shares.

While the value of debentures is offered to tax as dividend and taxpayers treat the amount taxed as dividend as the cost of acquisition of the debentures, one may argue that these provisions are not triggered.

But there is no payment being made by the investor to acquire the debentures. In cases where the buy/sell transaction happens within the prescribed threshold (3 months before the record date/within 9 months of the record date), tax authorities can argue that the provisions are triggered.

And if the provisions are triggered, a Mauritius-based fund investing in Indian equities will not be able to set off its losses against the equity shares.

The losses will be added as the cost of the debenture. But since gains on sale of debentures are exempt from tax under the India-Mauritius tax treaty, the investor will not get any benefit from the losses.

So, in effect, the investor will end up paying higher taxes.

Mauritius has become an attractive destination for debt investments in India as capital gains on sale of debt securities is exempt from tax under the treaty between the two countries.

Several Indian companies, such as Britannia, HUL, Blue Dart, NTPC, and Dr. Reddy’s, have issued bonus debentures in the past.

Firms issue bonus debentures to reward equity shareholders, who receive interest on these debentures at a pre-determined rate at fixed intervals until maturity.

These are redeemed on maturity and the principal amount (face value of the debenture) is paid out to them.

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Ashley Coutinho in Mumbai
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