Evolving the Taxation of Foreign Portfolio Investment : Clause 210 of the Income Tax Bill, 2025 Vs. Section 115AD of the Income Tax Act, 1961

Clause 210 Tax on income of Foreign Institutional Investors from securities or capital gains arising from their transfer.

Income Tax Bill, 2025

Introduction

Clause 210 of the Income Tax Bill, 2025, introduces a comprehensive framework for the taxation of income earned by Foreign Institutional Investors (FIIs) and specified funds from securities and capital gains arising from their transfer. This provision, situated within the broader context of special provisions for non-residents and foreign companies, seeks to update and rationalize the taxation regime applicable to such entities, particularly in light of recent developments in international fund flows, the evolution of specified funds, and India's ambition to remain an attractive investment destination. The clause is of significant relevance, given the increasing role of foreign investment in India's capital markets and the proliferation of alternative investment funds operating from International Financial Services Centres (IFSCs).

This commentary undertakes an in-depth analysis of Clause 210, elucidating its objectives, mechanics, and implications. It then compares and contrasts the clause with the extant Section 115AD of the Income Tax Act, 1961, as well as the operational rules-Rule 21AJ and Rule 21AJAA of the Income-tax Rules, 1962  that govern the computation and attribution of income for specified funds and investment divisions of offshore banking units. The analysis highlights both the continuities and the innovations introduced by the new Bill, as well as areas where legal or practical ambiguities may arise.

Objective and Purpose

The legislative intent behind Clause 210 is to provide certainty and clarity in the taxation of income arising to FIIs and specified funds from investment in securities. The provision aims to:

• Harmonize the tax rates and computation methods applicable to different categories of investors and types of income (interest, dividends, short-term and long-term capital gains).
• Facilitate the operation of specified funds, particularly those based in IFSCs, by allowing concessional tax treatment on income attributable to non-resident unit holders.
• Ensure alignment with international best practices and respond to the evolving regulatory environment governing portfolio investment and fund management.
• Prevent tax arbitrage and base erosion by clearly delineating the scope of deductions, exclusions, and computation rules.

The historical background to these provisions can be traced to the original introduction of Section 115AD in 1993, which sought to incentivize FII participation in Indian markets by offering a simplified and concessional tax regime. Over time, the scope has expanded to include specified funds, reflecting the growth of the fund management industry in India's IFSCs and the need to compete with offshore jurisdictions.

Detailed Analysis of Clause 210 of the Income Tax Bill, 2025

1. Structure and Scope

Clause 210 is structured to apply to two main classes of assessees: specified funds and Foreign Institutional Investors. The clause provides a tabular matrix specifying the type of income and the corresponding tax rates. The provision is designed to be self-contained, with definitions and references to other relevant sections (such as sections 196 and 198) to determine the precise nature of income and applicable rates.

2. Tax Rates and Income Categories

The clause categorizes income into six distinct heads, each with its own tax rate:

1. Income in respect of securities (other than units referred to in section 208):
   • 20% for FIIs
   • 10% for specified funds
2. Short-term capital gains (other than those referred to in section 196): 30%
3. Short-term capital gains referred to in section 196: 20%
4. Long-term capital gains (other than those referred to in section 198): 12.5%
5. Long-term capital gains referred to in section 198, exceeding Rs. 1,25,000: 12.5%
6. Other income: Taxed at normal rates on the residual total income.

This structure ensures a differentiated approach, recognizing the distinct nature of various types of capital gains and income streams, and aligning tax rates with policy objectives such as promoting long-term investment and fund management activity.

3. Attribution to Non-Resident Unit Holders (Sub-sections 2 and 3)

A significant innovation in Clause 210 is the explicit requirement that, in the case of specified funds, the concessional tax rates apply only to the extent of income attributable to units held by non-residents (excluding permanent establishments in India). The manner of attribution is to be prescribed, drawing upon the computation mechanisms set out in the Rules (notably Rule 21AJ and Rule 21AJAA).

Further, sub-section (3) carves out a special regime for specified funds that are investment divisions of offshore banking units, subject to conditions in Schedule VI. This reflects policy efforts to attract global fund management activity to Indian IFSCs.

4. Disallowance of Deductions (Sub-section 4)

Clause 210(4) restricts the availability of deductions u/ss 26 to 61, section 93(1)(a) or (e), and Chapter VIII, where the gross total income consists solely of income in respect of securities. Where the gross total income includes both such income and other income, deductions are allowed only on the residual income. This is designed to prevent double benefits and to ensure that the concessional tax regime is not eroded through the layering of deductions.

5. Exclusion of Section 72(6) (Sub-section 5)

The clause explicitly disapplies section 72(6) (relating to the carry-forward and set-off of losses of specified businesses) for the computation of capital gains arising from the transfer of securities under the relevant heads. This is a targeted anti-avoidance measure.

6. Definitions (Sub-section 6)

Key terms such as "Foreign Institutional Investor," "permanent establishment," "securities," and "specified fund" are defined by reference to other statutes or schedules, ensuring consistency and minimizing interpretational disputes.

7. Notes and Explanatory Material

The accompanying notes clarify certain corrections and cross-references, emphasizing the importance of precise legislative drafting in tax statutes.

Practical Implications

The practical impact of Clause 210 is substantial for several classes of stakeholders:

• Foreign Institutional Investors: The clause provides clarity on the applicable tax rates and the scope of income covered, reducing uncertainty and facilitating compliance. The rates are competitive by global standards, particularly for long-term capital gains.
• Specified Funds (including IFSC-based funds): The ability to apply concessional rates to income attributable to non-resident unit holders is a significant incentive, likely to boost fund inflows and promote the development of India as a fund management hub.
• Regulators and Tax Authorities: The clear attribution rules and the disallowance of deductions simplify administration and reduce opportunities for tax avoidance or disputes.
• Investors: Non-resident investors in specified funds benefit from transparent and predictable tax treatment, subject to compliance with prescribed reporting requirements.

However, the requirement for precise attribution and the need to comply with annual reporting (as prescribed in the Rules) may increase compliance costs and necessitate robust systems for tracking unit-holder status and income allocation.

Comparative Analysis with Existing Clause 210 of the Income Tax Bill, 2025 vs. Section 115AD of the Income Tax Act, 1961

I. Clause 210 Vs. Section 115AD

• Scope and Applicability:
  • Both provisions apply to FIIs and specified funds, with income from securities and capital gains as the taxable base.
  • Clause 210 more explicitly incorporates specified funds and investment divisions of offshore banking units, reflecting developments in investment structures.
• Tax Rates:
  • Section 115AD provided for 20% tax on income from securities for FIIs, 10% for specified funds, 30% on STCG (other than section 111A), 15%/20% for STCG u/s 111A, and 12.5% for LTCG (with 10%/12.5% for LTCG u/s 112A exceeding Rs. 1,25,000).
  • Clause 210 largely aligns with these rates but consolidates and clarifies the categories, and explicitly references the new sections (196, 198) for concessional gains. The rate structure is maintained, but the presentation is more systematic and transparent.
• Attribution to Non-Residents:
  • Both provisions restrict concessional rates to income attributable to non-resident unit holders, but Clause 210 mandates prescribed calculation methods, anticipating more detailed rules and compliance.
• Denial of Deductions:
  • Section 115AD(2) and Clause 210(4) both deny deductions for income solely from securities, and allow deductions only on the residual income where applicable.
• Loss Set-Offs:
  • Section 115AD(3) denied the benefit of the first and second provisos to section 48 (indexation and foreign exchange adjustment) for capital gains computation, while Clause 210(5) denies the application of section 72(6), which may relate to loss set-off. The focus is consistent: to prevent further reduction of concessional gains by deductions or losses.
• Definitions:
  • Both provisions define key terms in similar ways, with updated cross-references in Clause 210.

II. Clause 210 vs. Rule 21AJ (Attribution to Non-Resident Unit Holders)

• Purpose:
  • Rule 21AJ operationalizes the attribution of income to non-resident unit holders in specified funds, as required u/s 115AD(1A) (and now Clause 210(2)).
• Computation Formula:
  • Rule 21AJ prescribes a formula based on the ratio of daily assets under management held by non-resident unit holders to total assets under management, for both capital gains and income from securities. This ensures precise and proportionate allocation.
  • Clause 210 refers to "calculated in the manner as prescribed," indicating that similar or identical rules will be notified for the new regime.
• Compliance Requirements:
  • Rule 21AJ requires the filing of Form 10IH, verified digitally, and stipulates that concessional rates are available only if the statement is filed. This is a strict compliance measure to prevent abuse.
  • Clause 210 anticipates similar compliance but leaves the details to rule-making.
• Definitions and Concepts:
  • Rule 21AJ defines terms such as "assets under management," "specified fund," and "unit" by reference to Section 10(4D).
  • Clause 210 cross-references the new Bill and Schedules but the conceptual framework remains the same.

III. Clause 210 vs. Rule 21AJAA (Attribution to Investment Division of Offshore Banking Units)

• Purpose:
  • Rule 21AJAA provides the method for attributing income to the investment division of an offshore banking unit, as envisaged u/s 115AD(1B) (and now Clause 210(3)).
• Computation Formula:
  • Rule 21AJAA sets out a detailed formula for summing up various streams of income (LTCG, STCG, interest, etc.) accruing to the eligible investment division, with clear distinctions for securities covered by sections 111A and 112A.
  • Clause 210(3) refers to prescribed methods for such attribution, and the rules are expected to be carried forward or updated accordingly.
• Compliance Requirements:
  • Rule 21AJAA requires the filing of Form 10-IK, and denies concessional rates if the statement is not filed, mirroring Rule 21AJ.
  • Clause 210(3) is silent on compliance details but clearly intends to rely on such mechanisms.
• Denial of Deductions:
  • Rule 21AJAA explicitly denies the use of expenditure incurred for generating the specified income to offset income from other activities or sources, thereby preventing double-dipping.
  • Clause 210(4)-(5) achieves a similar result at the level of the principal provision.

IV. Key Differences and Harmonization

• Structural Reorganization:
  • Clause 210 reorganizes and clarifies the regime, especially in the categorization of income streams and the explicit referencing of new sections for concessional gains.
  • The move from section-based references (111A, 112A) to new section numbers (196, 198) in the Bill may require careful cross-referencing and transition management.
• Granularity and Anti-Abuse Measures:
  • Clause 210 is more granular in its references and more explicit in its anti-abuse measures, especially regarding attribution and compliance.
  • The rules (21AJ, 21AJAA) are expected to be updated or reissued to align with the new Bill, but the underlying principles are consistent.
• Compliance Burden:
  • Both the existing and new regimes impose significant compliance obligations on specified funds and investment divisions, including detailed record-keeping, annual statements, and digital filings.
  • Failure to comply results in denial of concessional rates, a strict but effective enforcement mechanism.
• Policy Continuity and Change:
  • The core policy-providing competitive tax rates to genuine foreign investors while preventing abuse-remains unchanged.
  • The changes are evolutionary rather than revolutionary, aimed at clarity, enforceability, and alignment with international norms.

Key Ambiguities and Potential Issues

While Clause 210 and the associated Rules provide a robust framework, certain areas may give rise to interpretational or practical challenges:

• Attribution Complexity: The requirement to track daily AUM and precisely attribute income to non-resident unit holders may impose significant compliance burdens, especially for funds with frequent inflows and outflows.
• Definition of "Permanent Establishment": The exclusion of units held by non-residents "not being a permanent establishment" requires careful analysis, particularly in light of evolving international tax treaties and the risk of inadvertent PE creation.
• Interaction with Other Provisions: The disallowance of deductions and the carve-out for section 72(6) may interact in complex ways with the broader provisions for loss set-off and carry-forward, necessitating careful tax planning.
• Thresholds for Capital Gains: The application of the Rs. 1,25,000 threshold for long-term capital gains may require aggregation across multiple transactions and funds, raising issues of tracking and consistency.
• Reporting Requirements: The strict linkage of concessional rates to timely filing of annual statements (Form 10IH/10IK) may result in harsh consequences for inadvertent non-compliance, though this is arguably necessary to ensure integrity.

Comparative Perspective: International and Domestic Context

The regime under Clause 210 is broadly consistent with international practice, where portfolio investors are typically taxed at concessional rates on capital gains and income from securities, subject to anti-abuse measures and attribution rules. The explicit focus on non-resident unit holders aligns with the OECD's BEPS Action 6 (preventing treaty abuse) and Action 7 (permanent establishment status).

Domestically, the move to codify and update the regime reflects the increasing sophistication of India's fund management industry and the need to provide a level playing field vis-`a-vis offshore jurisdictions such as Singapore, Luxembourg, and Ireland. The focus on IFSC-based funds is particularly significant, as India seeks to attract global fund managers and investors to its shores.

Conclusion

Clause 210 of the Income Tax Bill, 2025, represents a significant evolution in the taxation of FIIs and specified funds, building upon and refining the regime established under Section 115AD of the Income Tax Act, 1961. The clause provides clarity, certainty, and competitiveness, while incorporating robust attribution and compliance mechanisms to prevent abuse. The alignment with Rules 21AJ and 21AJAA ensures that the concessional tax regime is available only to bona fide non-resident investors and eligible fund structures, thereby promoting both tax integrity and the growth of India's capital markets.

While the framework is robust, stakeholders must be vigilant in ensuring compliance with attribution and reporting requirements, and may need to invest in systems and processes to meet these obligations. Policymakers may consider providing additional guidance or safe harbours to address practical challenges in attribution and compliance.

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Full Text:

Clause 210 Tax on income of Foreign Institutional Investors from securities or capital gains arising from their transfer.

 

Dated: 1-5-2025