Evolution of Special Tax Regimes for Offshore Funds : Clause 208 of the Income Tax Bill, 2025 Vs. Section 115AB of the Income-tax Act, 1961

Clause 208 Tax on income from units purchased in foreign currency or capital gains arising from their transfer.

Income Tax Bill, 2025

Introduction

Clause 208 of the Income Tax Bill, 2025 is a special statutory provision designed to govern the taxation of income earned by non-resident investors, specifically overseas financial organizations, from investments in units purchased in foreign currency and from capital gains arising from the transfer of such units. This clause is a successor to the existing Section 115AB of the Income-tax Act, 1961, a well-established provision that has, for decades, provided a concessional tax regime for offshore funds investing in India through specified channels. The evolution of this provision reflects India's ongoing efforts to attract foreign portfolio investment while ensuring tax clarity and compliance. The significance of these provisions lies in their impact on cross-border investments, the mutual fund industry, and India's image as an investment destination. By offering certainty and concessional tax rates, both Clause 208 and Section 115AB aim to foster the inflow of foreign capital, which is crucial for the development of domestic financial markets. At the same time, these provisions are tailored to prevent tax arbitrage and ensure that only qualifying entities benefit from the special regime. This commentary provides a detailed, itemized analysis of Clause 208, explores its legislative intent, practical implications, and addresses interpretational issues. It then undertakes a comprehensive comparative analysis with Section 115AB, highlighting both continuity and change, and concludes with observations on the likely impact and potential areas for further reform.

Objective and Purpose

The core objective of Clause 208, echoing that of Section 115AB, is to provide a special tax regime for overseas financial organizations (offshore funds) investing in units of mutual funds or the Unit Trust of India (UTI) using foreign currency. The legislative intent is twofold:

1. Attracting Foreign Investment: By offering concessional tax rates and clear rules, the provision aims to incentivize foreign portfolio investment, thereby deepening the Indian capital markets and providing access to global capital for domestic enterprises.
2. Ensuring Tax Certainty and Compliance: The provision sets out specific conditions, definitions, and compliance requirements to ensure that only genuine, regulated overseas financial entities benefit from the regime, thus preventing misuse and tax evasion.

Historically, Section 115AB was introduced in the early 1990s, a period marked by India's economic liberalization and opening up to foreign capital. The provision has since undergone amendments to keep pace with regulatory changes (such as the shift from the Foreign Exchange Regulation Act to the Foreign Exchange Management Act, and from the Companies Act, 1956 to the Companies Act, 2013), as well as evolving investment structures. Clause 208 of the Income Tax Bill, 2025 represents the next phase in this evolutionary process, aligning the law with current market realities, regulatory frameworks, and policy objectives.

Detailed Analysis of Clause 208 of the Income Tax Bill, 2025

Clause 208 is structured into three main sub-clauses, each addressing a distinct aspect of the tax regime for offshore funds.

1. Tax Rates on Specified Income

This clause 208(1) sets out the special tax rates applicable to different categories of income earned by an overseas financial organization (Offshore Fund):

Sl. No.	Income	Income-tax payable
1	Income received in respect of units purchased in foreign currency	10%
2	Long-term capital gains arising from the transfer of units purchased in foreign currency	12.5%
3	Total income as reduced by income referred to in 1 and 2 above	Income-tax chargeable on such income (i.e., normal rates)

Interpretation and Implications:

• Income from Units: Income (such as dividends or distributed income) received in respect of units purchased in foreign currency is taxed at a flat rate of 10%, providing a concessional regime compared to standard corporate or individual tax rates.
• Long-Term Capital Gains (LTCG): LTCG arising from the transfer of such units is taxed at 12.5%, reflecting a recent increase (see comparative analysis below).
• Other Income: Any income not covered under the above two heads is taxed at normal rates applicable to the entity, ensuring that the concessional regime is ring-fenced to specified income streams.
• Aggregation: The provision requires aggregation of tax computed under each head for total tax liability, ensuring clarity and preventing double taxation.

2. Deductions and Computation of Gross Total Income

This clause 208(2) addresses the allowability of deductions and the computation of gross total income in two scenarios:

1. Exclusive Income from Units or LTCG: Where the gross total income consists only of income from units or LTCG from their transfer, no deduction is allowed u/ss 26 to 61, section 93(1)(a) and (e), or under Chapter VIII.
2. Mixed Income: Where the gross total income includes such income (from units or LTCG) along with other income:
   • The gross total income is to be reduced by the amount of such income (from units or LTCG); and
   • Deductions under Chapter VIII are allowed as if the reduced gross total income were the gross total income of the assessee.

Interpretation and Implications:

• Ring-fencing of Concessional Income: The provision ensures that income eligible for concessional tax rates does not enjoy further deductions, thus preventing double benefits.
• Fairness in Mixed Income Scenarios: Where the offshore fund has other income, deductions are allowed only against such other income, not against the concessional income, maintaining the integrity of the special regime.
• Compliance Complexity: The requirement for precise segregation and computation of income streams may increase compliance burden for funds with complex portfolios.

3. Definitions

This clause 208(3) defines key terms for the purposes of Clause 208:

• Overseas Financial Organisation: Any fund, institution, association, or body (incorporated or not) established under the laws of a country outside India, which:
  • Has entered into an arrangement for investment in India with a public sector bank, public financial institution, or a mutual fund specified in Schedule VII (Sl. No. 20 or 21); and
  • Such arrangement is approved by the Securities and Exchange Board of India (SEBI).
• Public Financial Institution: As per section 2(72) of the Companies Act, 2013.
• Unit: Unit of a mutual fund specified in Schedule VII (Sl. No. 20 or 21) or the Unit Trust of India.

Interpretation and Implications:

• Strict Qualification Criteria: Only entities that meet the dual criteria of
  • (a) investment arrangement with specified Indian institutions, and
  • (b) SEBI approval, are eligible, ensuring regulatory oversight.
• Updated References: The provision refers to the Companies Act, 2013 and Schedule VII, reflecting legislative updates and alignment with current regulatory frameworks.
• Potential for Exclusion: Funds not meeting the precise definitional requirements, or investing through unapproved channels, do not benefit from the concessional regime.

Practical Implications

Clause 208, like its predecessor, has wide-ranging implications for various stakeholders:

• Offshore Funds: The provision provides certainty and a competitive tax regime, making India an attractive destination for foreign portfolio investment. However, strict compliance with eligibility criteria and documentation is essential to avail the benefits.
• Mutual Funds and UTI: The provision may increase flows into Indian mutual funds and UTI, boosting assets under management and market liquidity.
• Regulators (SEBI, RBI): The requirement for SEBI approval and alignment with Indian financial institutions ensures regulatory oversight and prevents misuse.
• Tax Administration: The clear segregation of income streams and denial of double deductions simplifies tax assessment but requires careful scrutiny of documentation and fund structures.
• Market Impact: By offering a competitive, stable tax regime, the provision may enhance India's standing in global capital markets, though changes in rates (such as the increase in LTCG tax) may affect investment decisions.

Comparative Analysis: Clause 208 vs. Section 115AB

1. Scope and Structure

Both provisions apply to "overseas financial organisations" investing in units purchased in foreign currency, and both prescribe special tax rates for income from such units and capital gains from their transfer. However, Clause 208 streamlines the structure and updates references to align with contemporary legislation (e.g., Companies Act, 2013, instead of 1956). The definitions are consolidated and clarified, enhancing interpretive certainty.

2. Tax Rates

- Section 115AB: Originally provided a 10% rate for both income from units and long-term capital gains. The Finance (No. 2) Act, 2024, amended the rate for long-term capital gains to 12.5% for transfers on or after July 23, 2024.

- Clause 208: Directly incorporates the updated rates: 10% for income from units and 12.5% for long-term capital gains, thus codifying the recent amendment and providing a forward-looking framework. This harmonization of rates removes ambiguity about applicable rates for future transactions and reflects the legislative intent to align statutory law with recent policy changes.

3. Deductions and Exemptions

- Section 115AB: Prohibits deductions u/ss 28 to 44C, certain clauses of Section 57, and Chapter VI-A, and excludes the application of the second proviso to Section 48 for long-term capital gains.

- Clause 208: Prohibits deductions u/ss 26 to 61, Section 93(1)(a) and (e), and Chapter VIII. While the intent is similar-to prevent double benefits-the references to specific sections differ, reflecting the reorganization of the Income Tax Bill, 2025. The exclusion of the second proviso to Section 48 in Section 115AB, which relates to indexation benefits on capital gains, is not explicitly repeated in Clause 208, potentially requiring clarification to avoid interpretive disputes.

4. Definitions and Eligibility

- Section 115AB: Refers to mutual funds specified u/s 10(23D), public sector banks as defined in the same section, and public financial institutions as per Companies Act, 1956.

- Clause 208: Updates references to Schedule VII and the Companies Act, 2013, and clarifies the role of SEBI approval. The updated references bring the law in line with current statutes and regulatory practice, reducing the risk of interpretive confusion.

5. Procedural and Compliance Aspects

Both provisions require that the arrangement for investment be approved by SEBI. This ensures regulatory oversight and prevents abuse by non-genuine funds. However, Clause 208's language is more streamlined and avoids the piecemeal amendments that have characterized Section 115AB over the years. This should enhance compliance and reduce administrative burden.

6. Ambiguities and Potential Issues

- Indexation: Section 115AB explicitly denies indexation benefits for capital gains. Clause 208 is silent, which may create interpretive uncertainty unless clarified by rules or explanatory notes.

- Deduction References: The shift from Chapter VI-A (Section 115AB) to Chapter VIII (Clause 208) may have substantive implications, depending on how the chapters are structured in the new Bill.

- Definition of "Unit": The cross-references to Schedule VII in Clause 208 versus Section 10(23D) in Section 115AB may affect the scope of eligible investments, depending on how mutual funds are listed or defined in the respective schedules/sections.

Comparative Table: Key Provisions

Aspect	Section 115AB of the Income-tax Act, 1961	Clause 208 of the Income Tax Bill, 2025
Eligible Assessee	Overseas financial organisation (Offshore Fund)	Overseas financial organisation (Offshore Fund)
Eligible Income	Income from units & long-term capital gains	Income from units & long-term capital gains
Tax Rate: Income from units	10%	10%
Tax Rate: Long-term capital gains	10% (prior to 23 July 2024); 12.5% (after)	12.5%
Deductions	No deduction under Secs 28-44C, Section 57(i)/(iii), Chapter VI-A; no indexation	No deduction under Secs 26-61, Section 93(1)(a)/(e), Chapter VIII
Approval Requirement	Arrangement approved by SEBI	Arrangement approved by SEBI
Definition of "Unit"	Mutual fund under Section 10(23D) or UTI	Mutual fund in Schedule VII or UTI
Reference to Companies Act	Companies Act, 1956	Companies Act, 2013

Ambiguities and Issues in Interpretation

While both the old and new provisions are broadly clear, certain interpretational issues may arise:

• Scope of "Units": The shift from Section 10(23D) to Schedule VII may require funds and tax authorities to carefully map which mutual funds are covered. Any changes in the list of eligible mutual funds could affect eligibility.
• Eligibility Criteria: The requirement for SEBI approval and specific arrangements may exclude certain investment structures or funds investing through indirect or pooled vehicles.
• Definition of "Foreign Currency": While Section 115AB provides a cross-reference to FEMA, Clause 208 is silent, though it may be presumed that the same definition applies.
• Interaction with Other Provisions: The denial of deductions under specified sections may require careful computation, especially for funds with complex income streams.

Conclusion

Clause 208 of the Income Tax Bill, 2025 represents a considered continuation and modernization of the special tax regime for offshore funds investing in India. By codifying the updated concessional tax rates, refining definitions, and aligning with current statutory references, the provision maintains India's attractiveness as an investment destination while ensuring regulatory oversight and preventing abuse. The comparative analysis with Section 115AB reveals that the core principles and structure remain unchanged, with the main substantive change being the increase in the LTCG tax rate to 12.5%. The provision continues to balance the twin goals of attracting foreign investment and safeguarding the revenue base. Looking ahead, clarity regarding the scope of eligible mutual funds, the definition of foreign currency, and the interaction with other tax provisions will be important to ensure smooth implementation and continued investor confidence. Periodic review of tax rates and eligibility criteria may be warranted to keep pace with global competition and market developments.

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Full Text:

Clause 208 Tax on income from units purchased in foreign currency or capital gains arising from their transfer.

 

Dated: 29-4-2025