Govt may cut withholding tax on FII debt

Last Updated: Tue, Dec 11, 2012 03:54 hrs

The finance ministry is considering a proposal by foreign institutional investors (FIIs) to bring down the rates of withholding tax on long-term government debt instruments.

The proposal was discussed in a meeting between finance ministry, Securities and Exchange Board of India (Sebi), top FIIs and intermediaries on Monday.

“The government officials indicated that they are keen to take all measures that will make the foreign investment environment more conducive,” said an official who attended the meeting. Economic Affairs Secretary Arvind Mayaram chaired the meeting attended by top Sebi officials, including whole time member Prashant Saran, representatives of Goldman Sachs, Morgan Stanley, Nomura, Citigroup and State Bank of India, among others.

Highlights of the a meeting between finance ministry, Sebi and top FIIs and intermediaries on Monday
  • Changes in withholding tax structure
  • Strengthening corporate debt market.
  • Attract flow of funds in debt & equity
  • Review of QFI norms with regard to KYC and other aspects
  • Harmonising different investment routes

All FII debt investments are subject to a withholding tax deduction on coupons. The tax, which varies between 20.6 per cent to 21.012 per cent depending on the nature and net taxable income of the FII, makes investments in Indian bonds uneconomical. If the cost of hedging exchange risk is also factored in then returns from the bond drops to unacceptably low levels, according to FIIs.

Due to this, long-term bond issues by the government often find few takers. The government is falling short of long-term debt issue targets. Another key issue that is hampering FII interest in government debt instruments is the lack of marketing from the government, some intermediaries said. “While lot of marketing and promotional activities are taken up for equity issues, there is hardly any step when long-term debt issues are made, the government now realises that these issues need to be marketed as well,” said the official.

Recently, the government had said it will cut the withholding tax on investments in long-term infrastructure under the external commercial borrowings (ECB) route to five per cent.

Type of Instrument Total
Unused limits
with entities
Free limit
(not acquired)
Government Debt Long Term 51,291 45,825.90 28323.13 17,503 5,465
(in Rs crore), Debt utilisation status as on November 15, 2012 Source:

For availing the tax benefit, the finance ministry has laid down conditions that in case of long-term infrastructure bonds the end use of the proceeds of such bond issue should be for the infrastructure sector as defined by the Reserve Bank of India under its ECB regulations.

FIIs also raised issues on know your client (KYC) (rules) and other compliance issues in the qualified foreign investor (QFI) regime and promoting the interests of the corporate debt market. QFI regime has been plagued with taxation issues for over a year now. One of the measures suggested was to have a common application form for KYC and permanent account number, which QFIs need to obtain. The meeting also discussed measures that need to be taken to harmonise the various investment routes available for foreign investors.

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