(Updates with quotes, details, background)
By Abhishek Vishnoi and Archana Narayanan
MUMBAI, Feb 28 (Reuters) - India's budget disappointed
foreign investors on Thursday by failing to deliver a much
anticipated cut in withholding taxes for debt investments and
creating confusion with a proposal that appeared to target tax
Several measures for foreign investors were unveiled for the
2013/14 fiscal year starting in April, including simplifying a
cumbersome registration process and allowing investments in
corporate bonds and government securities to be used as
collateral to meet margin requirements.
However, the measures on their own were seen as unlikely to
significantly boost foreign inflows at a time when India needs
capital flows to plug a current account deficit that hit a
record high in the quarter ended in September.
Indian shares were hit in part by concerns about the impact
of the budget on foreign investors, with the benchmark BSE index
ending down 1.5 percent.
"Easing the registration process for foreign investors is a
facilitator, but the game changer would have been a withholding
tax cut across the board, which would have helped the current
account deficit and the development of the onshore debt market,"
said Jayesh Mehta, Managing Director and Country Treasurer at
Bank of America.
The main announcement for foreign investors was the
simplification of the complicated "Know Your Customer" rules.
Finance Minister P. Chidambaram, who met foreign investors
last month as part of a roadshow, said the country would
consolidate the current system of mandating different
registration rules for different types of investors.
However, the government did not announce a cut in the
withholding tax imposed on income from government and corporate
debt investments and deducted at source that can now reach up to
The government also created confusion with a proposal
stating a tax residency certificate "shall be necessary but not
a sufficient condition" to take advantage of double taxation
avoidance agreements, according to the Finance Bill that was
part of the 2013/14 budget.
Tax authorities had previously considered this tax residency
as enough proof to allow foreign investors registered in
countries with these treaties to avoid paying taxes in India.
The amendment, due to take effect in 2016, sparked fears tax
authorities would have wider discretion to go after foreign
It also comes about a year after poorly written rules to
ensnare tax evaders, called the General Anti-Avoidance Rules
(GAAR), had sparked an outcry among foreign investors, prompting
the government to amend their provisions and delay
implementation for two years.
Ketan Dalal, a joint tax leader at PwC India called the
amendment "disturbing," adding that "this does create
Chidambaram addressed these concerns at a news conference,
saying the amendment had sought to clarify that tax authorities
would now look at not only the tax residency requirement, but
also enforce rules mandating these foreign investors are the
beneficiaries of any investments under double tax agreements.
Those rules already exist under certain double tax treaties
the ministry said, and were thus reiterating existing policy.
But Homi Phiroze Ranina, an advocate at the Supreme Court of
India and former director at the board of the country's central
bank, said questions still remained, especially as to which
investment gains would be taxed.
"He is not clarifying whether the issue of beneficial
ownership is there for capital gains," he told Reuters.
"The way the law is worded, if capital gains issues are not
clarified then FII capital gains may come under scrutiny," he
said referring to foreign institutional investors.
(Additional reporting by Subhadip Sircar, Swati Bhat, and Manoj
Rawal; Writing by Rafael Nam; Editing by Ron Popeski and Alex