What You Need to Know About Regulated Investment Companies and Indian Capital Gains Tax
Posted by admin on Jun 18, 2012 6:54:23 PM
The Indian Department of Revenue, as required under the India Income Tax Act of 1961 (“the Act”), assesses a tax on short-term capital gains recognized on the sale of Indian securities. The cost of acquisition and holding period must be determined by the first-in-first-out method (“FIFO”). Long-term is any holding period greater than one year. Short-term is any holding period less than one year.
Short-term capital gains arising on the sale of shares of Indian securities are subject to tax provided that the sale transaction was entered into on a recognized stock exchange and is subjected to the Securities Transaction Tax (“STT”). STT is a tax paid on both purchase and sale transactions.
Long-term capital gains arising on the sale of shares of Indian securities are exempt from tax, provided that the sale transaction was entered into on a recognized stock exchange and is subject to the STT.
Another item to note is that dividend income paid by an Indian company is subject to taxation to the Indian company, but not at the stockholder level.
How should Regulated Investment Companies (“RICs”) accrue for potential Indian tax liability?
On a daily basis the RIC should record an accrual for a tax liability based on the appreciation of all Indian security positions that are held in a short-term position. An entry should be made each day based on the tax rate multiplied by the daily change in unrealized appreciation or depreciation. The cumulative tax accrual should always equal the tax on the current unrealized appreciation on all Indian securities’ short-term positions. As the current day’s unrealized is not computed until the end of the day, the accrual entry should be based on the prior business day’s unrealized position. Since the tax is payable after the sale transaction is settled at the custodian, the RIC should have an adequate accrual on its books at the time of payment.
If the RIC’s methodology for cost relief on sale transactions is other than FIFO, the RIC should maintain a separate schedule to base the tax liability accrual on.
What happens if/when the Indian security position becomes depreciated?
The RIC should not continue to include a depreciated position (lot) in its tax liability accrual. The tax assessed at the time of sale is based on the gain or loss calculation of the individual position lot rather than the security as a whole. However, the change in appreciation/depreciation on depreciated lots excluded from the tax liability should continue to be monitored at the lot level in order for the RIC to start accruing the tax liability once the lot changes to an appreciated lot.
What happens when a security position moves from a short-term to a long-term position?
If the cumulative accrual that is represented on that security’s position lot(s) is in an appreciated state, it should be reduced to zero. The adjustment should be included as part of the daily accrual.
Annual Tax Return Filing Requirements
Under the requirements of the Act, the Return of Income for the 12 months ended March 31 of each year must be filed with the Indian Department of Revenue by July 31 of such year. The form requires detailed listings of realized capital gains (both long-term and short-term) from security transactions, dividend income received, and Indian tax payments for the period. A RIC is also able to offset current period net short-term capital gains with prior period short-term capital loss carry forward. Such loss carry forward is eligible to be used up to a maximum of eight years. Since long-term capital gains subject to STT are exempt from tax, any long-term capital loss carry forward are still identified for disclosure on the Return of Income only.
The RICs normally have an agent, i.e. Chartered Accountants registered in India, who monitor the tax calculations and payments throughout the tax year and who prepare the annual Return of Income on behalf of the RIC.
Please note that as the tax assessed and paid on the security sale transactions was based on gross realized short-term gains at the position lot level, there could possibly be additional tax due or an overpayment of tax for the tax period. Any tax due would be required to be paid with the filing of the return and any overpayment of tax would be refunded to the RIC. If the RIC files its tax return and a refund is due, they can accrue a tax refund asset on the books in the amount of such refund. Refunds normally take up to 3 years from the date of filing to be received by the RIC.