Introduction:

Several provisions and rules are connected with Section 115AD of the Income Tax Act. The most recent amendment to section 115 AD, which took effect from FY 2021–2022 and applies to the assessment year 2022–2023, introduces appropriate changes in the tax treatment of foreign institutional investor income derived from banks or securities of capital arising from such remittances. Notably, this tax does not apply to income from shares exempted under section 10(34) or income from mutual fund units exempted under section 10(35).

Section 115AD:

Section 115AD of the Income Tax Act delineates the taxation of income for Foreign Institutional Investors, often comprising capital gains. Nevertheless, this provision excludes income from mutual fund units and dividend income, both enjoying exemption under Sections 10(35) and 10(34) respectively.

Section 115AD of the Income Tax Act, 1961, deals with the taxation of income concerning Foreign Institutional Investors, including securities and capital gains. Amendments effective from FY 2021-22 affect AY 2022-23.

Foreign Institutional Investors(FIIs):

• Foreign Institutional Investments (FIIs) are companies outside India that invest in Indian securities or financial products. They have played a vital role in attracting foreign capital to the country and boosting growth in the capital market.
• The Central Government of India defines and designates eligible entities as FIIs through notifications in the Official Gazette. Some typical characteristics of FIIs comprise:
• Registered with the Securities and Exchange Board of India (SEBI),
• Invest in various financial instruments such as stocks, bonds and derivatives.
• Management of funds for international investors.

Amendment in Section 115AD : 

• The amendment provisions outlined in Section 115 AD of the Income Tax Act became effective starting from the fiscal year 2021-22, corresponding to the assessment year 2022-23. The pertinent amendments are detailed below:
• Section 115 AD section 1B came into force with effect from January 4, 2022 of the Finance Act
• The explanation pertaining to permanent establishments, securities, and the specified fund was replaced, effective January 4, 2022.
• The explanation regarding the investment division of an offshore banking unit was introduced with effect from January 4, 2022.
• The inclusion of ‘investment department of an offshore banking unit’ in both sections 115 AD and 115AD(2) came into force on 4th January, 2022, as per Finance Act 2021.

Benefits of Section 115AD:

• Though Section 115 AD mainly deals with taxation of FII income, it also provides certain indirect benefits.
• Streamlined compliance provisions in Section 115 AD have the potential to reduce transaction costs for FIIs.
• Greater participation of FIIs in the Indian market could increase market capitalization and enhance value realization.
• This section establishes a clear and predictable tax framework for FII investments, thereby fostering additional capital inflows.

Section 115AD(1):

• Section 115AD(1) ​​of the Income Tax Act describes the tax rules relating to capital gains and protection for foreign investors (FIIs). Income from transfer of securities under clause (i) of section 115AD, including short term gain (STCG) and long term gain (LTCG) is taxed at 20% .
• The provisions of this section do not include dividend income as per Section 115-O. Further, income from mutual fund units is also exempt, as provided in section 115AB. Section 115AB applies to income from offshore income derived from units purchased in any foreign currency or long-term interest arising from the transfer of such units.
• The Finance Act introduced overlapping provisions in sub-section (1) of section 115AD of the Income Tax Act 2013, which is explained as follows.
• It submitted that if the income tax computed on interest income under section 194LD is 5%, the temporary gains tax under section 115AD will be applicable at 30%.
• The next section shows the tax rate of 10% on long-term gains (LTCG) under section 115AD, as 15 rates of income tax on short-term gains (STCG) under section 111A are payable %.
• This clause applies when the income tax on short-term capital gains is calculated at a rate of 15% in accordance with the provisions of Section 111A. The income tax applicable to FIIs is computed after deducting income under clauses (a) and (b) of Section 115AD. In this context, the reduced income encompasses gains from securities, including both short-term capital gains (STCG) and long-term capital gains (LTCG).

Section 115AD(1A):

In addition to any specified fund falling within the scope of subsection 1 of this section, the provision applies to excess amounts in respect of units held by a non-resident Indian and this calculation must be made in the manner prescribed.

Section 115AD(1B):

The provisions of this Section pertain to the investment division of an offshore banking unit, with the caveat that they exclude the clauses outlined in subsection 1 of Section 115AD of the Income Tax Act.

Section 115AD(2):

• The provisions of this Section will apply in the following scenarios:
• If the earnings incorporate income as described in clauses a and b of subsection 1, the gross total income will be reduced by the amount of such income, and Chapter VI-A deductions will be permitted.
• If only securities, as described in clause a of subsection 1, are included, then no income tax deductions will be applicable.

Section 115AD(3):

• The first and second provisions of Section 48 are not applicable for the purposes of computation in respect of capital gains from transfer of funds as mentioned in Part B of Part 1 of the Income-tax Act in the 19th century. The Act defines the financial services sector of FIIs and offshore banking groups as follows.
• The investment division of offshore banking units must encompass the definition assigned in clause (aa) of the explanation regarding clause (4D) of Section 10.
• Securities must adhere to the definition assigned under Section 2, clause (h).
• FII denotes investors as specified by the Central Government through notification in the Official Gazette.

Applicable Taxes to Foreign Investors in India:

• Capital gains tax is applicable at 10% for both short-term capital gains (STCG) and long-term capital gains (LTCG) above ₹1 lakh.
• Dividend tax: From April 1, 2023, dividends received by foreign shareholders will be subject to tax at the rate of 20%.
• Dividend Distribution Tax (DDT): Until April 1, 2023, the 15% tax on dividends paid to foreign shareholders has been waived.
• Corporate Tax: For foreign companies, the tax rate is 25.17% inclusive of income tax and cess.

Conclusion:

As a foreign institutional investor, it is important to note that income from shares and mutual fund units is tax-free and not covered by Section 115AD of the Income Tax Act, however, it is important to know the appropriate tax rate provides the total tax liability.