Indian market may see red due to these tax uncertainties

Investors in India and abroad have been grappling with changing laws on equity investors. Amid the uncertain environment, there are possibilities of an increase in capital gains tax on equities. It is to see whether Finance Minister Arun Jaitley will announce tax measures in favour of investors or not in Budget 2017.

"A possible resolution of the tax issues in favour of investors this time around may drive outperformance in Indian equities after the Budget. If not resolved favourably, investor sentiment will be impacted negatively,” CLSA said in a note.

As per the CLSA, tightening tax treaties will have a negative impact on Indian markets. In May 2016, the government moved to tighten the India-Mauritius tax treaty, after which foreign portfolio investors (FPIs) ended up paying at the same short-term gains tax rate of 15% on Indian equities. Similar changes were made to the tax treaties with Cyprus and Singapore by the end of 2016.

"Renegotiation of tax treaties with Mauritius, Singapore and Cyprus would raise taxes from April 2017 for investors using those routes,” CLSA said in a note.

"We hope these issues are resolved in the Feb 1 Union Budget. If resolved in favour of investors, the underperformance of the domestic market would reverse, in the same way it did last year when similar concerns existed,” the note said.

Also, the retrospective FPI tax fear is back again. The Indian Government had issued clarifications on indirect tax provisions that bring end-investors in a foreign fund under Indian tax laws.

The clarifications impact those FPIs with over 50 per cent of AUMs in India with a concentrated end-investor base i.e. end-investor with less than 5 per cent of the AUM.

"Some of the India-dedicated funds will likely be impacted. Large end-investors in these funds may be subject to double taxation with this development," said the CLSA note.

Besides, if increased capital gains tax on equities in general happens, unit-linked insurance plans (Ulips) may see larger inflows.

Listed shares in India attract long-term capital gains (over 1 year holding, LTCG) tax at 0 per cent and short-term (less than 1 year holding) capital gains tax at 15 per cent. This is against a 30 per cent top tax bracket on interest and personal income.

The global brokerage firm is of the view that there is a possibility that short-term capital gains tax on equities which is partly being offset by the Securities Transaction Tax currently may be raised. "If any of the above happens, Ulips may gain prominence as they enjoy a tax advantage," it said.