India pursues investment funds for tax

UK funds invested in India could face demands for tax from which they thought they were exempt. Minimum alternate tax (MAT), a tax on the book profit of a company, has been in existence in India in its current form since 2001 and is levied at 18.5 per cent. Because the law states that a company’s books must be prepared according to Indian accounting standards, the rules have historically been interpreted to imply that MAT was taxable only on Indian companies, meaning funds that invest in India were not charged.

However after a 2012 ruling that a foreign entity, Castleton, which sold shares in an Indian company, should pay MAT on its capital gains, the tax authorities are now going after foreign portfolio investors with tax demands for the year 2012-13, and claims for the years back to 2009-10 are also expected. This will affect UK fund managers investing in India. The UK does not have a double taxation treaty with India, but foreign funds investing in India through either Mauritius or Singapore, for example, are protected by tax treaties.

The issue should not be indefinite as India’s Finance Bill 2015 has amended the MAT provisions to exclude capital gains earned by foreign portfolio investors from MAT from 1 April this year.

Foreign asset managers faced with a bill include UK asset manager Aberdeen, which has received a tax demand in respect to one of its offshore funds. This is reported to be less than $50,000, though, and Aberdeen is challenging the ruling in court. Some funds, however, are believed to have received tax bills for $1m or more.

The ruling has also been challenged by Castleton and the case is due to be heard by the Supreme Court. An outcome is expected in the next few months and should be important in determining what happens to foreign fund managers going ahead.

We count a number of Aberdeen’s investment trusts among our IC Top 100 Funds, and ones with substantial India exposure include New India (NII), Edinburgh Dragon Trust (EFM) with 14.3 per cent of its assets in India and Aberdeen Asian Smaller Companies Trust (AAS) with 13.3 per cent. To date none of these has received a claim for MAT.

Other funds with exposure to India among our IC Top 100 Funds include Pacific Assets Trust (PAC), which has more than 30 per cent of its assets invested there but has not yet received any tax demand.

First State Asia Pacific Leaders (GB0033874214) has 23 per cent in India, Templeton Emerging Markets Investment Trust (TEM) has 5.6 per cent and Lazard Emerging Markets (GB00B24F1P65) also has exposure.

But the possibility that funds might receive a tax demand is not a reason to disinvest or avoid investing in India, according to Adrian Lowcock, head of investing at AXA Wealth. “It might affect short-term fund profits, but ultimately it is the performance of the stock market that will drive your returns,” he says. “Investors should look through this and not get overly concerned.”

A number of commentators argue that there is a good investment case for India despite already substantial rises in its market.

Taxation of foreign dividends: Australia and the Netherlands

Funds investing in overseas equities are subject to the tax laws of foreign authorities and a reader recently asked what the position was for UK funds when they received dividends from Australia-listed companies.

Companies that generate the majority of their earnings in Australia generally pay 100 per cent franked dividends, which are not subject to withholding tax irrespective of domicile. Companies that have offshore earnings can have anywhere between 0 per cent and 100 per cent franked.

UK-domiciled funds benefit from double taxation treaties between the UK and Australia and pay 15 per cent withholding tax on unfranked dividends. In some cases, where the UK investment vehicle owns at least 10 per cent of the votes in the Australian company paying the dividend, the rate of Australian tax may be capped at 5 per cent.

However, this does not apply to some offshore funds. Asian equity income funds tend to be large investors in Australia. Some of these, such as Newton Asian Income (GB00B0MY6Z69), are domiciled in the UK so benefit from the UK’s taxation treaty with Australia. It offers a yield of 5.32 per cent.

Australia has similar treaties with both Luxembourg and Ireland, where most London-listed exchange traded funds (ETFs) are domiciled.

However, there are three Asian equity income investment trusts domiciled offshore. These include Henderson Far East Income (HFEL) and IC Top 100 Fund Aberdeen Asian Income (AAIF), which are domiciled in Jersey and subject to 30 per cent withholding tax on unfranked dividends. However, this does not seem to be a major problem as these companies offer attractive yields of 5.22 per cent and 4.27 per cent, respectively.

The reader also asks what a fund’s position is with regard to Royal Dutch Shell A shares (RDSA), as private investors tend to be advised to buy Royal Dutch Shell B shares to avoid Dutch withholding tax. However, FTSE 100 and FTSE All-Share tracker funds such as physical ETFs have to buy the A shares to replicate the index.

Under the UK-Netherlands double tax treaty the tax rate is 10 per cent for UK-domiciled funds. A UK fund would initially suffer tax at 15 per cent and reclaim 5 per cent from the Dutch tax authorities, according to the Investment Association.

Funds domiciled in Luxembourg are subject to a 15 per cent tax rate.