Industry Lobbies Government to Lower FPI Withholding Tax on Debt Securities to 5%
Centre Considers Reducing Withholding Tax on Foreign Investment Income
The Centre has received representations from the industry to cut the withholding tax on interest income earned by foreign investors from debt securities to 5 percent from 20 percent, according to sources.
The proposal is aimed at attracting higher foreign portfolio investment inflows, which would help ease pressure on the rupee. The rupee has depreciated around 6 percent against the dollar since the start of the Iran war. On May 27, the rupee was trading at 95.7 against the dollar after falling to new lows in recent weeks.
The RBI Bulletin reports that net foreign portfolio investment (FPI) outflows touched $13.1 billion in March against a net inflow of $4 billion in the year-ago period. The forex reserves were at $689 billion on May 15, down from an all-time high of $726 billion on February 28, just before the start of the Iran war.
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The current withholding tax rate of 20 percent on interest income from government bonds is seen as a deterrent for foreign investors. Prior to July 1, 2023, the rate was 5 percent on income from government securities, state development loans, and rupee-denominated bonds. This lower rate was initially introduced in 2013 to curb the rupee's decline in the wake of the so-called taper tantrum.
Tax Rate Comparison
| Tax Rate | Applicable on |
|---|---|
| 20% | Long-term capital gains on debt instruments (with indexation benefit) |
| 5% | Interest income from government securities, state development loans, and rupee-denominated bonds (till July 1, 2023) |
Experts believe that reducing the withholding tax rate would make India's bond market more attractive to foreign investors. Sandeep Sehgal, partner-tax at AKM Global, noted that foreign investors currently account for a relatively small share of India's bond market, and tax rationalisation is being viewed as an important lever to improve post-tax returns and enhance market liquidity.
Rajesh H Gandhi, partner at Deloitte India, added that debt investors are sensitive to taxes, and a reduction in withholding tax rates can materially boost investments in debt. Considering that debt investments have fixed returns, the spread on leveraged investments can be thin, and there could be challenges in claiming full tax credits.
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Investor Takeaway
A potential reduction in withholding tax on debt securities may attract higher foreign portfolio investment inflows, easing pressure on the rupee.
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