Section 115AD of the Income Tax Act
- Farheen Mukadam
- Sep 8
- 8 min read
When foreign institutional investors invest in another country, they expect more than a handsome return. They also seek tax benefits, making them an attractive reason to bring their money to a country. Section 115AD allows such institutions to be levied with lower tax rates on certain incomes. These organisations are non-residents without a permanent location in India. The tax ramifications of various forms of income received by foreign institutional investors are thoroughly explained in this article.
Table of Contents
What is Section 115AD of the Income Tax Act?
Section 115AD of the Income Tax Act focuses on the taxation of foreign institutional investors. It provides the investors with favourable tax rates. According to the income tax guidelines, foreign institutional investors are those that the central government has designated in an official publication. Securities transfers typically result in capital gains for FIIs, as well as other securities-related revenue and miscellaneous income.
Amendment in Section 115AD of the Income Tax Act
The Income Tax Act's Section 115AD amending provisions went into force in FY 2021-22, or the assessment year 2022–2023. The following are the pertinent amendments:
Section 115AD and Section 115AD (2) both refer to the "investment division of an offshore banking unit." According to the Finance Act of 2021, this went into effect on January 4, 2022.
Section 115AD (1), a new section, goes into force on January 4, 2022.
According to the Finance Act of 2021, Section 115AD Subsection 1B is added with effect from January 4, 2022.
The description of an offshore banking unit's investment division is included with effect from January 4, 2022.
As of January 4, 2022, the explanation for permanent establishments, securities, and the designated fund was replaced.
Section 115AD (1) of the Income Tax Act
The income tax requirements about foreign institutional investors' (FIIs') securities and capital gains are outlined in Section 115AD (1) of the Income Tax Act. According to Section 115AD's clause (i), there will be a 20% tax on income from the transfer of securities, short-term capital gains (STCG), and long-term capital gains (LTCG). This section's requirements do not include dividend income as defined by Section 115-O. Furthermore, the income from the mutual fund units listed in Section 115AB is not taken into account. Section 115AB describes the revenue that offshore funds get from the transfer of units that were bought in any foreign currency or LTCG.
Subsection (1) of Section 115AD of the Income Tax Act includes a few extra sections added by the Finance Act of 2013. They are as follows:
Clause (ii): This indicates that STCG taxes would be imposed at a 30% rate under 115AD if the income tax calculated on interest income under 194LD was 5%.
Clause (iii): According to the following clause, LTCG is taxed at 10% under Section 115AD, whereas STCG income tax is taxed at 15% under Section 111A.
Clause (iv): This clause applies if the 15% income tax rate on STCG is determined in accordance with Section 111A's rules. After income is deducted under clauses (a) and (b) of section 115AD, the income tax that FIIs are required to pay is determined. Gains from securities, such as STCG and LTCG, are included in the income reduction in this case.
Section 115AD(1A) of the Income Tax Act
The rules apply to the maximum revenue attributable to units owned by a non-resident Indian for any specified fund other than subsection 1 of this section. Moreover, this must be computed in a particular way.
Section 115AD(1B) of the Income Tax Act
An offshore banking unit's investment division is subject to the rules in this section. Nevertheless, the provisions listed in Section 115AD, Subsection 1, of the Income Tax Act shall not be included.
Section 115AD (2) of the Income Tax Act
The following circumstances will make the requirements in this section applicable. When an offshore banking unit's or FII's investment generates income:
There will be no deductions for income tax if only securities as defined in clause a of subsection 1 are included.
Earnings that contain income as defined by subsection 1 clauses a and b will have their gross total income deducted by the amount of such income, allowing for Chapter VI-A deductions.
Section 115AD (3) of the Income Tax Act
According to clause b of paragraph 1 of the Income Tax Act, the first and second provisions of Section 48 will not be used for calculating capital gains from the transfer of securities. According to this Act, FIIs and the offshore banking unit's investment sector are:
Investors are designated as FIIs by the Central Government through the publication of a notification in the Official Gazette.
The definition given in clause (aa) of the explanation about clause (4D) Section 10 must be included in the investment division of offshore banking units.
It is necessary to comprehend clause (iiia) of Section 92F for a permanent establishment to exist.
Securities must be understood in accordance with Section 2 Clause (h).
Clause (c) of Section 10 requires that the particular fund have significance.
Who are Foreign Institutional Investors?
These are international organisations investing in the economy. Deutsche Bank and BlackRock are some renowned entities that have invested in the Indian economy. In India, they are well-known foreign institutional investors. FIIs are typically banking and financial institutions. In India, SEBI oversees the regulation of these entities.
Can FIIs be Residents Under the Income Tax Law?
We must take a different approach and take a closer look at SEBI laws.
According to SEBI's rules regarding foreign portfolio investors, an FPI is not allowed to reside in the country.
Nevertheless, a resident, whether an individual or not, may be a "constituent to the fund" if they meet the specified requirements.
As a result, people can donate to the fund managed by FIIs after meeting certain requirements, even though they are not permitted to invest.
Understanding Specified Funds
The definition of designated funds must be understood before discussing tax treatment. The funds mentioned under Section 10(4D) of the Act are the ones that are designated. They are:
Category III AIF in accordance with applicable SEBI requirements
According to the applicable IFSC requirements, it is registered as a retail scheme or exchange-traded fund.
Any IFSC-located units
Funds where all of the units are owned by non-residents (with the following exceptions)
Conditions as specified for an offshore banking unit's investment division.
Tax Treatment of Income from Specified Funds for FIIs
The income collected by the designated funds can be divided into two groups:
Money received from the sale of securities
Any additional revenue generated by these securities
Tax Treatment of the Transfer
The assessee is exempt from paying taxes on any income resulting from the transfer of funds mentioned under Section 10(4D), provided that the following requirements are met:
Convertible foreign exchange is used to cover the consideration for unit transfers.
A recognised stock exchange that is linked with the IFSC hosted the transfer.
The transfer is subject to the following taxes if neither of the above requirements is met:
Transfer of Securities Other than Equity-Oriented Mutual Funds or Equity Shares of Listed Companies:
10% if a long-term financial gain occurs (without indexing).
If a short-term capital gain occurs, it would be 30% (without indexation).
Transfer of Securities: Equity-Oriented Mutual Funds or Equity Shares of Listed Companies
If the transfer took place before July 23, 2024,
10% (without indexation) in the event of a long-term capital gain (there is a Rs. 1,25,000 exemption available).
15% in the event of a short-term capital gain (without indexing)
If the transfer took place on or after July 23, 2024,
If a long-term capital gain occurs, the rate is 12.5% (without indexation); however, there is an exemption of Rs. 1,25,000.
20% in the event of a short-term capital gain (without indexation)
Tax Treatment of Income Other Than Income from Securities
Except for income from securities, all other income is subject to standard tax rates.
FIIs pay standard rates as long as they don't have a permanent location in India. Since they do not have a permanent establishment in India and their business income is derived from activities conducted outside of India, it is not taxable in India because it is earned for a non-resident outside of India.
FIIs typically pay fees based on their lack of a permanent presence in India. The income is subject to a 40% tax rate for foreign corporations when the FII is a foreign company, since it originates from business activity in India.
Conclusion
You should be aware that mutual fund units and dividend income are not taxable under Section 115AD of the Income Tax Act if you are an overseas institutional investor. Make sure you know all about the applicable tax charges to determine your total tax obligations as a foreign institutional investor.
FAQs
1. What is section 115AD?
Section 115AD offers foreign institutional investors a reduced tax rate on a specific amount of their revenue.
2. What is the difference between section 112A and 115AD?
Capital gains from listed equity shares and equity-oriented funds are subject to special tax rates under Section 112A. In contrast, foreign institutional investors are subject to preferential tax rates on certain types of income under section 115A.
3. Will section 112A apply to capital gains income earned by FIIs?
If FIIs fulfil the requirements, they can take advantage of the reduced tax rates under Section 112A.
4. What is FPI in ITR?
FPI is an acronym for foreign portfolio investors. Foreign portfolio investors are individuals who make investments in India to earn returns from the capital growth of their investments rather than making company profits. In essence, they are foreign investors rather than foreign entrepreneurs. Their classification as Foreign Institutional Investors is based on the Income Tax Act.
5. What is the tax rate on income from securities for FIIs u/s 115AD?
Section 115AD(1) states that FIIs are subject to an income tax rate of 20% on income earned from securities other than the units mentioned in Section 115AB.
6. How are short-term capital gains taxed for FIIs under Section 115AD?
According to Section 115AD(1), FIIs are subject to a 30% income tax rate on short-term capital gains resulting from the transfer of securities. On the other hand, short-term capital gains covered by Section 111A are subject to a 15% tax rate.
7. What is the tax rate on LTCGs for FIIs u/s 115AD?
Section 115AD(1) stipulates that FIIs must pay 10% income tax on long-term capital gains from the sale of securities. However, when the income exceeds ₹1 lakh, the tax rate for long-term capital gains covered by Section 112A is 10%.
8. Are there any deductions available for FIIs under Section 115AD?
According to Section 115AD(2), a FII is not eligible for deductions under Sections 28 to 44C, 57, or Chapter VI-A if its entire income is made up solely of revenue from securities mentioned in clause (a) of paragraph (1). The deductions under Chapter VI-A, however, shall be permitted as if the income from securities were subtracted from the gross total income if the total income includes other income.
9. How are capital gains computed for FIIs under Section 115AD?
According to Section 115AD(3), the capital gains calculation resulting from the transfer of securities mentioned in clause (b) of subsection (1) is exempt from the first and second provisos of Section 48, which deal with capital gains computation.
10. What does STT mean?
The Securities Transaction Tax, or STT, is a direct tax that is applied to the buying and selling of stocks listed on India's respected stock exchanges (BSE, NSE). It functions similarly to TCS (Tax Collected at Source) and is a form of financial transaction tax.
11. What is DTAA?
A tax treaty known as a Double Tax Avoidance Agreement (DTAA) is signed by two or more nations to assist taxpayers in avoiding paying taxes twice on their income. This applies to people who are citizens of one country yet receive their income from another.
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