Indian markets lose Rs 1 lakh crore as HNIs pull-out investments amid taxation woes

Indian markets are estimated to have lost around Rs 1 lakh crore or about $20 billion worth of investments from the overseas funds and ultra-rich foreign individuals over a period of less than three months on new taxation proposals and the government's recent white paper on Black Money. General Anti-Avoidance Rule (GAAR) remained the buzzword over last three months in the financial circles and though not many knew about the nitty-gritty’s of it, most witnessed how talks surrounding its implementation from April 1, 2012 rattled foreign institutional investors (FII) which in turn triggered a free-fall off sorts in Indian stock markets.

Foreign investors, who mostly invested through P-Notes (participatory notes) in the Indian markets either pared their exposure to the Indian securities or deferred their investments ever since India proposed GAAR, a new tax policy late in March 2012. According Securities and Exchange Board of India’s (SEBI) recent data, around Rs 1,30,012 crore or $25 billion worth of investments in Indian  markets were done using PNs at the end of April 2012, which declined sharply from Rs 1,83,151 crore at the end of February and Rs 1,65,832 crore as on March 31, 2012. The PNs’ share in total FII holding remained at 16.4 percent in February, which plunged to 11.4 percent by April.

The amount of investment through these PNs has dropped further in recent months and hit its rock-bottom levels of just about 10 percent of total FII holdings which a few years ago accounted for nearly 50 percent of all foreign institutional investment (FII) held in India. High Net worth individuals (HNIs) outside of India frequently used PNs to make investment into India’s markets as it did not mandate them to register their details with market regulator SEBI and also saved their time and money, leading to money laundering and tax evasion.

In an attempt to erase the thin line between tax avoidance and tax evasion and to bring both of them under the purview of taxing statute in India, the government in its direct tax code (DTC) proposed to introduce GAAR. GAAR generally empowers the tax authorities to deny the tax benefits of transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefit. However, on May 7, 2012, Finance Minister Pranab Mukherjee surrendered to the unrelenting pressure from stakeholders affected by his stringent budget proposals and deferred by one year the adoption of the “General Anti-Avoidance Rules” guidelines designed to curb tax evasion.