Tax Relief on Bond Investments and FPIs

Why in the News?

The Government of India is considering reducing the withholding tax (WHT) on foreign investors’ bond income from 20% to 5% to attract overseas capital inflows.

What is Withholding Tax (WHT)?

• A tax deducted at the source of income before payment is made to the investor.
• Similar to Tax Deducted at Source (TDS).
• Paid by foreign investors on interest earned from Indian bonds.

Background

• India introduced a concessional 5% WHT on interest from government securities and certain rupee bonds in 2012 under Section 194LD of the Income Tax Act.
• The concessional regime expired in July 2023.
• Tax rate reverted to around 20%, reducing India’s attractiveness for global investors.

Why is High WHT a Concern?

Higher withholding tax:

• Reduces post-tax returns for FPIs.
• Weakens long-term compounding gains.
• Creates liquidity and reinvestment constraints.
• Increases compliance burden under Double Taxation Avoidance Agreements (DTAAs).

How Will Tax Reduction Help FPIs?

• Improve effective yields on Indian bonds.
• Increase attractiveness of Indian debt markets.
• Encourage foreign capital inflows.
• Support forex reserves and external stability.

Global Comparison

• Countries imposing WHT on foreign investors:
  • United States: 30%
  • Germany: 26.4%
  • France: 25%
  • China: 10%
• No WHT: Hong Kong and Singapore

FPIs in India’s Debt Market

• FPIs hold a limited share of India’s government debt market.
• Investments increased after inclusion in global bond indices such as:
  • JPMorgan Government Bond Index-Emerging Market
• RBI cap on FPI investment in government securities:
  • 6% of outstanding stock