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Surcharge hike on India’s rich sharpens focus on tax efficiency: Sanctum WM

Asian Private Banker, Jul 15, 2019

In the wake of India’s proposal to raise income tax surcharges on high net worth individuals (HNIs) in its latest Union Budget, Prateek Pant, head of products and solutions at Sanctum Wealth Management envisions that HNI investment preferences could shift towards more tax-efficient solutions.

“It is estimated that about 100,000 individuals comprising business promoters and top-end professionals — including CXOs — would be impacted due to this taxation,” Pant told Asian Private Banker, adding that part of this impact would be on their savings as a “larger chunk” of their income would go towards paying taxes.

“Investment preferences could shift to more tax-efficient investment options (market-linked debentures, tax-free bonds, stocks) and away from interest-bearing investments.”

In the Union Budget 2019-2020 presented on 5 July, the surcharge for HNIs earning above Rs 5 crore (US$729,000) was increased to 37% from 15%, bringing the effective tax rate up around 7 percentage points to 42.74% — a level more in line with that of a developed economy.

For HNIs earning between Rs 2 crore to Rs 5 crore (US$291,000 to US$729,000), the surcharge was raised to 25% from 15%, with the effective tax rate creeping up some 3 percentage points to 39%.

“Many HNIs also have exposure to category 3 alternative investment funds (long/short funds),” Pant added.

Indeed, according to data from SEBI, the annual funds raised by category 3 AIFs have swelled from US$0.1 billion in 2014 to US$2.3 billion last year.

“As per the budget proposal, the taxation on these funds is also expected to increase from approximately 35% to 42%. This could have a significant impact on post-tax returns, impacting flows into these funds.”

Opportunities rife for wealth planning

To be sure, taxation had long been a major concern — and a contentious topic — for India’s HNIs prior to the unveiling of this year’s budgetary proposals. According to Global Data’s Global Wealth Managers Survey, India ranked the highest among the 24 countries surveyed for HNI demand for tax advice, with 98% of respondents describing demand as ‘quite strong’ or ‘very strong’.

“Traditionally, depending on client goals, wealth managers have focused on investment plans which provide capital preservation or growth in a tax-efficient manner,” Pant said.

Over the last few budgets, however, capital market instruments have been progressively taxed, starting with dividend income exceeding Rs 1 million, long-term capital gains on equities, and, in this budget, share buybacks.

“All these measures, in a challenging market environment, are making it tougher to meet longer-term investment objectives on post-tax returns,” Pant said. “While we believe the asset allocation preference might not change, routes to market could lean towards more tax-efficient investment options.”

Due to the anticipation of a spike in client interest for the latter, Pant has seen many wealth management firms in the country set up wealth structuring teams to help clients plan for succession and tax efficiency.

Echoing his stance, Heike van den Hoevel, senior wealth management analyst at GlobalData commented, “Being able to provide sound advice to help HNW investors reduce their tax liabilities in a legal manner — be it through the use of trusts, insurance policies, or other vehicles — is becoming increasingly important, especially as tax rates for the rich are becoming more and more punitive.”

Further, Pant observed that more and more of India’s HNIs are eyeing overseas investments for portfolio diversification.

While each domestic Indian investor remains limited to investing a maximum of US$250,000 overseas per financial year under the Reserve Bank of India’s Liberalized Remittance Scheme, GlobalData’s research revealed that 16.2% of Indian HNI wealth is booked abroad — low compared to the wider Asia-Pacific region, but in line with the global average of 16.9%.

“In many cases of the next generation going overseas for higher education, the need for a better lifestyle, flexibility to explore opportunities to optimize personal tax and estate planning, or moving to a safe haven in times of political instability, HNIs are looking at investment programs for alternate residency and citizenship very keenly,” Pant explained.

“Tax efficiency is the prime reason why HNW investors hold wealth abroad,” van den Hoevel said, adding that while the importance of this driver has diminished in most countries due to the numerous scandals in the offshore industry, it remains twice as important in India than globally. “To mitigate the need for HNW investors to channel wealth abroad, wealth managers will do well to up their game when it comes to the provision of tax advice,” she said.

Varied results for NRIs

Meanwhile for non-resident Indians, the latest Union Budget appears to have mixed implications.

According to Pant, the merging of NRIs’ portfolio investment scheme (PIS) with the foreign portfolio investment (FPI) regime could relax restrictions on NRI investments in multiple portfolio management services (PMS) in India. Before, each NRI was limited to holding only one PIS account.

“The increase in statutory limits for FPI investments in companies could [also] be positive for NRIs to take additional exposure in certain stocks,” Pant added.

However, he pointed out that NRIs may face taxation on gifts received from Indian residents — hitherto non-taxable apart from those originating from a specified list of relatives.

“The Union Budget proposed to amend the rules to make it mandatory for NRI recipients to disclose such gifts received if they originate in India and then pay a tax on it as per the slab rates,” he concluded.

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