India’s flight of capital: Union Budget must take steps to minimise HNI exodus

While the global economy struggles with uncertainty and fear of possible recession, energy crisis and weak demand, the Indian economy has shown buoyancy owing to its strong fundamentals.

India’s growth story has been fueled by domestic demand, but a very significant contributing factor has been capital inflows. Net foreign direct inflows remained robust and rose to USD 22.7 billion during April to October 2022 from USD 21.3 billion during April to October 2021.

At the same time, there is a disturbing trend of migration of high net-worth individuals (HNIs) from India. Around 30,000 to 35,000 HNI’s have left India in the last 5 years and this trend is expected to continue. It is estimated that 8,000 HNIs left India in 2022. Some of the preferred destinations for HNI migration are US, UK, UAE, Canada, Australia, Singapore and Europe. HNI migration needs to be addressed as its negative impact on tax revenue, wealth creation, employment generation and reduced consumption is immense.

With the Union Budget around the corner, there are expectations from the finance minister (FM) to take steps to minimize HNI exodus. Some of the suggestions are discussed here.

Reduction of tax rates and relaxation of tax residency norms

The highest effective tax rate applicable to HNIs is a whopping 42.74%, which is much higher than the corporate tax rate. To compound the problem, the tax residency norms have been modified and certain deeming fictions have been introduced whereby non-resident individuals are taxed on India sourced income exceeding INR 15 lakhs. To incentivize HNIs to stay in India, there is a need to relook at the tax residency rules and ensure that the high effective tax rate on individuals is rationalised.

Boost to setting up business in India

HNI exodus can also be triggered by the need to move businesses outside India to a more tax friendly jurisdictions, and hence there is a need to take measures to encourage setting up businesses in India.

India ranks 3rd in the list of countries having the largest startup ecosystem. As of 7 September 2022, India is home to 107 unicorns with a total valuation of over USD 340 billion. The government has recognized the need to incentivize Indian start-ups and has introduced various initiatives to encourage the start-up culture in India. Unfortunately, these measures are not adequate. Indian start-ups continue to relocate to countries like UAE and Singapore which have a much friendlier tax regime and simpler regulatory regime.

There is an urgent need to look at the underlying reasons why the benefits and incentives provided by the Government are not culminating into the desired results. For instance, “eligible start-ups” incorporated between 1 April 2016 to 31 March 2023, are entitled to tax benefits but it comes with a rider that the benefit is only available for start-ups which are recognized by the Department for Promotion of Industry and Internal Trade (DPIIT), creating an operational roadblock.

There are certain other benefits provided to eligible start-ups such as tax exemption on amounts received on issue of shares, in excess of fair market value, option to defer tax deduction on perquisites arising on of exercise of Employee Stock Options (ESOP) by employees, etc. The government should consider simplifying the procedural aspects for claiming these incentives by extending these benefits to all start-ups including start-ups established after 31 March 2023.

Uniform corporate tax regime

Today different categories of companies are subject to varying corporate tax rates. Many companies in India have their parent holding companies located in countries like Singapore, Mauritius, Dubai, UK and USA which have lower effective tax rate. Introducing a uniform rate of 15%, currently applicable to newly setup manufacturing companies, to all companies, will encourage Indian promoters to set up holding companies in India.

Foreign sourced income to be taxed at concessional rates

Lower tax rates can be prescribed for income such as dividend, royalty, interest income earned from group companies and subsidiaries outside India to provide a boost to setting up holding companies in India and thereby retaining HNI’s in India.

Simplify capital gains tax regime

India’s capital gains tax regime is highly complex there is a dire need to simplify it. Different asset classes are classified as long term or short-term assets based on holding period, which is again separately prescribed for each asset class. It is suggested that assets should be classified into only 3 categories, equity, non-equity financial assets, and all others including property. Further, the rate of surcharge on capital gains should be capped at 15%.

Tax on virtual digital assets (VDAs)

VDAs are currently being taxed at 30% and only cost of acquisition is allowed as deduction. There is no provision to offset losses against income from transfer of VDAs. Transfer of VDA attracts TDS at the rate of 1%, which is very high. Moreover, there is no clarity regarding the regulatory framework for VDAs. These uncertainties and stringent tax measures have forced crypto exchanges and its co-founders to move their base to crypto friendly countries like Dubai and Singapore. The government needs to rationalise its VDA tax regime and lower the TDS on transfer of VDAs to retain such exchanges and its co-founders in India.

Relaxation of regulatory requirements for investment outside India

Indian residents can invest in immovable property outside India through the liberalised remittance scheme upto USD 250,000 per financial year. The limitation makes it impossible for an HNI to invest easily as desired properties may be higher in value, especially as Reserve Bank of India does not permit the HNI to obtain loans outside India. There is a need to relook at these regulations.

In addition to the specific measures detailed above, it may be worthwhile to look at upgrading infrastructure, health care and education facilities and to promote ease of doing business. Other key areas to be addressed are need for a fast-track dispute resolution model, simplification of regulatory framework and tax incentive schemes for green energy and solar energy.

To conclude, while there are numerous efforts being taken by the government, there is a lot to be done. Focused measures will act as a catalyst for encouraging investment in India and help India achieve the target of becoming a USD 30 trillion economy by 2047.

This article was originally published on The Times of India.