Seth Freeman

India: Trigger Happy on the Sensex

There already is a 15+% short-term capital gains tax on Indian securities. There is no long-term gains tax at present.

Shiv refers to the use of Mauritius or Singapore structures to enter the Indian market and take advantage of India's anti-double taxation treaties with those countries. We have two of them. Trading through these structures avoids double-tax (as the result of withholdings in India) for US tax-payers. as there is no such treaty between the US and India. However, US taxpayers do pay tax in the US on their Indian profits. I think most foreign investors with Mauritius structures, their company administrators, custodian banks and tax advisors do a proper job in maintaining the substance of these entities. Besides, the Certificate of Residency issued by the local authorities provides a prima facie protection. I don't think the new budget policies have any form over substance implications for these entities.

Given the significant participation of foreign investors as a % of total investment in the Indian securities market, I do not believe the government will impose higher short-term gains taxes or any long-term capital gains tax on portfolio gains.

One of the big risks as illustrated last week is the ill-timed and ill-conceived policy statements from Indian government officials that precipitate large declines in the market. SEBI did this over a year ago when they issued their policy P-Notes. Both times the market abruptly sank. Its this kind of volatility that dissuades foriegn investors and distracts them from the outstanding long-term investment opportunity. seth.freeman@emcapital...

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The impact on investors is less clear. My own view is that we shall see a removal of the Security Transaction Tax and a return of short and long term capital gains tax. This could be a negative trigger because the post tax return expectation will fall below where it stands today. It may lead to debt as an asset class gaining attractiveness relative to equity.

For foreign portfolio investors operating with no treaty privilege, the attractiveness of the Indian market versus other emerging markets will reduce as a result of a change in long term post tax return expectations.

For portfolio investors operating with treaty privilege, the introduction of capital gains tax will be neutral. However, anti avoidance rules will certainly result in elevated disputes. At a minimum, foreign portfolio investors will need to substantially increase the substance of their inbound investing vehicles in order to qualify for treaty privilege.

Because the cost of substance will be well below the tax savings, I expect a massive shift in the structures used to deploy capital. To be honest, any portfolio investor operating with treaty privilege, who operates through an inbound investment vehicle lacking in substance is either foolish or ill advised!

Invest in BIC, Not BRIC

I agree that its likely both the local markets and the ETF's would rise. However, Investors (whether or not they are day-traders or mid or long term investors) are buying and selling India and China ETFs at prices that are de-coupled from the closing prices of the underlying portfolio. Recently, U.S. India ETF's and India ADRs have been highly sentiment driven based upon volatile U.S. market sentiment not just local market dynamics and fundamentals. ETF Investor returns (without regard to day-traders) are impacted by entry and exit prices that are de-coupled from the local market during U.S. hours. Its my admittedly self-serving belief that the best way to be an Investor in these markets is by buying into a basket of local shares with a portfolio-level NAV that reflects the value of the local shares' closing prices, not the price paid between buyers and sellers after (or before) the local markets are open.


On Apr 22 04:46 PM Eric Peterson wrote:

> Seth: I don't understand your comment about ETF's. "Investing" is
> not day-trading. So it doesn't matter if the ETF's trade during hours
> that the Indian and Chinese markets are closed. If India and China
> rally 10% in a month, I guarantee you the ETF's will also rally.
> It's irrelevant that they trade at different hours.

Invest in BIC, Not BRIC

India is not dependent upon external demand for its growth. That is a fallacy. India is the largest English speaking democracy with a tradition of capital formation and the least dependent of any of the BRICs on exports and commodities; with a middle-class almost as large as the entire U.S. population. Half of India's 1+bn population is under 25 and haven't started spending, yet. No banks or insurance companies failing there. Meanwhile, China's aging population under the one-child rule is beginning to look like Western Europe's. And, China's politburo can change the rules whenever it wants to.

The second fallacy is Investing in India and China using ETF's. ETF's are a fake way to gain India and China country exposure. Why? The whole concept of an ETF is for the single ETF share to represent the basket of underlying stocks. However, both the China and India stock markets are long closed when the U.S. India and China ETFs are trading. Intraday China and India ETF prices reflect U.S. market sentiment and highly sophisticated trading by hedge funds and institutional investors using ETFs.