Foreign portfolio investors (FPI) have given thumbs down to the higher surcharge on income-tax for the ultra-rich at Finance Minister Nirmala Sitharaman’s maiden Budget.

As most of them fall in that income category, they are awaiting clarity from the government on tax treatment.

“One of key risks of investing in emerging markets such as India is the immaturity of tax regimes, wherein frequent and sudden changes are made without issuance of any consulting paper and/or giving due notice period to the potential assesses to plan their affairs,” said Sanjay Guglani, CIO of Singapore-based Silverdale Capital,

“Every such episode ticks up the India’s risk premium and turns away long-term investors,” he said. “Given the tiny threshold of less than $300k, it will impact practically all FPIs in India.”

The increase in surcharge on income-tax hit foreign portfolio investors (FPIs) hard, leading to a steep selloff in the Indian equities over Friday and Monday.

Under the Indian tax laws, equity investors need to pay a 10 per cent (11.96 per cent effective) tax on long-term capital gains in the case of selling of shares of listed securities when the gains are in excess of Rs 1 lakh. A 15 per cent tax (17.94 per cent effective) is levied, if such capital gains are short term in nature (less than 1 year).

What has now changed is the surcharge in the Rs 2-5 crore income group from 15 per cent to 25 per cent, and for Rs 5 crore-plus income group from 15 per cent to 37 per cent.

Overseas funds, especially mutual funds, have in the past preferred to be structured as AOP (association of persons) or trusts to avoid minimum alternative tax (MAT).

If such FPIs earn an income of over Rs 2 crore entirely from listed equities, they will now need to pay 25 per cent surcharge on their capital gains, short or long. In the case of income of Rs 5 crore and above, the same will go up to 37 per cent.

In case of gains from unlisted securities and derivatives trade, STCG for the Rs 2-5 crore group will be 39 per cent, while it will be as high as 42.74 per cent for the Rs 5 crore-plus group.

These rules would likely impact all foreign funds and AIFs established as trusts. Some estimates show more than 2,000 funds fall in this category.

A few believe a clarification from the government was due to allay investor concerns. “I think foreign funds are not the target of this surcharge. It is designed to tax wealthy individuals, which is a common practice in many countries,” said Hertta Alava, Senior Strategist at Nordea

“Foreign funds are important for Indian capital markets and there are already enough taxes for those. I would expect the government to clarify this issue soon, which would be a relief,” Alava said in an email from Helsinki, Finland

“Of course the Budget didn’t really bring any positive triggers for the stock market. So it looks like the Modi 2.0 optimism is waning,” she added.

Finance Minister Sitharaman has ruled out an immediate clarification on the issue. “I don’t think a clarification at the moment is all that required. Let’s see as it goes. You think it is required? Will take it as it comes,” she said at a press conference on Monday, after addressing the customary post-budget board meeting of Reserve Bank of India in the capital.

This articled originally appeared on Economic Times: “Why are FIIs selling? FM’s surprise tax hike raised India’s risk premium”