The tax challenge: How foreign investors lose millions and how to avoid this

India has become a popular destination for foreign investors because of its fast-growing economy, large population, and business-friendly reforms. But while the country offers great opportunities, investing here also comes with challenges. One of the biggest hurdles is understanding India’s complex tax rules. Different types of foreign investments—like FDI and FPI—are taxed differently, and things like capital gains, dividends, and interest income are treated based on specific laws and agreements between countries. Knowing how these rules work is essential for avoiding surprises and making the most of your investment.  

Avnish Arora, executive director, Direct Tax, Forvis Mazars in India, said that foreign investment in India has steadily increased over the past decades, driven by the country’s strong economic growth, large consumer base, and reform-oriented government policies. "However, despite the opportunities, foreign investors often face significant taxation and regulatory challenges that can impact returns," he said.

Understanding India’s complex tax framework is crucial for structuring investments efficiently and ensuring compliance.

The Indian tax regime differentiates between Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI), with each category subject to distinct tax treatments.

"Capital gains taxes, for instance, vary depending on the nature of the asset, the duration of holding, and the investor’s country of residence, which is governed by applicable Double Tax Avoidance Agreements (DTAAs). Additionally, withholding tax on dividends, interest, and royalties can affect returns, particularly in the absence of understanding India’s DTAA framework," he said.  

"India’s General Anti-Avoidance Rules (GAAR) and Place of Effective Management (PoEM) guidelines can further complicate tax planning by targeting arrangements lacking commercial substance or driven primarily by tax avoidance. This has led to greater scrutiny of foreign investment structures, especially those routed through jurisdictions such as Mauritius and Singapore," Arora further added.

Moreover, foreign investors must navigate frequent regulatory changes and adhere to compliance requirements under the Foreign Exchange Management Act (FEMA), the Securities and Exchange Board of India (SEBI), and the Reserve Bank of India (RBI). These agencies enforce sectoral caps, entry routes, KYC norms, and operational guidelines that influence both the inflow and repatriation of capital.