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India gets right to tax capital gains in new Mauritius treaty

The central government today said it had signed an amended bilateral tax treaty with Mauritius that would tweak the previous previous Double Tax Avoidance Agreement (DTAA) the two countries have signed.

The government said the new treaty (effect April 1, 2017) would help prevention of fiscal evasion by giving it right to levy taxes on income and capital gains.

For capital gains arising during April 1, 2017 to March 31, 2019, investors will get a benefit of 50 percent reduction in tax rate in India. However, taxation at full domestic rate in India will take place from FY20.

Under this pact, interest arising in India to Mauritian banks will be subject to 7.5 percent withholding tax.

Reacting to this new development, Dinesh Kanabar of Dhruva Advisors said that this was a welcome move from the government and pointed out that the current tax exemption enjoyed by investors will continue till March 31, 2017.

In the same interview, Ketan Dalal of PwC India said that the ‘gandfathering’ of investments made up to April 1, 2017 is a sensible move.

He also said that as uncertainty spooks investors. And clarification under this treaty should have a neutral to minimum effect on the market.

Dalal also feels that one needs to see whether India will amend its treaty with Singapore as well or not.

Sudhir Kapadia of EY agreeing with Kanabar and Dalal, said that he welcomes the two-year transition offered in the reworked treaty.

But the change in treaty will reduce post-tax returns on investment from Mauritius, he added.

Mukesh Butani, BMR Legal, said that India is sending out a message to the rest of the G-20 members with this treaty, making it clear that it is committed to implementing action that will remove all the treaties which result in what the Organisation for Economic Co-operation and Development (OECD) calls stateless income.

He does not see this as an alarming development that will cause mayhem in the market.

Rajesh Gandhi of Delloitte Haskins & Sells said that with this amendment done, Cyprus is the only country left that is offering tax exemption on capital gains now.

He sees this treaty as impacting foreign institutional investments (FIIs), asset managers and India’s treaty with Singapore.

Below is the verbatim transcript of the interview of tax experts with CNBC-TV18.

Latha: Those are the three things that Sapna has picked up, that a new double tax avoidance agreement (DTAA) has been signed under which capital gains can be taxed, however a lower tax rate will be applicable for slightly bigger companies because the intention is that they are not shell companies and this benefit I believe will goes off anyway in 2018, if I am not mistaken. Your first comments does this completely now seal this confusion between Mauritius based companies and the advantage they have in India?

Kanabar: Well, I have not had a chance to look at the amendments, but if I go by what Sapna explained essentially what we are talking about is gains which arise from 1 April 2017 will be liable to tax, which means that the current treaty and non-taxation continues to apply till 31 March 2017.

Now from 1 April 2017, India kicks in general anti-avoidance regulation (GAAR) as we call it and once GAAR comes in there was always this question what happens to India-Mauritius treaty post the implementation of GAAR.

This is a very welcome move at least because it is going to indicate on a going forward basis when GAAR kicks in Mauritius treaty will continue to apply in whatever form and again just I am interpreting what Sapna said as oppose to reading the tax break at this point of time, that if your investment was made prior to 2017 then may be treaty continues to apply.

Post April 2017 whatever are the fresh investments made they will be liable to capital gains tax. Just let me elaborate a little bit on limitation of benefit, essentially what we are talking about is that, so this is for example India-Singapore treaty where if a Singapore entity has to qualify for the benefits of the treaty then it has to be not incorporated in Singapore only for the limited purposes of getting capital gains benefit and has to incur an expenditure of at least SGD 200,000, so similarly a test seems to have been put out as Sapna mentioned about Rs 2 crore that seems to be a rather higher limit than what is prescribed in India-Singapore treaty which is unlikely to be the case, but that means that if a company is incurring that expenditure in Mauritius it is a genuine establishment there, it is not a question of big or small it just indicate that the company may be has it owns office, has its own employees and is therefore a company of substance which is entitled to benefits of the tax treaty.

Net-net it’s a very, very welcome move because the uncertainty was not something which was desirable at all.

Latha: The limitation of benefit will be only for the transition period that is up to 31 March 2019. I suppose after that there is even the limitation of benefit is not available is that how we should understand it?

Kanabar: A limitation of benefit is not enabling, it is the other way around. A limitation of benefit actually provides that the benefits will be available only on prescribing certain conditions, so apparently there seems to be a suggestion to say that despite you are not qualifying the limitation of benefit is hold you might get a lower tax rate up to a point of time and then it will go away.

The more important thing from everybody’s point of view is the grandfathering, so if the investments made prior to 31 March 2017 are indeed grandfather as Sapna seem to suggest that could be a very, very welcome.

Latha: I hope you heard what Mr Dinesh Kanabar was telling us. So, basically the General anti-avoidance rule (GAAR) kicks in from April 2017 and we now have the Mauritius treaty amended to suit GAAR, is that the way we have to read this?

Dalal: Yes, as Dinesh mentioned and of course I did not have the benefit of listening to Sapna unfortunately but from what I gather from what you said and Dinesh said GAAR of course kicks in from April 1, 2017 and there was this uncertainty.

It appears from what I heard that a limitation of benefit clauses have been incorporated in the India-Mauritius treaty but just one additional point. Singapore has a couple of objective tests including the 200,000 Sing Dollars and also the subjective test that the company must not be incorporated in Singapore only for the purpose of tax saving. I am not sure whether under the India-Mauritius treaty it is only an objective test or there is also a subjective test.

The reason I mentioned this is that a subjective test has always got a potential of different interpretations. So, while yes, the Rs 2 crore limit is very high if there is an objective test then to that extent at least the clarity will be more.

Although it will be difficult for so to speak shell up pass-through entities to get the advantage of the India-Mauritius treaty under the capital gains exemption as it currently stands and of course as it seems it will stand till March 31, 2017.

Latha: What do you think should be the reaction?

Dalal: A couple of things. Much of it has been covered but two points I want to raise. Just stepping back it will just divide the investor into three baskets. Let\’s say FIIs, private equity and strategic.

Now, strategic investors usually don’t sell anyway. So, it may be in that sense less relevant to them. But if you look at private equity and FIIs insofar as private equity is concerned usually the share is usually long term in nature and if it is listed share in any case it will be exempt.

And if it is unlisted shares as was pointed out the investment made only after April 2017, so in practice what will happen is they usually hold the shares for 3-7 years. So, the taxability dimension is in that sense differed to let us say, 2021-2022 that a lot of things could change.

So, in that sense the fact that there is a grandfathering of investments made up to March 2017 is very welcome. Insofar as FIIs are concerned if there is long term it is in any case exempt because that is usually anyway enlisted shares.

If it is short term to that extent there will be of course some impact but again subject to compliance of the benefits that you read out even that is 50 percent it is a better thing to have that clarity and pay 50 percent than to live in that uncertainty for quite some time.

Kritika: How significant would this really be in tackling the issue of round tripping of funds attributed to the long pending India-Mauritius treaty?

Kapadia: There are two points, one is to the extent that there is round tripping happening, to the extent that there is money washing happening, it always helps that there is a tax exemption opportunity goes away and tax cost of such so called round tripping goes up. Keeping in mind the objectives of the BEPS Project on tax transparency this is welcome.

My point here is that in terms of India’s tax policy and in terms of let’s say attracting this kind of investment and when I say this kind of investment I am focusing not on the shady time but on the investments which come through two channels – one is the whole FPI window or what was known as FIIs earlier or portfolio investments and the other is the private equity venture capital channel.

If you look at these two channels what happens is that of those kind of entities make gains in India which are either short term in listed securities or even if they are long term they are in unlisted securities, to that extent you are taking away the capital gains tax benefit.

One is it gives level playing field to domestic investors something which they have been asking for and to that extent it is fine. However it increases the tax cost for them or it decreases the after tax returns for them. If you link it up to a potential – if there is a rupee volatility or depreciation it then makes the after tax return that much the hurdle rate higher.

So, I think in the two years period if everything goes well, if the rupee really appreciates, returns get better I agree that it is just a tax cost which everybody else pays for making gains in Indian securities, theoretically that is fine but practically if we are looking at some other jurisdictions around the world which do not tax non-residents for making capital gains on securities in their home countries, we will have to be, the economy will have to really generate that much better returns for those investors.

Latha: First thoughts, welcome, unwelcome?

Butani: You have to give a context to why these changes have occurred. You have India as a signatory to the G20 Base erosion and profit shifting (BEPS) project which amongst various action points has listed abuse of treaty as one of the important objectives to which all the G20 have committed.

So, they need to look at all that treaties which result in what the Organisation for Economic Co-operation and Development (OECD) calls it as a stateless income. So, that is the first point. What India is doing is it is sending out a signal to the rest of the members of G20 that this is its commitment now to implement various action steps and one action step being treaty abuse provision.

The second important element that you need to bear in mind from a tax policy standpoint in India is the GAAR which kicks in on April 1, 2017 and with that as it is there is a degree of doubt and scepticism in the minds of investors who were making use of tax friendly jurisdictions and whether GAAR will kind of come in the middle of those forms of incentives that were available because of use of tax friendly treaty. So, that was the other aspect.

The third aspect is that if you look at the draft regulations that were released insofar as GAAR is concerned, this is in 2013 it clearly provided that the grandfathering provisions will be upheld till August 2010 and the reason that date was chosen was because that was the date on which the direct tax code of 2010 was released.

So, if you keep all of that in background and if you look at the three changes that have been carried out, one grandfathering up to April 2017 to a concessional rate of 50 percent between 17 and 19 in my view augurs well besides the point that was made earlier on certainty.

I also feel that how India could have been able to live with the Mauritius-India treaty with no capital gains tax and it was one of those exceptional treaties which was kind of going against the grain of source based taxation and giving the rights to Mauritius to tax such income. So, I don’t really feel that this is something which is alarming and it is going to cause mayhem in the market.