India has amended its 33-year old tax treaty with Mauritius that may hit investment inflows, especially considering over the past 10 years, it was nearly $81.8 billion or 34% of the total inflows routed through that country. India has signed a protocol agreement with Mauritius to prevent evasion of taxes on income and capital gains by entities of either side. Among other measures in the protocol pact with Mauritius is to have a source-based taxation of capital gains on shares.
According to Edelweiss Broking Ltd, nearly 60% of investments coming into India through participatory notes (P-notes) or overseas direct investments (ODIs) come through Singapore and Mauritius. The changes in tax laws would mean that short-term capital gains would now are taxed for but starting 1 April 2017. This means the government has given ample room for changes to take effect and even out the transition, it added.
Edelweiss said, "Private and venture capital investments may also see an impact. As most of these investors prefer to invest through alternate routes like preferential shares, the changes in tax law would entail applicable taxes on conversion. Therefore, some of these investors may accelerate investments till the window of 1 April 2017 kicks in."
"Indian markets have seen a number of factors turn in favour over the recent months. Reversal in commodities has removed the threat of systemic risk in commodity producing emerging markets, monetary policy in US and elsewhere remain accommodative, monsoon rainfall is expected to be above normal, government investment in infrastructure remains supportive and banking stress seems to be priced in. There we believe that the current reaction to the changes in tax laws is an opportunity to benefit from the upcoming bull trend. We continue to remain bullish on markets," the report added.
Here are the important changes and its effects...
The Treaty Change
- If as a foreign investor you invest in Indian companies by buying shares, at the time of selling these investments you pay capital gains tax. Now there are certain countries with which India had a long standing double taxation avoidance agreement (DTAA).
- This agreement allowed capital gain on the sale of shares to be untaxed in India. Countries like Mauritius, Cyprus and Singapore had a these DTAA which allowed investors to set up shell companies in these countries to enjoy no taxation.
- There are around 88 countries with which India has DTAA agreement but in few countries (Mauritius, Singapore and Cyprus) DTAA agreement clause give exception from capital gain, interest received, dividend tax. After the change in treaty with Mauritius this tax haven status will go away.
The Tax Change
The “worry” part
a. From 1 April 2017, any shares that are purchased, by Mauritius entities, will see capital gains taxes in India.
b. 7.5% withholding tax on Interest income arising in India to Mauritian resident banks in respect of debt claims or loans made after 31 March 2017.
c. Shares bought and then sold after 31st March 2019 will attractive full domestic tax rates
The positive, Grandfathering
a. Shares bought before 1 April 2017 will exempt from tax, as per amended DTAA
b. Shares bought after 1 April 2017 and sold before 1 April 2019 will attract half the domestic tax rate (7.5%, which is half of 15%). For this to be applicable the investor needs to qualify under the limitation of business (LOB) principle Long term capital gain on sale of shares is currently zero in India; therefore the impact would be on futures and options (F&O) activity, P-Notes (intensity of impact would be clear after releasing of protocol text.)
The Foreign Flows
- In the past 10 years India has received $239 billion of foreign direct investment (FDI) inflows. Out of this, nearly $81.8 billion or 34% has come through Mauritius. So, Mauritius is very important for FDI flows into India.
- In the same period Singapore has accounted for $42 billion or 22% of FDI flows into India. So put together Singapore, Mauritius account for more than half of the FDI into India.
- Since both these countries had DTAA, amendment to the tax laws can cause changes in flow of FDI.
