New Delhi: India will begin imposing capital gains tax on investments routed through Mauritius from April next under a revised tax treaty inked Tuesday to curb tax evasion and round-tripping of funds -- a move that may have a significant bearing on capital flows from the island nation.
Besides, a similar amendment is being negotiated to the tax treaty India has with Singapore. Mauritius and Singapore are among the top-most sources of foreign direct investments into India and together also account for a big chunk of total inflows into the country's capital markets.
The signing of the Protocol with Mauritius follows a decade long negotiations.
Under the amended treaty with Mauritius, for two years beginning April 1, 2017, capital gains tax will be imposed at 50 percent of the prevailing domestic rate. Full rate will apply from April 1, 2019, a finance ministry statement said.
But this concessional rate would apply to a Mauritius resident company that can prove that it has a total expenditure of at least Rs 27 lakh in the African island nation and is not a 'shell' company with just a post office address.
The amendment to the 1983 Double Taxation Avoidance Convention (DTAC) with Mauritius was signed at Port Louis, Mauritius today. Till now the DTAC did not provide for taxing capital gains in either of the two nations.
Revenue Secretary Hasmukh Adhia said similar amendment to tax treaty with Singapore is being renegotiated.
Stating that the Singapore pact will be amended on similar lines, Economic Affairs Secretary Shaktikanta Das said it will provide "a level-playing field between domestic investors and investors who had unfair advantage when they came through the Mauritius route."
Adhia said the amendment "brings about a certainty in taxation matters for foreign investors" and bring certainty for FIIs while also reinforcing India's commitment to OECD-BEPS initiative.
Tax experts said the amended treaty provides certainty to foreign investors, but the cost of foreign investment in India will go up.
Of the total FDI inflows of USD 29.4 billion in April- December, 2015-16, Mauritius and Singapore accounted for USD 17 billion of foreign equity investment.
At one point of time, the two countries also accounted for nearly two-thirds of overall foreign portfolio inflows into India but the inflows have been declining in the recent past. Now, Mauritius accounts for nearly 20 percent (over Rs 4.3 lakh crore) while Singapore-based FPIs have over 11 percent share (nearly Rs 2.5 lakh crore).
As per the revised treaty, investments made prior to
April 1, 2017, will be protected from new tax provisions.
The island nation with just 1.3 million people was the biggest single source of foreign direct investment into India in 2014-15, accounting for about 24 percent of USD 24.7 billion foreign direct investment (FDI). Singapore accounted for 21 percent.
The three-decade-old taxation treaty, which came into force from April 1, 1983, is said to have been misused by many Indian and multinational companies to avoid paying tax or to route illicit funds.
"While the amendment does provide certainty to foreign investors especially considering that GAAR will be in force next year, it will significantly increase the cost of investment in India for foreign funds," said Rajesh H Gandhi, Partner, Deloitte Haskins & Sells LLP.
The amendment, Gandhi added, will provide for a concessional tax rate for two years i.E. Gains accrued during 2017-18 and 2018-19, which makes Mauritius apparently better than Singapore for those two years.
KPMG (India) National Head for BEPS & Tax Dispute Resolution Rahul K Mitra said the Mauritius amendment is likely to impact the India-Singapore tax treaty in a similar manner, as per the protocol signed between the countries.
India has been insisting on review of the treaty since 2006 as it felt a chunk of the funds were not real foreign investment but Indians routing cash through the island to avoid domestic taxes, a practice known as "round tripping".
It wanted to ensure firms in Mauritius that invest in India are not just 'shell' and instead have substantial operations in the island, such as paying staff there, before qualifying for treaty terms of getting exemption from payment of capital gains tax in India.
Mauritius agreed for a review only in June 2011.
Prime Minister Narendra Modi discussed the treaty on a visit to Mauritius in March last year.
The DTAC till now provided that capital gains on sale of assets in India by companies registered in Mauritius can only be taxed in Mauritius. While short-term capital gains are taxed at 15 percent in India, they are exempt in Mauritius. So, such companies escape paying taxes in both countries.
A large proportion of foreign investment in the stock market comes through companies registered in the Indian Ocean island nation and are exempted from tax in India under the treaty.
According to the amended DTAC, interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5 percent in respect of debt claims or loans made after March 31, 2017.
However, such interest income in respect of debt-claims existing on or before March 31, 2017, shall be exempt from tax in India, it added.
The Economic Affairs Secretary, however, said he expects surge in investment flow.
"With regard to impact on market, this provides a level playing field between domestic investors and foreign investors and in as much as the investments up to April 1, 2017, are grandfathered, there should not be any adverse impact on the market," Das said.
Das said the process of transition of taxing capital gains has been made phased and benign.
"Nobody likes to pay tax, but when there is a capital gain, it has to be taxed and markets world over will have to accept it sooner or later that some amount of tax will have to be paid," he said.
Das said India offers very good returns as compared to what investors get in other countries and therefore the flow of investment will definitely continue into India.
From next financial year, he said, exchequer will be benefit from capital gains tax on share deals with Mauritius.
On whether P-Notes will cease to exist after April 2019, he said, "We will issue clarity on these things as we go by".