Mumbai: India`s move to plug suspected losses in tax revenue through Mauritius, a top source of foreign investments into the country, has not sent financial markets into a tailspin as it would have just a few years ago.
But while markets took the move in their stride, analysts warn India is likely to expand its crackdown on tax treaties and make it harder for investors to shop around for new havens.
India will start imposing capital gains tax on investments coming from Mauritius starting next year, after the two countries agreed to amend a three-decade old treaty.
Now, funds from Mauritius interested in India will have to weigh paying capital gains taxes that could range from zero to as much as 20 percent versus the expense of setting up a new structure.
Investors say they will wait for final details and consider how it will affect India`s tax treaty with Singapore. The rules state any changes to the capital gains exemption provided to Mauritius will lead to changes in the agreement with the city-state.
Mauritius and Singapore account for the bulk of the $278 billion in foreign equity investments since 2000.
Even with capital gains, analysts say shopping around for a new tax haven may not make sense. India will next year toughen the criteria under which offshore funds can claim tax benefits abroad, a key priority for Prime Minister Narendra Modi`s government.
"World over, the wind is blowing against tax treaty shopping and treaty abuse. Structures set up only for the purpose of claiming tax exemptions but without adequate substance are no longer likely to work," said Suresh Swamy, a partner at PwC in Mumbai.
Investors were relieved the taxes would only apply to investments starting next year and not affect existing investments. India`s main share index fell 0.5 percent.
India has become a favourite destination of foreign investors under Modi on hopes of major reforms targeted to revitalise Asia`s third-largest economy. Gross foreign investments reached a record $55.5 billion in the year to March 2016, up 23 percent from the previous year, according to brokerage Religare Capital Markets.
The tax changes could hurt short-term foreign investment inflows, but investors say they may still choose Mauritius if it proves cost effective.
"I don`t think shifting everything lock, stock and barrel for an existing fund is going to be that easy," said a director for a private equity fund in Mauritius, who declined to be identified given the sensitivity of the subject.
A hedge fund manager who had been considering setting up in Mauritius said his firm would also keep its options open, while exploring other locations such as Delaware or Cayman Islands.
"Ultimately, if Mauritius proves to be a more cost-effective offshore jurisdiction for non-U.S. investors, then I think many India funds will continue to domicile their funds and management companies in Mauritius."