Revised Mauritius tax pact may hit overseas fund flows

The new pact to levy capital gains tax on investments coming through Mauritius may put foreign portfolio investors in a fix and the impact is likely to be reflected in stock markets Tuesday with experts expecting the cost of foreign investments to go up.

New Delhi: The new pact to levy capital gains tax on investments coming through Mauritius may put foreign portfolio investors in a fix and the impact is likely to be reflected in stock markets on Tuesday with experts expecting the cost of foreign investments to go up.

Tax exemption on capital gains would be done away with in the case of investments from Singapore also.

The "colossal tax development" would have a significant impact for institutional investors as well as private companies which have been routing their funds into India through Mauritius, according to analysts.

Investments from Mauritius and Singapore account for a big chunk of foreign portfolio funds coming into the Indian stock market.

While there was no immediate reaction from leading foreign investors, the decision on capital against tax is largely expected to have its impact on the stock market.

"This is a colossal tax development and will have a significant impact for numerous institutional funds, asset managers and private companies which have used the Mauritius route to invest into India," Deloitte Haskins & Sells LLP's Partner Rajesh H Gandhi said.

Analysts felt that the revised treaty would raise costs for foreign funds investing in India.

"With this change, the capital gains tax concession for investments from Mauritius into India gradually comes to an end. Further, this will also impact the similar benefit under the India-Singapore treaty.

"It will be interesting to see as to what impact this amendment will have on FPI/ FII investments into India eventually," Girish Vanvari, who is National Head of Tax at KPMG in India said.

After years of negotiations, India and Mauritius today inked protocol for amendment of the Double Taxation Avoidance Convention (DTAC) whereby capital gains tax would be imposed at 50 percent -- for two years starting from April 1, 2017 -- on investments coming from the island nation.

The full rate of capital against tax would be applicable on investments from Mauritius from April 1, 2019.

Experts said the decision to grandfather investments up to March 31, 2017, and giving a year's time to graduate to the taxation system will lend tax certainty to investments.

BMR Legal Managing Partner Mukesh Butani said the amendment will lend "certainty to investors on the applicability of treaty as investors have been nervous on the future of the Mauritius treaty".

Nangia & Co Managing Partner Rakesh Nangia said with a major part of FDI coming through Mauritius, many may argue that this is an unfortunate step in terms of the timing and the situation where a significant amount of reallocation is happening in terms of global investors from India to many other markets.

"But the way the treaty changes have been proposed to be implemented is very well-balanced," Nangia said. 

Experts also said the revised tax treaty would expedite

investments that were waiting in the wings as tax concessions will be available till April next only.

On the other hand, the new pact with Mauritius provides certainty to foreign investors, especially considering that GAAR would be in force next year.

Gandhi noted that Singapore becomes a less attractive destination for investment into India because the capital gains tax exemption under the Singapore treaty will also be automatically removed.

"There is a proposal to provide for a concessional tax rate for two years ie gains accrued during 2017-18 and 2018-19 which makes Mauritius apparently better than Singapore for those two years," he said.

Under the amended treaty, the 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.

Rahul K Mitra, who is National Head of BEPS & Tax Dispute Resolution at KPMG in India said while the amendment is not likely to impact FDI flow in India.

"For FIIs, investing in listed shares on the stock market, capital gains on shares held for more than 12 months would any way continue to be exempt from tax," he added.

While short-term capital gains are taxed at 15 percent in India, they are exempt in Mauritius. Capital gains arising out of long term investments of 12 months is exempt from taxes in India.

Manoj Purohit, who is Director at Grant Thornton Advisory Pvt Ltd said the amendment would have a greater impact on the FDI of India coming from Mauritius as well as Singapore considering the co-terminus clause in India-Singapore treaty with India-Mauritius treaty.

"On the other hand, it will also provide a great relief to the bonafide investors as it would give them a clarity of taxation and end the litigation on treaty abuse," he noted.

Calling the long-awaited amendment "a mixed bag", Khaitan & Co's spokesperson Daksha Baxi said, "All the investments which were waiting in the wings would probably get expedited... It remains to be seen how the change in the India-Mauritius treaty impacts the exemption under the India-Singapore treaty," he added.

Another issue that needs to be addressed would be about re-negotiating the India-US treaty to get "resourcing" rule incorporated in that treaty similar to what that country has with many other countries including China.

"Currently, the source rules in the US prevent US resident from claiming credit for the Indian capital gains taxes against the US capital gains tax liability.

"If India succeeds in renegotiating the India-US treaty within this transition period, the US investor would be less weary and concerned about the capital gains tax incidence in India," Baxi noted.