Demand of over Rs 500 crore additional tax slapped on PE/VC funds

Large global funds, including those dealing in private equity, have misused tax treaties with the Mauritius, Singapore, and Cyprus and under-reported income, the Income-Tax (I-T) Department has said. The additional tax demand on these fund houses is more than Rs 500 crore, according to an estimate.

The tax authorities gave assessment orders to at least 12 such houses last week, and initiated penalty proceedings against them.

This follows the reassessment notices issued to them last fiscal year, seeking an explanation for irregularities in calculating income in 2013-14, 2014-15, and 2015-16.

The department has reopened old assessment cases against these entities.

The assessment orders were issued under Section 144C of the I-T Act, which is concerned with draft orders on unassessed income.

“It is proposed that the treaty benefits under India-Mauritius DTAA (Direct Tax Avoidance Agreement) be denied to the assessee on account of ‘fiscal evasion’ of taxes by means of treaty shopping and the income be taxed as per the provision of Income-Tax Act, 1961,” the department’s concluding remark in one of the orders, reviewed by Business Standard, said.

It further reads: “consequently, long-term capital gains on transfer of unlisted shares of Indian company to another entity is added to the income of the assessee and is proposed to be taxed as per the provisions of Section 112 (1) (C) of the Act.”

The order said many jurisdictions were in the process of challenging tax structures, where there was evidence that fund’s place of effective management is not in Mauritius. 

The draft order has proposed a levy of 10 per cent capital gains tax with interest, along with a penalty, which goes up to 50 per cent of the income under-reported, a tax source said.

A draft order typically goes to the dispute resolution panel of the department within 30 days of its issue. After that, the department finalises the tax demand on the assessee.

Bhavin Shah, partner, PwC, said: “While withdrawing capital gains exemption under the India-Mauritius Tax Treaty, the government’s move to provide protection to the existing investments was regarded as a pragmatic step to safeguard the investor community who had invested in the India growth story. However, this recent disturbing trend of denying tax treaty benefits to grandfathered shares is alarming and contrary to the government’s stated objective of providing tax certainty. Swift, corrective and decisive intervention by the government will go a long way in restoring investor confidence.”

The case 

In FY22, assessment notices relating to unassessed income were issued. Under Section 148 of the I-T Act, the department can probe assessments as far back as 10 years if the concealment of income is found to be Rs 50 lakh or above.

Most of the investment was routed through the Mauritius and Cyprus during the assessment years. The tax department wants to know why they did not invest in India directly.

The government may cancel the tax residency certificate of an entity if it is found abusing tax treaty benefits and indulging in treaty shopping.

According to the Organisation for Economic Co-operation and Development, treaty shopping means a person or an entity indirectly accessing the benefits of a tax treaty between two contracting countries without being a resident of any one of those.

India’s Double Taxation Avoidance Agreement with the Mauritius exempted the companies based in the island nation from capital gains tax on Indian shares sold by them to investors. This was used by offshore entities to evade billions of dollars in tax. However, the treaty was amended in 2017.