Going against spirit of law, taxmen deny grandfathering benefit to FPIs

Nil withholding certificates not issued to investors from Mauritius, Singapore for shares bought before April 1, 2017

In what is being deemed as going against the spirit of the law, tax authorities are avoiding issuing a nil withholding tax certificate to entities from Mauritius and Singapore that have bought shares prior to April 1, 2017.

As per the amended treaties with these countries, shares bought prior to April 1, 2017 are eligible for grandfathering and no capital gains is to be paid on sale of these shares. Capital gains on derivatives and fixed income securities also remain exempt.

"Tax authorities have become a lot more reluctant to issue the nil or lower withholding certificate in the light of India's renegotiated tax treaties with countries such as Mauritius and Singapore and the grandfathering clause provided by these," said a tax expert, on condition of anonymity.

Foreign entities can ask for a tax withholding certificate under section 195 and section 197 of the I-T Act. The assessee can ask for a nil withholding certificate if it believes that it does not have any tax liability in India or can ask for a lower tax rate than what is prescribed under the law.

Historically, tax officials have been reluctant to issue these certificates despite the fact that the Supreme Court has held that a tax residency certificate is adequate proof of residence of a taxpayer a few times in the past, said experts.

"The authorities do not want to issue any certificate that absolves the tax payers from any liability without a proper and thorough investigation of the facts. This logic is flawed because when they issue the certificate they say it is temporary and the final decision will be taken at the time of assessment," said the person quoted above.

This is how the process typically works. Let's assume that someone purchases shares from a Mauritius tax resident who has bought shares prior to April 1, 2017. The buyer will make an application to the tax officer and make a case for a nil withholding tax certificate invoking the grandfathering provision. The tax officer may review the application and ask for further clarifications or additional documents if required. After providing the requisite details, the certificate will, typically, be issued within 2-3 weeks.

In the past few months, however, tax authorities are choosing to issue 1 per cent or 2 per cent tax certificates even though the foreign investor has no tax liability on the sale of shares. This, say experts, is not provided for by the law. "The department has to either apply a zero tax rate or apply the full rate," said a second person familiar with the matter.

Those being issued 1 per cent or 2 per cent tax certificates will have to necessarily file for refunds, which could take anywhere between three to four years. By doing so, the tax authorities are hoping to improve compliance and get relevant details of as many foreign assessees as possible, experts said.

Tax officers are taking two to four months to issue the certificate during which time the transaction may be held up. In most cases, sellers are choosing to offload the shares after getting the requisite indemnity from the buyers.

"There is no statutory time limit within which these certificates have to be issued, so the authorities will typically delay it for so long that a party will be compelled to go ahead with the transaction without the certificate," said the second person quoted earlier.

It's been more than two years since India renegotiated its double taxation avoidance agreements with Singapore and Mauritius. The revision of the treaties was aimed at preventing double non-taxation, curbing revenue loss and streamlining flow of investments.

Under the net

• Tax authorities reluctant to issue ‘nil withholding certificate’ to investors from Mauritius and Singapore 
• No capital gains to be paid on sale of these shares bought before April 1, 2017 owing to grandfathering clause
• Officials issuing 1 per cent or 2 per cent tax certificates, despite no tax liability
• Authorities are taking 2-4 months to issue withholding certificates
• Foreign entities can ask for a tax withholding certificate under section 195 and section 197 of the I-T Act
• Section 197 allows for a lower rate of tax to be deducted at source/no tax to be deducted at source
• Section 195 covers TDS on non-resident payments; identifies tax rates or deductions on business transactions with a non-resident