Mauritius tax treaty: Long-term impact on markets limited, say analysts

Markets opened sharply lower on Wednesday, after India and Mauritius inked a protocol that amends the double tax avoidance arrangement between the two nations. After a knee-jerk reaction that saw the S&P BSE Sensex slip over 1%, or over 300 points at open, the markets recovered some lost ground. At 9:30am, the benchmark index was trading at 25,620 levels, down 0.6%.

As per the protocol, capital gains arising in Mauritius from sale of shares acquired on or after April 1, 2017, in Indian firms will be taxed. According to reports, Mauritius accounted for 34% of foreign direct investments in India between 2000 and 2015.

Investment by foreign portfolio investors (FPIs) / foreign institutional investors (FIIs) – the key drivers of markets – in the equity segment during calendar year 2015 (CY15) stood at Rs 17,808 crore according to NSDL data. In the first five months of CY16 (till May 11 2016), they have already put in 12,623 crore in the equity segment.

Foreign investors were a consistent buyer from June-September 2012 till end-March 2015. During this period, FIIs cumulatively invested nearly Rs 3.3 lakh crore in Indian markets, becoming the single largest group of non-promoter shareholders and the biggest market movers on Dalal Street. CLICK HERE FOR THE FULL STORY

IMPLICATION ON MARKETS
 

So, what are the implications of the protocol and will it impact foreign flows into the markets?

Analysts say this treaty shouldn’t upset the Indian equity markets in the short-to-medium term, as only half of the fund flows would be taxed at 50% for the 24 months (April 1, 2017 to March 31, 2019) and current investments would be exempt from the tax. It is only from April 1, 2019, that the flows coming from Mauritius and Singapore which account for 50% of overall foreign flows would be taxed fully.

“From April 2019, this move may curtail speculative short-term money and encourage healthy long-term foreign investments into Indian equities. In our view, this treaty looks like a brilliant compromised one which is unlikely to upset the domestic market in any significant way in the short-to medium term. In the long-term, of course, some of the speculative flows may stop, however, along with that the volatility in the Indian equity markets also would come down. In the long-term, both the economy and markets get adjusted to new set of equilibrium forces. This treaty would also be digested by the markets in a linear way beyond 2019 April,” points out G. Chokkalingam, founder & managing director, Equinomics Research & Advisory.

“In the long term, not all FIIs coming through these two countries will stop investing. The benefit of wealth creation would outweigh the tax burden for the long-term investors. Of course, many short term investors ETFs and users of P-notes coming through these two countries would slowly withdraw. Since there is 34 months for the total concession to elapse, the impact of such withdrawal would be gradual and hence, it would avoid any major fall of Indian equities,” he adds.

Another key positive measure, according to analysts, is that the tax is not being levied from retrospective effect. As a result, market players will be able to plan their future strategies accordingly.

“In the long run, the clarity that the government has provided on the taxation front is going to be fundamentally very positive because it will tell investors across the globe that India as an investment destination cannot be abused under the tax treaty. However, we have been seeing a large amount of participation from traders from global markets that have used the promissory note (P-Note) route. These are some of the transactions where one is suspicious about round tripping taking place. So the round tripping will now get arrested to some extent given the development. Overall, the market volatility should also stay under check. Another positive is that the tax is not from retrospective effect. The knee-jerk reaction in the markets is justified as the traders will use the nervousness to make money. I don’t see anything wrong with the taxation protocol,” says Deven Choksey, managing director and chief executive officer, K R Choksey Shares and Securities.

"Nearly 60% of investments coming into India through P-notes or ODIs come through Singapore and Mauritius. The changes in tax laws would mean that short term capital gains will now get taxed for but starting April 2017. This means the government has given ample room for changes to take effect and even out the transition," points out Sahil Kapoor, chief market strategist at Edelweiss in a co-authored note with Anand Laddha.

"Indian markets have seen a number of factors turn in favour over the recent months. Reversal in commodities has removed the threat of systemic risk in commodity producing emerging markets, monetary policy in US and elsewhere remain accommodative, monsoon rainfall is expected to be above normal, government investment in infrastructure remains supportive and banking stress seems to be priced in. There we believe that the current reaction to the changes in tax laws is an opportunity to benefit from the upcoming bull trend. We continue to remain bullish on markets," they add.