The draft guidelines of the Income Tax Department on the General Anti-Avoidance Rules (GAAR) have stumped private equity (PE) funds that have routed their investments in India through tax havens.
The majority of PE investments are routed through Mauritius to avail of the benefits of the double-taxation avoidance treaty. But, according to GAAR, while interpreting tax legislation, “substance” needs to be preferred over legal form.
In case the only purpose of routing these is to avail of tax benefits, GAAR provisions would not allow it. Mauritius-based structures are often established by foreign investors for routing investments. In the absence of a clear definition, it would not be too difficult for tax authorities to establish lack of the so-called commercial substance.
Indian Private Equity and Venture Capital Association (IVCA) would raise the issue of the ‘unlimited powers of tax authorities’ with the finance ministry next week. It would seek a clear definition of substance for Mauritius-based structures.(A SNAPSHOT ON PE ACTIVITY & DEALS)
“Almost 90 per cent of private equity investments come through the Mauritius route,” says Mahendra Swarup, president, Indian Private Equity and Venture Capital Association.
“The absence of any clear definition of what amounts to ‘commercial substance’ has created a lot of uncertainty.” Funds say due to this, wide discretion rests with tax authorities. Shailesh Vickram Singh, executive director of Seed Fund Advisors, says, “The authorities are given a lot of power to decide whether a particular transaction would be covered or not. This uncertainty is worrying.”
Mauritius-based entities incur capital gains tax of 15 per cent, against 30 per cent payable in India, says Singh. If PE funds are asked to pay the higher rate once GAAR is implemented, the funds would have to account for this before taking investment calls. Earlier, the industry had sought exemption from GAAR for sums already invested. But, the government said this would not be permitted.
Tax consultants say investors staring at GAAR would have three options: First, build substance in their existing jurisdiction; second, move to a jurisdiction where building substance would be easy; and third, accept the taxman’s view.
Sunil Jain, partner, JSA, says, “It is under circulation that moving to Singapore may solve problems of substance completely. This is not entirely true.” The government is not expected to give a thumbs-up to structures in Singapore just because of compliance with limits such as S$2,00,000 a year to be spent, as provided in the India-Singapore tax treaty, he says. “GAAR has not been planned to benefit Singapore, but revenue numbers.”
“FIIs (foreign institutional investors), PE/VC (venture capital) investments are long term,” says IVCA’s Swarup. “FIIs can sell in the secondary market and start trading from Singapore the next day. But PE/VC holdings are not liquid. Unwinding will not be easy,” he adds.
Singapore laws do not allow a company to migrate. A fresh company has to be set up, and this would not resolve the issue of existing investments. “Total revamping of the portfolio is impossible, because this would mean unwinding structures right up to the limited partner level,” says Swarup.
On suggestions to the finance ministry, Swarup says, “We are planning to recommend a threshold of $50,000 for minimum annual expenditure, against S$2,00,000 in Singapore.” Other suggestions would include at least two resident directors in Mauritius and conducting board meetings in that country.
