 "India-Mauritius treaty: some clarity, more confusion")
Finally, there is some clarity on the India-Mauritius bilateral tax treaty. The government said it had signed an amended treaty with Mauritius, which would tweak the previous Double Tax Avoidance Agreement (DTAA). Markets opened marginally lower, recovered a bit and then resumed its journey lower.
There is little doubt that from an operational point of view, the treaty brings in a lot of clarity. But from the market's perspective, there are a few issues in the medium term. Let’s look at the treaty first from an operational point of view before looking at how it will impact the market.
The treaty will surely help curb black money from entering the country by giving it the same treatment that an Indian investor gets. The government will now be able to tax investment coming in the country through Mauritius route. There is a window given by the government for investors which will help them plan their India strategy. For capital gains arising during April 1, 2017 and March 31, 2019, investors will get a benefit of 50% reduction in tax rate, but from FY20 taxation will be at full domestic rates.
Mukesh Butani of BMR Legal gave a context to the entire issue in his interview with CNBC. According to Butani, India as a signatory to G20 Base erosion and profit shifting (BEPS) project, which requires flagging stateless incomes and preventing it. The treaty sends the message that India is serious and taking the right steps towards it.
The second point Butani mentioned was from a tax policy standpoint. GAAR will kick in from April 1, 2017, and this treaty will now have to be kept in mind by policy makers while implement GAAR. Economic Affairs Secretary Shaktikanta Das pointed out that GAAR cannot ignore that we have signed up with Mauritius. GAAR will take note of the amendments appropriately, he said.
The third point was that the earlier grandfathering provision was upheld till August 2010. But now, it has been extended to March 31, 2017, in order to accommodate the delay. Butani pointed out that the India-Mauritius treaty with no capital gains tax was one of those exceptional treaties which was going against the grain of source based taxation and giving the rights to Mauritius to tax such income.
While there is operational clarity in terms of taxation, there are some issues which will have an impact on the market. First is the impact of tax. As Mauritius does not have short term capital gains tax, all profits post FY17 will be taxed at half the rate and post FY19 at full domestic rates. Investors will have their returns curtailed by the tax component.
Experts do not feel that this will prevent short- and long-term players from investing in India, as in a buoyant market taxes are taken as a small impediment. But the tax will definitely hurt algo traders and arbitragers for whom the profits will now be smaller. Options of routing the money through Singapore or Cyprus, the two other countries which enjoy the same tax treaty, will also be closed as Das clarified in the interview that the treaties were dependent on India-Mauritius treaty.
The bigger issue pertains to participatory notes or P-notes as they are popularly known. Of the $120 billion that foreign investors have pumped into the country, nearly $33billion is through P Notes. According to media reports, around 30 to 50% of the P Notes money is routed through ETF (exchange traded funds). Taxing ETF will impact liquidity in the market and probably make the investors shift to Singapore exchange to buy Nifty.
There are many issues in P Notes which will need clarity from the government. Not all P Notes participants might be inclined on disclosing their details. Brokers have repeatedly admitted that transition from P Notes to a regular account is a tedious task. India asks for details which no other country does. Many investors would not be comfortable with undergoing through the process. Further, there is still confusion on GAAR and the India-Mauritius issue.
There are taxation issues in P notes which can be a nightmare. Sridhar Sivaram of Enam Holding points out that the product will be very difficult even if capital gains are imposed on it. This is because of the structure of the product. It is like buying mutual fund units but the fund allowing each unit holder to trade according to them. The broker issuing P-notes will get taxed for every transaction.
Suppose if client A buys Reliance through the P-note route and client B sells Reliance the next day, again through P-note route. As far as India is concerned the broker has bought Reliance and sold it the next day and will be taxed on a short term basis. Client A will naturally object to him being taxed. Broker at his end will have to create a set-up to monitor the transactions for tax purpose or will ask the client to shift to a regular account.
Interview with foreign investors on TV channels showcase their confusion. The government will have to come out with clarifications as soon as possible. As has been this government’s habit, it has always reacted after considerable damage has been done. Retrospective tax issue is a case in the point. It would be better if they clarify as soon as possible so that investors get time to realign their strategy. Arvind Sanger of New York-based Geosphere Capital rightly said that Indian markets may be under a cloud till further clarity emerges on it.
