The re-negotiations on the Double Taxation Avoidance Agreement (DTAA) with Mauritius will not have a major impact on India's equity capital markets. Company analysts and tax experts say neither the foreign direct investment (FDI) nor the portfolio investment by large institutions will be affected.
The experts are not worried for two reasons. All the past investments through Mauritius are safe as India cannot impose any tax on foreign investment with retrospective effect. Also, India has a comprehensive DTAA with 79 countries, which effectively means that foreign flow of money from tax havens will continue from other locations, if not Mauritius. Till now, over 40 per cent of FDI in India has come from Mauritius.
"Today's fall in the stock markets was a knee-jerk reaction. Tax cannot be levied on past investments. Only, the money will flow in from other locations if the government shows too much seriousness in amending the treaty with Mauritius," said Kishor Ostwal, a chartered accountant and director of CNI Research, which specialises in equity investments.
The BSE benchmark Sensex plunged by over 556 points in intra-day trade on Monday on widespread panic selling by funds as well as retail investors, triggered by reports the government may impose capital gains tax on investments through Mauritius.
DTTA specifies agreed rates of tax and jurisdiction on specified types of income arising in a country to a tax resident of another country. Under the Income Tax Act 1961 of India, there are two provisions, section 90 and section 91, which provide specific relief to taxpayers to save them from double taxation.
Section 90 is for taxpayers who have paid the tax to a country with which India has signed DTAA, while section 91 provides relief to taxpayers who have paid tax to a country with which India has not signed a DTAA. Thus, India gives relief to both kinds of taxpayers.
According to Pramod Gubbi, an equity and tax expert with Ambit Capital, the renegotiation of the treaty may impact only short-term investments. "There is no capital gains tax in India, if you are invested for over a year. This zero long-term capital gains tax makes it easy for foreign investors anyway," said Gubbi.
A director with a Mumbai-based leading accounting firm, which is advisor to several large FIIs, said, "In the short run, there will be portfolio re-alignment by those funds which are short-term investors as there will be no problem for long-term investors since there is no long-term capital gains tax in India. However, still there has to be more clarity on the issue. Also, while India has a DTAA with several other countries, the terms may differ from those with Singapore," he said.
However, after the implementation of the direct tax code, which is likely next year, all the income of FIIs from the purchase and sale of securities will be taxed under the head ‘capital gains’. Experts say still it is beneficial for FIIs as those who showed their income from the securities market as business income can claim exemption.
While income from equity derivatives was considered as business income, for certain FIIs (who are investing from countries with which India has a DTAA), income from any equity investment is business income if they do not have any permanent establishment in the country and provide a commercial justification for their investment income. Most FIIs operate with tax and legal experts' office addresses in India.
While FIIs investing from tax havens are completely exempted from capital gains tax, major US and UK-based pension and mutual funds claim their gains are business income and exempted from any tax. By the double taxation avoidance agreement (DTAA) with countries like the US and the UK, the business income of FIIs was exempted from tax in India, as it was paid in their home country. Experts say the government's move to revisit the DTAA with Mauritius alone may have more to do with the abuse of the treaty by large corporations rather than any other reason. "The issue seems to be more about the abuse of tax relief through Mauritius. So, only the incremental flow would be affected for a short while until there is more clarity on what the government exactly wants," said Gubbi.
Why was Mauritius important for fund flows into India till now?
Experts say until recently, every fifth FII dollar coming into India came from the Mauritius route. FIIs have had the tradition of routing money through Mauritius for the past 13 years as it was among the first few countries with which India signed a DTAA. Mauritius enjoys an advantage over other tax havens like Cyprus and the UAE on account of better infrastructure. FIIs set shop there as the regulatory clearances in Mauritius move at a faster pace than its peers.
The list of FIIs that have preferred to invest in India via Mauritius includes Aberdeen Asset Management, Citigroup Global, CLSA Merchant Bankers, Deutsche Securities, Emerging Markets Management LLC, Fidelity Assets Management, Golden Sachs Investments, HSBC Global Investment, JP Morgan Fleming Asset Management, Merrill Lynch Investment Managers and UBS Securities Asia. These FIIs have set up their equity funds in Mauritius, where the government does not levy any tax on capital gains.
