Firing yet another salvo in its fight against back money stashed abroad in safe haven jurisdictions, Modi – government revised on May 10, 2016 India’s Double Taxation Avoidance Agreement [DTAA] with Mauritius that now provides for withdrawal of exemption from tax on capital gains made by investors from alienation/sale of shares of Indian companies.
The investors from Mauritius have been enjoying this exemption on their equity investment in India for over 3 decades under the extant DTAA [it was signed in 1983]. Juxtaposed with the fact that they don’t pay tax on such income in that country also [courtesy, a highly liberal taxation and eco-system therein], they had a prolonged “honey moon” period almost eternally.
The dispensation was so attractive that even persons/companies resident in India could not resist the temptation of exploiting it to their advantage. So, they would send their money to Mauritius [and other similar jurisdictions like Singapore] only to bring it back either as foreign direct investment [FDI] or portfolio investment. The practice is euphemistically described as “round tripping” in common parlance.
The money moved abroad could be legitimate viz., surplus from business activity after paying taxes or even black money i.e. income on which no tax is paid here. It may even be bribe money taken by a government official as quid pro quo for favour granted to a private entity. The DTAA has thus been abetting an unhealthy practice [albeit indirectly] of incentivizing indulgence in corruption.
All of this led to massive surge in investment from this tax haven. Of total foreign inflows US$ 278 billion that came to India during 2000-2015, one-third was from Mauritius alone. During April-December, 2015 however, of total FDI US$ 30 billion, 20% came from Mauritius while one-third came from Singapore [the reduction may have to do with investors factoring in Modi – government’s moves to conclude amendments in the agreement on fast track].
Similar attempts made in the past to remove the preferential treatment of investors from Mauritius were nipped in the bud by vested interests – both within [including the so called “round trippers”] as well as from outside. But, Modi has taken the bull by the horn and deserves accolades for successfully consummating the re-negotiation process that was pending for for nearly 2 decades.
Under the new architecture of DTAA, any investment in shares by an entity from Mauritius from April 1, 2019 onward will be subjected to the same rate of tax on capital gains as applicable to the domestic investor viz., 15% for listed companies and 40% for un-listed companies. However, all existing investment in shares by such entities will continue to enjoy exemption from capital gain tax; in other words, these will be “grandfathered”. This is in sync with government’s commitment that it will not make any retrospective change in the laws.
The government has also moved a step ahead of times by giving investors a smooth transition period to plan their strategies for the future. Thus, all investment in shares made during 11 months till March 31, 2017 will also enjoy exemption as per pre-revised agreement. This is to care off even those who had planned and finalized their financial commitments but not executed as yet or are in the process of executing.
For investment made during April 1, 2017 to March 31, 2019, investors from Mauritius will pay 50% of applicable tax for domestic investors i.e. 7.5% for listed equities and 20% for un-listed . However, this is subject to their fulfilling the LOB [limitation of benefit] criteria which requires that the entity should have operational expenses of Rs 2.7 million
(Mauritian Rupee Rs 1.5 million) in the immediately preceding twelve months. The objective behind imposing this condition is to give concession only to serious players avoiding fly-by-night operators who open shell/conduit companies only to take advantage of the tax arbitrage.
Interestingly, investments from Mauritius in other Indian securities such as exchange-traded derivatives and convertible or non-convertible debentures would remain exempt in India from capital gains tax even after April 1, 2017. In case however, convertible instruments are converted in to equity then, they will loose exemption if the option is exercised after
April 1, 2017; in case it is done before then, this will be grandfathered.
The above dispensation is of course subject to the General Anti-Avoidance Rules (GAAR) that kicks in from April 1, 2017 [the government has made it abundantly clear, there won’t be any further deferment]. GAARs are designed to check tax avoidance for investments by entities based mainly in overseas tax havens.
The DTAA with Singapore [signed in 2005] runs co-terminus with tax treaty with Mauritius. As per Article 6 of the protocol, the capital gains exemption under the former would remain in force only till the time latter provides for capital gains exemption on alienation of shares. Now, that exemption under treaty with Mauritius has been withdrawn, automatically investors from Singapore too will loose the exemption from April 1, 2017.
As regards, grandfathering of existing investment until March 31, 2017 and concessional tax [50% of applicable tax on capital gains to domestic investors] on investment made during April 1, 2017 to March 31, 2019, the government should initiate the process of incorporating these into the Singapore Tax Treaty as well. This would provide a level playing field for investments, and avoid arbitrage between jurisdictions.
Having made a good beginning with Mauritius/Singapore, the government should now seek amendment in tax treaties with other jurisdictions. For instance, the extant treaty with Netherlands provides that if a company based therein holds less than 10% equity in an Indian entity, it would not attract capital gains on the sale of those shares to residents or non-residents. Even if it were to own more than 10% equity in an Indian company, the treaty allows it to sell the shares to a non-resident without attracting tax.
All such agreements should be redone within a tight time frame otherwise we would run the risk of forfeiting the gains from tweaking the Mauritius/Singapore accord as then, the transfer of black money and “round tripping” will continue unabated; only the base for conducting such dubious transactions and money laundering would change.
As finance minister, Arun Jaitely has argued the objective of plugging loopholes in tax treaties is two fold viz., (i) shut all avenues for stashing black money abroad and (ii) attract foreign investment on the strength of our economic fundamentals. That the government is well on its way to fulfilling both these objectives is clearly reflected in its actions on the ground.
Indeed, it is strong rebuff to Modi’s opponents who like a child in play school keep asking “where is Rs 15 lakh in the bank account of each citizen” oblivious of his action on multiple fronts not merely to bring back the black money lying in safe havens but also curb its generation.