A major challenge facing Modi – government in its fight against black money is so called ‘rounding tripping’ of Indian black money. The euphemism refers to money that leaves the country, often routed to non-resident Indians [NRIs] and making its way back to India in the form of foreign direct investment [FDI].
Until a few years ago, the extant policy and regulatory environment hugely facilitated ‘rounding tripping’. Thus, there was little regulatory oversight on money leaving and there were tax haven jurisdictions ever ready to attract it. The shell companies [albeit owned by persons to whom the money belonged] set up in those jurisdictions would then, invest in India fully leveraging benevolent tax treaties between India and those countries.
Under India-Mauritius double taxation avoidance agreement [DTAA], India granted tax exemption on capital gains made by investors resident in Mauritius [the definition of ‘resident’ was so generous that even post-box/shell companies were eligible] from sale of shares of Indian companies. Since, no capital gain tax is levied in Mauritius either, the income accruing from such gains escaped tax in both countries. The same dispensation applied to investors from Singapore.
The investment from these countries was made mostly in offshore derivative instruments [ODIs] or Participatory notes [P-notes in common parlance]. ODIs are instruments issued by foreign portfolio investors [FPIs] registered with Securities and Exchange Board of India [SEBI] against Indian stocks to overseas subscribers who themselves do not wish to get registered with the national regulator.
Though, the stated rationale for allowing investment through this route was to avoid hassles of extensive documentation and compliance that go with registration, its real intent was to offer a veil of secrecy to those [read round trippers] who were making such investment. No wonder, investment via ODI/P-notes reached a crescendo in 2007 when these accounted for 56% of total portfolio inflows.
To address the problem, since 2011, SEBI initiated a series of steps which on the one hand, simplified and rationalized process of direct registration and on the other, tightened norms for investment via P-notes. The national regulator exercised greater regulatory oversight over FPIs issuing such instruments. But, that did not help much in reining in such inflows.
This was because the root cause viz. veil of secrecy surrounding these instruments remained un-addressed. Unlike domestic investors who are subject to onerous Indian KYC [know your customer] norms, issuers/FPIs and subscribers of P-notes had only to comply with KYC norms of the jurisdiction where these entities are located [read Mauritius/Singapore].
What made the scenario even more gruesome was that even the issuer of ODIs/P-notes [read FPIs] was not expected to know their identity. This is because when the original subscriber sells to another person, he is under no obligation to inform the issuer about the transaction forget taking latter’s prior concurrence.
The situation was so pathetic that an Indian company won’t even know its share holding pattern viz., who owns how much? One can fathom a scenario whereby money launderer [or for that matter, a drug trafficker, smuggler, narcotic dealer, human trafficking etc] could end up having a controlling stake in an Indian company. This could even have serious security implications.
Modi – government has adopted a three pronged strategy to countenance the menace viz. (i) enactment of a law – Black Money [Undisclosed Foreign Income and Assets] and Imposition of Tax Act [2015]; (ii) tightening the norms for foreign investment via ODIs; (iii) revision in tax treaties with safe haven jurisdictions.
(i) Under the Act, a person having ‘undisclosed’ income and assets in a foreign country/jurisdiction will have to pay in addition to 30% tax, penalty equal to 3 times the tax or 90% and jail term up to 10 years. Failure to file returns of foreign income/assets or declare incorrect figures will also attract imprisonment up to 7 years in addition to tax and penalty. The offences cannot be compounded. This is huge deterrent to offenders wanting to stash money abroad.
As regards (ii), SEBI norms now subject subscribers of P-notes to same KYC norms as applicable to domestic investors. The KYC status of former has to be reviewed annually. The issuers will be required to report information reg their investment on monthly basis. The P-notes status has to be updated every six months. The original subscriber will be mandatorily required to seek prior approval of issuer before selling instrument to another person.
The issuer will also be required to ‘immediately’ inform to financial intelligence unit [FIU] as and when unusually high volumes of P-notes have changed hands. These instruments are not allowed to be issued to Indians, NRIs or Persons of Indian origins [PIO]. In short, amendments have sought to lift veil of secrecy around these instruments and bring clarity about the beneficial owners.
These amendments have made a salutary impact. SEBI has submitted a list of foreign fund houses that are found to have issued P-notes to Indian nationals, while it is probing several other suspected cases of NRIs/PIOs. It has also shared a list of investors who have parked large amounts of money, each worth over US$100 million, through these instruments.
As regards (iii), the DTAA with Mauritius was revised [May, 2016] to say that any investment in shares by an entity from that country from April 1, 2019 onward will be charged same rate of tax on capital gains as applicable to domestic investor viz., 15% for listed companies and 40% for un-listed. For investment made during April 1, 2017 to March 31, 2019, investors will pay 50% of applicable tax for domestic investors i.e. 7.5% for listed equities and 20% for un-listed . However, all existing investment in shares till March 31, 2017 will enjoy exemption as per pre-revised agreement.
In short, an investor based in Mauritius no longer enjoys preferential treatment vis-à-vis domestic investors in regard to taxation of capital gains made from investment in Indian companies. The tax treaty with Singapore has also been revised on same lines thus taking away the concession enjoyed by investors from that jurisdiction as well.
The strategy has paid off. A number of FPIs including HSBC and UBS have stopped issuing P-Notes. There was a drastic decline in outstanding values of the ODIs during October – December 2016. HSBC Bank Mauritius Ltd stopped issuing further ODIs and reported ‘nil’ outstanding values of ODIs as of December 31, 2016.
All of this has led to steep decline in the share of ODIs/P-notes in overall foreign portfolio investments in Indian markets from 56% in 2007 to less than 7% currently [accounted for mostly by Mauritius and Singapore] even as total inflows have scaled new highs.
More than changes in laws, treaties and norms, the key to virtual decimation of P-notes and hence, ‘round tripping’ is their strict and meticulous implementation/execution by national regulator and other investigative wings agencies of the government. Team Modi deserves accolades for bringing about this metaphorical change in governance.