India and Mauritius signed a protocol this week which amends the tax treaty between the two countries and will allow India to tax capital gains on investments made onshore by companies registered in Mauritius.
The protocol will give India “taxation rights on capital gains arising from alienation of shares acquired on or after April 1, 2017, in a company resident in India,” the finance ministry said in a statement. Investments made before this date will not be subject to taxation.
Currently, investments are taxed in accordance with a double tax treaty signed in 1983 that allows companies making investments into India through Mauritius to only incur capital gains taxation in Mauritius. The rules have made Mauritius the biggest source of foreign direct investment into India, with 90 percent of foreign investment into India routed through the island nation, and a popular domicile for private equity funds.
There are a number of private equity firms actively investing in India. Everstone is currently investing its third India-focused fund, which closed last year with total commitments of $730 million. Last month, the International Finance Corporation (IFC), the World Bank’s private investment arm, also proposed to commit $40.6 million to Mumbai-based private equity firm Multiples Alternate Asset Management’s second fund, as reported by PEI.
According to the revised treaty, India will introduce a two-year transition period, between 1 April, 2017 and 31 March, 2019, where capital gains tax will apply at 50 percent of the domestic rate, after which it will increase to the full domestic rate. Currently, the rate of domestic tax in India is anywhere up to 40 percent, depending on the maturity of the investment.
Indian tax authorities have been seeking to make these changes for several years. Since it began its pursuit of hundreds of millions of dollars in back-taxes from Vodafone connected to the use of offshore structures and an outsourcing arm based in India, there has been continued uncertainty among managers and LPs regarding the direction of the anti-tax avoidance regime, as reported.
The amendment “will tackle the long pending issues of treaty abuse and round tripping of funds attributed to the India-Mauritius treaty, curb revenue loss, prevent double non-taxation, streamline the flow of investment,” the finance ministry said in the statement, as well as improve transparency in tax matters and curb tax evasion and tax avoidance.
The revision would also mean amending the tax treaty with Singapore, which is linked to the tax regime via the Mauritius treaty. Investments routed to India through Singapore are currently treated in the same way. As a result of the amendment, these investments may also be taxed in both countries.
If both treaties are terminated, it may impact which country firms decide to invest from and could result in them opting for countries that have lower tax rates, such as the Netherlands, which also has a double tax treaty with India, or opting to invest directly from where the fund is placed, said Yash Rana, Asia Chairman at Goodwin Procter.
In India’s recent budget, the Indian government proposed lowering the capital gains tax rate for foreign investors to 10 percent. However, it is unclear whether the proposal will go ahead.