Tropical Mauritius is no longer quite so comfortable for investors routing money into India through the island nation.
The two sides have reworked their tax treaty to close a popular loophole that allowed investors to use the tiny country to skirt levies on capital gains made in India. The pact was about three decades old.
In the past, any whiff of such change caused gyrations in India’s markets because so much money has come into Asia’s No. 3 economy via the agreement. But the response this time was far more muted, pointing to an oh-so-rare phenomenon: an Indian tax overhaul that doesn’t spread terror.
The revised rules will phase out benefits gradually after March 31, 2017, according to a May 10 statement, but spare investments made before the deadline. It’s the latest step in something of a global crackdown on tax havens. Prime Minister Narendra Modi is also seeking to increase the tax take in India.
“This was anticipated in the backdrop of the general global negativity around tax treaty abuse,” said Ketan Dalal, senior partner at PricewaterhouseCoopers India.
Q: What’s changed?
A: India signed a treaty with Mauritius -- a friendly nation with a significant Indian diaspora -- in the early 1980s to avoid double taxation and promote trade and investment. Officials back then didn’t foresee India becoming a $2 trillion economy and a magnet for inflows looking for the lowest-cost and easiest way in.
The nations said on May 10 that they are amending the pact so that India gets the right to tax short-term capital gains. The new regime starts from April 1, 2017. Companies routing funds into India through Mauritius from then on will have to pay short-term capital gains tax at half the rate prevailing during a two-year transition period. The levy is currently at 15 percent. The full rate applies from April 1, 2019.
But note that there’s no capital gains levy on investments held for over a year.
Q: Who gains and who’s hurt?
A: India may gain tax revenues, while Mauritius may lose some of its financial sheen. Still, the changes bring clarity and certainty, according to Mukesh Butani, managing partner at BMR Legal. Mauritius-based investors such as participatory note issuers, private equity funds and holding companies may have to reconsider their tax costs, according to Nishith Desai Associates. Ernst & Young said the phased transition avoids disruptive changes.
Q: What are the ripple effects?
A: The Mauritius adjustment may trigger a similar amendment in India’s tax treaty with Singapore, India’s Revenue Secretary Hasmukh Adhia said in a Twitter message. The treaty with Singapore will have to be renegotiated after which talks with Cyprus will follow, Economic Affairs Secretary Shaktikanta Das told Bloomberg TV India.
Q: What does it mean for foreign fund flows into India?
A: Depends who you ask. There could be a flurry of investments before March 31 next year to capture the window for tax exemption, Khaitan & Co. predicts. On the other hand, Nishith Desai Associates expects a significant impact on inflows.
Q: Why did Mauritius go along?
A: A global push to ensure companies pay their fair share of tax weakened the island’s initial reluctance. India will also be implementing laws to check tax avoidance next year, making the loophole in Mauritius less tenable.
Q: What does the episode show?
A: That after officials began opening up the economy in the 1990s India’s rapid expansion outstripped bilateral agreements struck in a more austere era. About a decade after signing the Mauritius treaty, India began saying it wanted to review the pact due to changes in the global economic environment and domestic tax laws.