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Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

One thing investors have learned about India in the past four years, either from their own sorry experiences or from watching the government's high-profile disputes with Vodafone, Cairn, Nokia, IBM and Aberdeen Asset Management, is this: If the authorities in New Delhi come up with a rule, and it has the word ``tax'' in it, they might as well sell first and ask questions later.

So it was a pleasant surprise that the stock market chose not to get too bothered by India's announcement Tuesday night that it had managed to rejig a three-decade-old tax agreement with Mauritius, which foreign investors used to escape the short-term capital-gains tax of 15 percent that locals pay.

The changes mean that profits on shares bought after March 31 next year will be taxed for 24 months at half the domestic rate. From 2019, the advantage of investing via Mauritius will completely disappear. (The capital-gains tax is only on Indian shares or mutual funds held for less than a year.)

Mauritius Losing Out
Foreign direct investors in India now prefer to route their money via Singapore
Source: Reserve Bank of India/Bloomberg

Foreign investors have about $283 billion in Indian equities, of which $57 billion is from Mauritius. Only the U.S. portion, at $97 billion, is bigger.

Tiny Mauritius Is Big in Indian Equities
Top five sources of foreign portfolio investment
Source: NSDL
*Data as of March 31, 2016.

Upsetting the cozy relationship might sound like a bad idea, but it really isn't. For one thing, the new measures are far from draconian. Gains already accumulated won't be taxed, and a 7.5 percent levy for two years afterward will hardly be a showstopper. At worst, some venture-capital funds will have to tweak the way they control their stakes in Indian startups. Ditto for managers of existing structures that have been legitimately created to garner the tax benefit, such as JPMorgan's Copthall Mauritius Investment, which according to data compiled by Bloomberg owns $1.7 billion of Indian equities. Most such vehicles, however, are small. Deutsche Securities Mauritius, for example, has less than $62 million in Indian shares.

Besides, the logic of the tax increase is hard to fault. As long as it remains cheaper to invest in the Indian market from overseas, locals will have an incentive to move wealth out of the country illegally. Apart from abetting corruption, this round-tripping of capital adds to exchange-rate volatility. Closing the loophole is therefore a good start. 

Restricting the discounted 7.5 percent rate to companies that spend at least $40,000 a year in Mauritius will curb sham operators, if not completely eliminate them. Investing in India via Singapore requires companies to spend $146,000 in 24 months for them to avoid the short-term capital-gains tax.

What's more notable is that the Indian government managed to communicate its intention without causing a stock-market rout. That means one of two things: Either the plan really is an honest effort to flush dodgy money out of the stock market; or the devil is in the fine print, and nobody has quite grasped it yet. We'd all better hope it's the former.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net