India will levy capital gains tax on investments routed through Mauritius from April 1 next year, bringing down the curtains on a contentious three decade-old rule that allowed companies to bring in billions of dollars by paying negligible taxes.
The taxes on capital gains will apply to investments made from April 1, 2017 and will be imposed at 50% or half of the domestic rate until March 31, 2019, and at the full rate thereafter.
Investments made before April 1, 2017 have been “grand-fathered” and will not be subject to capital gains taxation in India.
The new rules, which are part of amended Double Taxation Avoidance Agreement (DTAA) signed between India and Mauritius, will effectively eliminate the incentive to route investments through Mauritius-based `shell’ or `conduit’ companies.
Under the new rules, only those companies that show that have spent a total of at least Rs 2.7 lakh in the previous 12 months in Mauritius will be eligible for a reduced capital gains taxes from 2017 to 2019, a finance ministry statement said.
The new rules will also likely apply to investment originating from Singapore as the bilateral DTAA with Singapore is directly linked through a specific clause with the Mauritius DTAA.
Singapore is India’s second-largest FDI source with 15.5% of the equity investments in the last 15 years originating from the South East Asian nation.
“Capital gains on shares for Singapore can also now become source-based due to direct linkage of Singapore DTAA Clause with Mauritius DTAA,” Revenue Secretary Hashmukh Adhia tweeted.
This could raise the tax outgo for thousands of companies forcing many to redraw their strategies.
It could hurt short-term foreign investor (FII) inflows into India, particularly from those whose investment strategies are guided by minimizing tax outgo.
This could pull down markets initially.
The government, however, expects that the new rules will remove ambiguity on tax rules and improve investment flow into India.
“The Protocol 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 and stimulate the flow of exchange of information between India and Mauritius,” a finance ministry statement said.
“It will improve transparency in tax matters and will help curb tax evasion and tax avoidance,” it said.
The earlier treaty allowed capital gains on Indian shares owned by a Mauritius company to be exempted from Indian tax.
A Mauritius-based company was simply taxed as per Mauritius tax laws that are extremely favourable.
As a consequence, Mauritius -- a small tropical island off the coast of Africa with 1.3 million population -- has emerged as the biggest tax haven for companies eyeing India, with hundreds registering in this country and allegedly indulging in “round tripping”-
India and Mauritius had signed the DTAA in 1983 and the tiny nation was also suspected to have become a safe dumping ground for black money of Indians, who used it to bring back undisclosed money into the legitimate financial system by avoiding taxes.
“With this change, the capital gains tax c oncession for investments from Mauritius into India gradually comes to an end,” said Girish Vanvari, National Head of Tax, KPMG, an audit firm.
“Further, this will also impact the similar benefit under the India- Singapore treaty. It will be interesting to see as to what impact this amendment will have on FPI/ FII investments into India eventually,” Vanvari said.