India’s decision to amend its tax treaty with Mauritius allowing for the taxation of capital gains tax on investments channelled through Mauritius is likely to lead to short-term nervousness in the equity market and an eventual churn in investments held via participatory notes or P-notes.
In the long term though, most see the government’s decision as a positive.
“Any volatility or nervousness in the market will only be a temporary reaction,” said Ajay Bodke, chief executive officer and chief portfolio manager (portfolio management services) at Prabhudas Lilladher Pvt. Ltd.
“The long-awaited measure would bring in much-needed transparency and check tax evasion as well as round tripping. Genuine foreign investors would wholeheartedly welcome this measure which is in consonance with the worldwide revulsion against tax evasion. By grandfathering all investments made before 1 April 2017, the government has allayed all concerns on capital gains tax of existing investments by foreign investors,” he added.
Brokerage house Motilal Oswal, in a note on Wednesday, expressed a similar view, and said that the change is a step in the right direction as it paves the way for a clear and well-defined tax regime.
The immediate reaction on the market, however, was negative. Sensex recovered 220 points, while Nifty recovered 60 points, on Wednesday morning. At 9.30am, Sensex was trading at 0.54% or 138.15 points to 25,634.38, while Nifty fell 0.6% or 47 points to 7,840.80. In intra-day trade, Sensex fell as much as 1.41% or 363.29 points and Nifty fell as much as 1.36% or 106.90 points.
In the near term, there will be a knee-jerk reaction and our market will decline,” said Dipen Shah, head of private client group, research, Kotak Securities Ltd. “One needs to evaluate and assess the flows coming from the companies in Mauritius which may not pass the bonafide test. However, the dust will settle soon as the impact is not retrospective. The investors, going ahead, will give more importance to the fundamentals of the Indian market, rather than tax benefits,” Shah added.
Impact on P-note flows
More than two-thirds of investments through P-notes or offshore derivative instruments (ODIs) come via Mauritius and Singapore, both of which will now get taxed for short-term capital gains, starting 1 April 2017. Investments made before that date will not be taxed by the Indian authorities.
Some 36.5% of the total ODIs have been channelled through Singapore and 30% through Mauritius, according to a 30 March report in Mint.
P-notes are instruments issued by registered foreign portfolio investors (FPIs) to overseas investors, who wish to invest in Indian stock markets without registering themselves with capital markets regulator Securities and Exchange Board of India (Sebi).
According to experts, these flows will get redirected.
“Flows from Mauritius are definitely going to be impacted because of this move. Companies and individuals who used to invest via Mauritius may prefer to come directly with the treaty benefits gone. Additionally, this move will make P-notes less attractive as it is costlier than registering as an FPI. Smaller players who are less compliant may continue to do so but bigger players may prefer to register with India directly,” said Rajesh Gandhi, partner, Deloitte Haskin & Sells.
Impact on PE/ VC investments
There could be some impact on private equity and venture capital investments as well. Sector experts say the provisions of the treaty could accelerate investments in the current year as the tax impact kicks in only for investments made after 1 April 2017. Investors who have been sitting on the fence might consider accelerating their investments, given that they have 11 months before the rule kicks in.
Start-ups and companies, which are heavily dependent or seeking foreign investment, may register abroad to avoid tax implications for investors, rather than receiving funds routed through these geographies.