Singapore beckons

International players looking to invest in India have preferred Mauritius, along with Singapore, The Netherlands and Cyprus to locate their holding companies. Topping the charts, Mauritius contributes a staggering 39 per cent to India’s foreign direct investment.

For long, revenue authorities have been persistently litigating capital gains tax related issues, especially in the case of investments from Mauritius. However, the proposed General Anti-Avoidance Rule and recent judicial pronouncements have begun to dramatically influence the above investment structuring patterns. The otherwise settled tax position for capital gains exemption under the India-Mauritius treaty is now a matter of widespread uncertainty and debate.

Consequently, many investors are now exploring the possibility of shifting their investments from Mauritius to Singapore. However, the relocation should be a carefully planned move, after evaluating the pros and cons.

To begin with, Singapore is viewed in a more favourable light than Mauritius. Statistically speaking, Singapore is a leading financial centre, a top logistics hub with one of the busiest ports in the world, and a top foreign-exchange trading centre after London, New York and Tokyo. These factors certainly add strength to its reputation and credibility.

Further, in terms of bilateral tax laws, the India-Singapore tax treaty contains a ‘purpose test’ and a ‘substance test’ to ensure that its beneficial tax provisions are not exploited by shell/ conduit companies. According to the ‘purpose test’, a shell/ conduit company is an entity with negligible or nil business operations, or with no real and continuous business activity. Further, the ‘substance test’ requires a resident to show a minimum annual spend of S$200,000 in Singapore in the 24 months immediately preceding the date from which the gains arise.

These checks confer on the India-Singapore tax treaty greater acceptability among revenue authorities as compared to the India-Mauritius tax treaty, which has no such ‘substance test’. Furthermore, there is a general belief that it is easier to build substance in Singapore — set up a full-fledged office, hire people, and make Singapore a hub for investments into the Asia Pacific region (such as China, Australia, Indonesia among others).

The moot question is whether this resolves the issue on hand — what is adequate substance? At present the guidelines are quite insufficient, unclear and untested. People are grappling with issues such as:

How many people should one hire?

What should the size of the Singapore operations be?

-Should you have individual Special Purpose Vehicles for each Indian investment or would you need a consolidated SPV for all investments?

Should the management company and the investment SPVs be one or separate?

What should be the proportion of Indian investments vis-à-vis the region?

What should one do with foreign institutional investors’ investments, foreign venture capital investments and so on?

So, what are people doing at the moment as far as new investments are concerned? To understand this, let’s categorise Indian investments into two kinds — strategic and financial. As far as strategic investments are concerned, many global companies have Singapore as their hub, and thereby have substance in Singapore. It makes immense sense for them to consider Singapore for acquisition/ investments into Indian companies. As far as financial investors are concerned, they are actively looking at setting up new funds/ investment vehicles in Singapore, wherein they are looking at pooling investors for investing in the Asia Pacific region. Further, they are looking at ways to build substance.

The story is a little different for existing investments. Are people rushing to transfer their existing investment from Mauritius to Singapore, especially before GAAR comes into force from April 1, 2013? The answer is very case-specific. For investments which are trailing the cost, there is a good case to transfer it to Singapore, wherein better substance can be built for future divestments. However, this has one drawback: If for some reason, the Singapore substance fails and the capital gains tax exemption is denied, then there will be cost base erosion in the computation of future capital gains.

For investments which are doing well and are above cost, there is an opportunity to transfer it to Singapore, get a higher tax base, and hopefully have better substance in future for capital gains tax exemption. The key risk here is that the gains on such transfers could be challenged by Indian authorities for taxation in India, denying the India-Mauritius treaty benefit, even though GAAR is not yet in place. Further, the transfer of foreign venture capital’s investments has its own set of limitations and challenges.

The need of the hour is careful planning and analysis. There is no one-solution--fits-all, and the ‘me too’ approach could be fatal. One has to keep an eye on the situation as it evolves before executing any irreversible step.

(Girish Vanvari is Partner, Tax, KPMG in India.)

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