Indian markets have been moody in 2011 with a steady inflow of gloomy news and no disruptive positive sentiment. Recent news of a possible amendment in the Double-Tax-Avoidance Agreement (DTAA) with Mauritius to tax capital gains in India spooked the markets. A majority of the foreign investment that has nurtured and groomed the Indian markets for some time now flowed in from Mauritius-based entities. Mauritius has always been soft on tax-payers and has special clauses in DTAAs with different tax jurisdictions.
The sticky clause
The DTAA with Mauritius was inked 28 years ago. Article 13 of the India-Mauritius DTAA elaborates on Capital Gains. Gains from alienation of immovable property are taxed in the country in which the property is located. Movable properties that are a part of the fixed base or permanent establishment can be taxed in the other contracting state. Alienation of ships and aircraft and property and movable property linked to them are taxed only where the effective management is situated.
It is the residual clause that is sought to be amended — this clause states that apart from the above, all other gains derived by a resident of a contracting state shall be taxable only in that State. Most foreign institutional investors (FIIs) are registered and thereby resident in Mauritius.
The Income-Tax Act, 1995 of Mauritius does not tax capital gains save when immovable properties are alienated. The combined reading of these laws ensures that FIIs do not pay any capital gains tax on their earnings when they ply their trade on the Indian bourses.
Round-tripping
The line that separates tax planning and tax avoidance is a blur. The Mauritian tax structure encouraged consultants to innovate a practice called “round-tripping”— using the tax holiday advantage in Mauritius to take money out of India only to bring it back disguised as foreign investment. The money is routed through firms set up in the tax haven.
To ensure that there are no instances of such round-tripping, the Financial Services Commission (FSC) of Mauritius, the regulator which supervises non-banking financial services sector and global businesses, has carried out reforms in the Financial Services Act.
Resident corporations proposing to conduct business outside Mauritius would have to apply to the FSC for a global business licence. Though there are no restrictions on any business activity, the FSA now specifically mentions that a licence will not be granted, or would be revoked, if found that the activity is unlawful and causes serious prejudice to the good repute of Mauritius as a financial services centre.
Global business companies (GBC) would have to now compulsorily hold board meetings in Mauritius, have at least two resident directors in Mauritius, and maintain their principal bank account and carry out their auditing in Mauritius.
The Articles on Capital Gains in the DTAAs with both the US and the UK state that “except as provided in Article 8 (Air Transport) and 9 (Shipping) of this Convention, each Contracting State may tax capital gains in accordance with the provisions of its domestic law”.
Considering the cloud of doubt that has always surrounded Mauritius and taxation, a similar clause may well be included in the DTAA with Mauritius. Clause 51(2) of the Direct Taxes Code provides for an exemption for equity shares or units of mutual funds that are held for more than a year and are subject to securities transaction tax. Such assets held for less than a year are entitled to a 50 per cent deduction.
If the DTAA is amended on par with the treaties with other jurisdictions, Mauritius-based FIIs would have to start planning for taxes on capital gains.
There has been litigation over whether the income of FIIs would qualify as business income. The 2009 version of the DTC had proposed that domestic legislation would take precedence over international tax treaties. The 2010 version has reversed this though general anti-avoidance rules (GAAR) have been retained.
Whichever way one looks at it, days of free lunch for FIIs in India appear to be coming to a close.
(The author is a Bangalore-based chartered accountant.)