Magazine issues » Autumn 2015

INDIA: The Mauritius factor

MauritiusAs one tax dispute is clarified in India, fund managers wonder if the next battle will be over the country’s double taxation agreement with Mauritius. George Mitton reports.

Much of India’s tax system dates from the socialist period that followed independence in 1947. Since then, governments have sought to make the system more business-friendly by introducing exemptions, loopholes and other tax breaks. The result is a complex if not confusing system in which foreign companies sometimes find themselves slapped with unexpected bills.

This is what happened to Vodafone in 2012, when it was charged with more than $2 billion in back taxes (a demand the Indian Supreme Court later quashed). It happened again, to oil exploration firm Cairn India, in March 2015. The tax authorities say Cairn India, which is now owned by UK-based Vedanta Group, owes $3.6 billion for a transaction that occurred in 2006-07.

The good news is those foreign portfolio investors can relax – the government has stepped in to say they won’t have to pay backdated taxes. However, the episode has caused concern among many investors that the battle to define India’s tax rules isn’t over. There could yet be more conflict and more litigation, especially over the double taxation avoidance agreement with Mauritius that allows investors to avoid paying capital gains tax in India.Foreign portfolio investors have been hit too. In April 2015, it was reported than about 100 offshore funds had been given tax notices estimated at $5-6 billion for “untaxed gains” in previous years. One firm, Aberdeen Asset Management, took its case to the Bombay High Court.

The recent tax notices sent to Aberdeen Asset Management and others concerned India’s minimum alternate tax (Mat) and an ambiguity in the law that made it unclear whether this tax was applicable to foreign portfolio investors or not (see box ‘Game, set and Mat?’).

The matter seems to have been settled thanks to an inquiry led by Justice AP Shah, which recommended that Mat not be applied to foreign portfolio investors. 

“Providing certainty in tax law is the function of the government. The ambiguity required to be clarified, so we have done it,” said Indian finance minister Arun Jaitley at a press conference, adding that the government would amend the necessary law in the winter parliamentary session. India box

That’s that, then. Except that anyone who followed the case can see there are still unanswered questions with regards to India’s tax approach to foreign investors. The key one is over the status of Mauritius.

Before continuing, it’s worth examining a positive step made earlier this year by the government of Narendra Modi, whose party, the Bharatiya Janata Party (BJP), was elected last year by a landslide. After campaigning on a pro-business platform and promising to do away with what his party called “tax terrorism”, Modi’s government made a welcome move to harmonise tax treatment for onshore and offshore investors in a set of new rules, effective as of April 2015.

The rules say no investor pays capital gains tax on equity trades if the securities are held longer than 12 months. If they are held less than 12 months, capital gains are taxed at 15%. The treatment is the same for offshore and onshore investors.

“Modi has made it clear for stakeholders what India’s situation is,” says Ajay Tyagi, fund manager at UTI International, the global division of Indian asset manager UTI. “He has given a level playing field for foreign portfolio investors. There is clarity.”

The rules ought to end what had been a grey area in Indian tax law, in which foreign portfolio investors were sometimes taxed as if their capital gains were business income. 

Now, they will pay short-term capital gains tax only, just the same as onshore funds.

So far, so good. Except, the problem with this situation is that many offshore Indian funds will not, in fact, pay tax on their short-term capital gains because they are domiciled in Mauritius, which has a longstanding double taxation avoidance agreement (DTAA) with India.

The Mauritius DTAA dates back to 1983 and ensures that Mauritius-based entities that do business in India pay tax only in Mauritius. There is zero capital gains tax in Mauritius, which means foreign portfolio investors that domicile their India funds there can escape the tax entirely.

Naturally, asset managers have favoured the small island for domiciling India funds. So have all manner of investors into India. It has been estimated that 40% of India’s foreign direct investment comes in via Mauritius. (Singapore accounts for another sizeable chunk.)

The so-called Mauritius route is controversial, though. Not only is there aggravation in India that Mauritius-based entities are avoiding tax, there is a widespread belief that unscrupulous people are using Mauritius to channel their ill-gotten gains, or so-called ‘black money’.

It is frequently reported in the Indian press that some wealthy Indians use Mauritius to route black money back into the country. For its part, Mauritius insists it meets good standards on anti-money laundering and has its own unit, the Financial Intelligence Unit, to prevent this form of crime.

It seems clear the DTAA with Mauritius frustrates Modi’s efforts to provide a level playing field for foreign portfolio investors. As it stands, a fund domiciled in, say, Ireland will pay tax on short-term capital gains in India while a Mauritius-domiciled one will not.

How much longer will this imbalance exist? Tyagi, of UTI International, thinks not long. His firm decided to domicile its most recently launched fund in Dublin instead of Mauritius.

“It’s important for investors to understand that the Mauritius DTAA is under a lot of scrutiny,” he says. “After a couple of years, the Indian government may say the DTAA is too loose, has led to tax evasion, and ends the treaty.”

He adds: “Some investors will continue to come though Mauritius. It could take two, five or ten years, and, while the DTAA stays alive, they will not pay any tax, but this is a loophole that could be plugged some time in the future.”

There is good reason to think there may be some movement on the DTAA. Indian and Mauritian officials are reported to be in talks to renegotiate the treaty. 

That said, they have been reported to be in talks for four to five years. It seems likely that something will happen, but no one is sure when.

Another law exists that could complicate matters: the General Anti-Avoidance Rule (GAAR). The GAAR was signed into law by the then finance minister, Pranab Mukherjee, on March 16, 2012. The government at the time wanted a law to help it claw back what it said was lost tax revenue. It was signed into law only two months after Vodafone won its bid to avoid a tax bill of $2 billion.

The GAAR was designed to counter aggressive tax avoidance schemes. It allows tax officials to deny tax benefits if a deal is found to have taken place without commercial purpose other than tax avoidance. The GAAR also allows officials to deny the benefits of tax treaties if they are being used to avoid taxes – a highly relevant fact for Mauritius-based funds.

It is a powerful piece of legislation, albeit one that has been criticised in some quarters for being anti-business and in others for containing ambiguities. The catch is that the GAAR has been repeatedly postponed since it was first introduced. In his budget presentation this year, Jaitley, the finance minster, postponed it again, until 2017.

It is possible that the GAAR will be put off once more, perhaps even delayed indefinitely by politicians nervous of harming India’s economy. But fund managers cannot assume this. Some Mauritius-based funds may soon need to justify their choice of domicile to avoid being hit by taxes.

How would a tax demand work under the GAAR? “The tax authorities will have to establish the reason for coming through Mauritius was to gain tax benefits – that there was no commercial justification,” says Pritin Kumar, a partner at Deloitte Haskins and Sells. The authorities may try to prove the Mauritius-based entity was a brass-plate-type organisation and not, say, a genuine commercial outfit employing staff. Deciding on these cases will be a job for the courts.

“There will definitely be some litigation going forward in relation to the GAAR,” says Kumar. “That is expected.”

He adds that the GAAR may encourage some asset managers to consider domiciling their funds away from Mauritius. If they cannot claim they chose to domicile in Mauritius for commercial reasons, they may be liable for a tax bill that would wipe out any benefits gained under the DTAA.

Kumar says the GAAR would almost certainly be forward-looking. “Existing investments would be grandfathered,” he says. Nevertheless, the law could be highly effective at increasing Indian tax revenues.

One of the reasons given for delaying the GAAR is that India is working with the Organisation for Economic Co-operation and Development (OECD) on a project to tackle base erosion and profit shifting (BEPS), which refers to the effect of tax avoidance strategies by multinational organisations.

For India, the key part of the BEPS action plan is point six, which is designed to tackle treaty abuse. According to the draft, the OECD wants to include anti-abuse rules in tax treaties to prevent persons or funds exploiting treaties to avoid tax. 

“India is an active participant in these discussions,” says Kumar. “India would like to align its GAAR with point six of BEPS.”

It is unclear how and when the GAAR will be synchronised with BEPS. There is always the chance that any decision will be delayed. Having complained about “tax terrorism” in his campaign, Modi will not want to be associated with an initiative that is seen as a tax grab. That said, the thinking behind the BEPS project betrays more than a hint of common sense, and in a world still recovering from the financial crisis of 2008-09, there is significant political will behind the project to clean up global tax standards.

Asset managers would be wise to monitor the Mauritius DTAA. Perhaps a renegotiated version of the treaty will not be so generous to offshore funds.

©2015 funds global asia

Industry comments

Investing in tomorrow’s world

investmentAt times like these, HSBC Asset Management easily pivots towards emerging markets.

The spotlight on growth markets and the need to be nimble and dynamic is ever-sharper, given the difficulty in predicting monetary policy in the world’s major nations.

Sponsored feature: Navigating the complexities of FX execution and currency risk

A comprehensive, cost-effective, and transparent currency overlay hedging solution is crucial to mitigate FX exposure risks in the complex landscapes of Japan and China's FX markets, explains Hans Jacob Feder, PhD, global head of FX services at MUFG Investor Services.


Asia credit: An outsized winner in the region’s energy transition?

Ross Dilkes, fixed income portfolio manager at Wellington Management, examines the opportunities and risks for bond investors presented by the region’s decarbonisation agenda.

A quiet revolution in Japan’s corporate governance

revolution, Japan, corporate governance, Shareholders, corporate, governance, standards, improvement, Tetsuro Takase, SuMi TrustShareholders in Japan no longer accept below-par corporate governance standards. Changes are taking place, but there are still areas for improvement, says Tetsuro Takase at SuMi Trust.

Why rising demand for healthcare is creating investment opportunities in China

rising demand, healthcare, investment, opportunities, China, Robert St Clair, Investment Strategy, Fullerton Fund ManagementRobert St Clair, head of investment strategy at Fullerton Fund Management, explores the reasons investors should be paying attention to the rising demand for healthcare in China.

Why take advantage of the recent dip in China’s internet sectors

advantage, China, internet, market, OctoberChina's internet market presents one of the most compelling long-term growth potentials for investors today, given the catalysts supporting the sector from both macro and fundamental perspectives, explains Dr Xiaolin Chen, head of international, KraneShares.

Executive Interviews

Executive interview: PGIM CEO on where the ESG flowers should bloom

Sep 27, 2021

David Hunt, president and chief executive of PGIM, tells Romil Patel about leading a top 10 global asset manager in times where “empowering and encouraging the kind of investment decisions as...

Executive interview: Nicolas Moreau’s orderly transition

Jul 12, 2021

Nicolas Moreau, CEO of HSBC Asset Management, is moving to Asia as the firm looks to connect more directly with the region’s growth story. ESG is also a key focus – including the ‘just’ carbon...


India: An “obvious choice for global investors”

Jun 22, 2023

Funds Europe, the sister publication of Funds Global Asia, hosted an India investment discussion with two seasoned experts and asked if India is the ‘last one standing’ from the Brics phenomenon. We also hear that for India, the inclusion of Indian bonds in a major index may not be the desired...

Roundtable: Singapore comes of age as an Asian ESG hub

Dec 01, 2021

Strong ESG credentials strengthen the case for Singapore as a leader in Asia of the post-Covid recovery. Our panel discusses the risks and opportunities.