Indo-Mauritius pact may lower tax on interest income from bonds

MUMBAI: Mauritius, which serves as the gateway to Dalal Street for most foreigners, will be back in news soon. India and the tax haven are believed to be close to finalising a revised tax treaty that would lower tax on interest income of overseas investors betting on Indian debt papers. The move could make Mauritius as attractive a destination as Singapore for investors putting money in Indian debt securities.

The revised treaty, however, would lay down new conditions that investors would have to fulfil. Better known as “limitation of benefits” (LoB) in international tax parlance, it could require investors to spend a certain amount every year in Mauritius for enjoying tax benefit, two persons familiar with the negotiations told ET.

The move could temporarily impact inflow of foreign money into Indian securities as the terms of LoB may put off many non-serious players and make round-tripping of money tougher. Non-resident investors coming in through Mauritius pay no tax on their capital gains on equity investment. But the double taxation avoidance treaty is silent on interest earnings from rupee debt securities like bonds and non-convertible debentures which attract significant foreign inflow due to higher yields. Thus,the applicable tax on interest income could be as high as 41% for foreign investors after June 2017 when the period for lower withholding tax comes to an end.

At present the withholding tax – the tax that a company floating debt securities deduct before remitting the interest amount to foreign investors – is as low as 5%. “But this will end in 2017. That’s when India will also have to take a call on GAAR. I understand both Mauritius and India would like to put in place a stable treaty that would be investor friendly as well as minimise concerns and allegations related to treaty shopping,” said one of the persons.

GAAR, or General Anti-avoidance Rule, which the Indian government pushed back till 2017 following sharp reaction in the stock market, requires investors to have a substance – and not merely a post-box or “brass plate” presence – in tax havens like Mauritius (which has tax treaty with India) to obtain tax exemption. Compared to GAAR, which keeps the definition of ‘substance’ unclear and leaves it to the interpretation of tax officials, LoB is a specific anti-avoidance rule. It clearly states the conditions a foreign portfolio investor has to meet to avoid tax.

Since GAAR cannot be scrapped or postponed beyond 2017 without amending the law, Mauritius and India are keen to revise the treaty.

“The LoB clauses could slow down inflow for some time but many equity and debt investors would welcome it. Today, investors with tax residency certificate can avail treaty benefits… Also, for investors in debt, Mauritius would emerge as a strong alternative to Singapore where the withholding tax is capped at a lower level. Other treaty countries for investors in Indian rupee debt are The Netherlands and Cyprus. The former is expensive while the latter has become a more uncertain destination following the financial turbulence,” said a senior securities lawyer.