Revised tax treaties usher in a new era in investment, taxation

• Policy tweaks  curb evasion,  show  India  can woo investments without  sops
• Singapore, another major FDI contributor to India, too, enjoyed the same tax sops under a similar treaty with India

NEW DELHI: For about a decade-and-a-half, revenue authorities examining foreign investment proposals received by the erstwhile Foreign Investment Promotion Board (FIPB) had a big headache—a large part of it came from companies set up in Mauritius. Many of these were ‘letter box’ entities in Mauritius through which millions of dollars of investment flowed into India and whenever investors exited, their gains were taxed neither in India nor in the island nation.

India’s worries were on two counts. One, the treaty notified in 1983 for avoidance of double taxation and prevention of fiscal evasion with Mauritius had resulted in double non-taxation after India opened up its economy in 1991. Second, suspicions that funds that escaped taxation in India may have been laundered abroad and were making its way back to India through Mauritius-resident entities in the guise of foreign direct investment (FDI). This came to be known as ‘treaty shopping’.

After a decade of negotiations, the radical change in the treaty came in 2016, allowing India to tax any capital gain that Mauritius-resident firms made in India. A two-year transition period was given to investors to adjust to the changes. The revised tax treaties curb tax evasion and indicate that India has fundamentals strong enough to attract investments without tax sops.

The impact
Singapore, another major FDI contributor to India, too, enjoyed the same tax sops under a similar treaty with India. Since the tax concessions in the treaty India had with Singapore were co-terminus with those in Mauritius, the changes impacted investments from the city state, too. After a two-year transition period starting 1 April 2017 during which capital gains arising from all investments into India from Mauritius and Singapore were taxed in India at half the rate, these investments have become fully taxable from 1 April 2019.

Experts said investors have now learned to live with the treaty changes and one thing that matters to them a lot was certainty in tax matters.

“Amendment to the two treaties laid to rest two aspects. Firstly, grandfathering of pre-April 2017 investments and, secondly, taxability of investments thereafter,” said Jayesh Sanghvi, tax partner and national leader-international tax services, EY. All investments that have come in from companies set up in these two nations prior to 1 April 2017 are not subject to tax whenever they are sold. Sanghvi said that with the global efforts against erosion of tax base, the “space for non-taxation of income has significantly shrunk”.

Investors from Mauritius, however, have now developed a taste for Indian debt instruments, experts said.

Daksha Baxi, head, international taxation, Cyril Amarchand Mangaldas, said investment strategies of foreign portfolio investors and private equity investors have accordingly been altered. “A lot more focus on debt is seen as also global restructuring. The fear that investor interest in India would reduce has been belied,” said Baxi.

What the world is doing
National governments have in recent years been taking a strong position against aggressive tax avoidance by businesses by artificially shifting profits from the country where their economic activity takes place to low or zero tax jurisdictions.

India has been at the forefront of supporting the OECD effort to have a global regime of information sharing and best practices in taxation by amending all bilateral tax treaties nations have with one another by way of a multilateral treaty. India joined other countries in signing this multilateral agreement in 2017 that in one sweep changed India’s double tax avoidance agreements (DTAAs) with 93 nations including the ones with countries like Cyprus, Mauritius and Singapore, making them more foolproof.

To further tighten India’s ability to tax the gains and profits that non-residents make in India, New Delhi is now planning to change its foreign taxation norms under the proposed new direct tax code. One of the changes under consideration is to change the way officials attribute taxable profits to a non-resident enterprise operating in India without a subsidiary.