Tax residency certificates will do fine until GAAR

Written by fe Bureau | New Delhi | Updated: Mar 2 2013, 16:19pm hrs
GAARTax residency certificates will do fine ? until GAAR. (Reuters)
Mauritius-bases foreign institutional investors (FIIs) who have provided tax residency certificates (TRC) from the island nation do not face the threat of having to pay capital gains tax if they sell the listed securities they hold in India before the introduction of the General Anti-Avoidance Rules (GAAR), going by a clarification issued by finance minister Chidambaram on Friday afternoon. Once GAAR takes effect in April 2016, sale of FII investments made in listed securities in India after August 2010 will be subject to the rigorous anti-avoidance rules, even if TRCs are provided and are accepted as proof of tax residence. FII investments made prior to August 2010 will not be subject to GAAR for denial of zero capital gains tax, a benefit under the India-Mauritius double tax avoidance treaty.

Chidambaram clarified that the proposed introduction of a clause in the Income Tax Act saying TRC is essential but not sufficient for investors to avail of benefits under DTAA does not mean these certificates would be questioned. Market players had pointed out that the language in the proposed sub-clause could mean that the TRC could be questioned by the Indian tax department. The government wishes to make it clear that that is not the intention of the proposed sub-section (5) of Section 90, the minister said in a clarification.

TRC produced by a resident of a contracting state will be accepted as evidence that he is a resident of that contracting state and the Income Tax Authorities in India will not go behind the TRC and question his resident status, the minister said.

Besides tax residency, there are other parameters such as 'beneficial ownership' of the income generated by the assessee and 'limitation of benefits' that determine whether treaty benefits are available or not. However, since these considerations do not apply in the case of tax on short-term capital gains from sale of listed securities of Mauritius based entities, they will not have to pay 15% tax in India until GAAR is introduced in 2016, experts said. Capital gains tax evasion on sale of listed securities by Mauritius-based portfolio investors is considered an abuse of the India-Mauritius double taxation avoidance treaty. There is no recent estimate of the amount of tax foregone on this count.

Assessment of who actually is the beneficial owner of the income generated by a Mauritius-based entity, however, will be a parameter that will be applied along with tax residency to allow concessional tax rate on income from royalty and technical services rendered by the overseas entity, explained Amit Maheshwari, partner, Ashok Maheshwary & Associates. Interestingly, Chidambaram also proposed in his budget to raise the concessional 10% tax rate on such income to 25% in India's Income Tax Act from 2013-14. Chidambaram's idea is to deny any concessional tax rate in Indian laws that is lower than what bilateral tax treaties mandate. Assessees from Mauritius and Singapore will still have the option to claim a 10% concessional tax rate on royalty and technical service fees, while investors from US and UK will have to pay 15% tax as provided in the tax treaties India has with these respective countries.

Chidambaram had said in his post-budget press meet on Thursday that in case of income from interest, dividend and royalty, the person must be a resident as well as a beneficial owner to claim the benefits of the treaty. If you produce the TRC, that answers the question of residency. But you also have to separately prove that you are the beneficial owner. Everyone has to also satisfy the second condition (on beneficial ownership), wherever it applies, he had said.

Experts welcomed Friday's clarification. It is heartening to note that the intent of not going beyond the TRC for applying the tax treaty with Mauritius is cemented by Friday's circular, said Sudhir Kapadia, national tax leader, Ernst & Young. Ideally, when the Finance Bill is presented for passing in Parliament, the proposed amendment (to section 90) should be scrapped altogether as otherwise questions relating to other treaties like Singapore and Cyprus may still remain open to interpretation, he said.

The debate seems to have unnerved FIIs and the finance ministry seems to have reacted immediately to clarify that the proposed amendment will be reviewed and that it didn't intend to question or go beyond the TRC issued, said Mukesh Butani, chairman, BMR Advisors.