India on May 10 amended the 34-year-old tax treaty with Mauritius. After toiling for almost a decade to redraw the treaty, India will begin imposing capital gains tax on investments in shares through Mauritius from April 2017 onwards. The redrawn Mauritius treaty will trigger a similar amendment in India’s tax treaty with Singapore. Mauritius and Singapore accounted for $17 billion of the total $29.4 billion India received in FDI during April-December 2015.
Short-term capital gains tax will be levied at half the rate prevailing during the first two-year transition period from April 1, 2017 to March 31, 2019. Short-term capital gains are taxed at 15 per cent at present. The full rate will kick in from April 1, 2019.
After the announcement Sakshi Prashar of FinancialExpress.com asked a few questions to US-based foreign institutional investor Seth R Freeman, CIRA, CEO and Chief Investment Officer of EM Capital Management, LLC to know how the move will impact foreign institutional investments in India.
Q) What does the India-Mauritius tax pact mean for Indian equity markets?
Ans) For US Investors that are index based, it will not affect them as they must invest according to the index allocation. For active US Investors, they may invest more selectively as the impact of paying tax in India will reduce returns. I think the greatest impact will be on IPOs, where many are short-term investors and US Investors will incur short-term capital gains in India and US. This will reduce US investor participation in India IPOs.
Q) Will it impact foreign inflows in the long run?
Ans) The new tax amendment may reduce P-note investment and thereby reduce flows and growth in flows. Basically, investing through Mauritius is over for US equities investors. There is no longer any incentive to domicile in Mauritius. All US investors might as well become direct FIIs and FPIs and avoid all the costs associated with a Mauritius vehicle if Indian taxes need to be paid.
Q) Is the pact positive for Indian stock markets?
Ans) The only positive I can think of is that higher short-term tax costs for US may encourage long-term investing. This would be good for capital markets by reducing volatility and reducing hot-money.
Q) Will the amendment impact P-notes inflows in coming years?
Ans) The greatest impact will be on US Participatory Note (P-Note) investors for the same reasons as regular direct FII and FPI Investors. However, the reasons why P-note Investors use P-notes instead of registering with SEBI remain the same. Just, now they will incur tax payable in India for short term gains.
The FPI’s issuing P-notes will need a way to collect tax from their customers incurring short-term tax. The extra costs will be passed on as higher broker fees charged to P-note investors. These higher trading costs, plus the added tax costs, may reduce investment by opportunistic investors.