1. Tax pacts and India: Bye bye, treaty shopping

Tax pacts and India: Bye bye, treaty shopping

In May this year, when the government announced changes to the India-Mauritius Tax Treaty, everyone was taken aback by the timing, yet almost no one questioned why it was done.

By: | Published: November 22, 2016 6:20 AM
Similarly, while investors were happy that all existing investments were protected and no tax would be levied on capital gains on sale of shares already held in Indian companies, they were also ready to pay tax on a go-forward basis after the end of the two-year transition period. Similarly, while investors were happy that all existing investments were protected and no tax would be levied on capital gains on sale of shares already held in Indian companies, they were also ready to pay tax on a go-forward basis after the end of the two-year transition period.

In May this year, when the government announced changes to the India-Mauritius Tax Treaty, everyone was taken aback by the timing, yet almost no one questioned why it was done. Similarly, while investors were happy that all existing investments were protected and no tax would be levied on capital gains on sale of shares already held in Indian companies, they were also ready to pay tax on a go-forward basis after the end of the two-year transition period. These reactions reflected the deep desire of international investors to get clarity and certainty and to place a premium on these over tax exemptions.

It was only expected thereafter that India’s liberal tax-treaties with a handful of other jurisdictions would also follow suit, and the ones with Singapore and Cyprus were on the top of that list. Cyprus particularly has been a pain-point for investors because of the jurisdiction being tainted with the tag of a non-cooperative jurisdiction when it came to exchange of information, and this meant that investors were facing a penal 30% withholding tax on their income from India. The pain was exacerbated owing to most of the investments from Cyprus being in the real-estate sector that already had liquidity pressures; a high withholding tax was the proverbial last straw on the camel’s back. In this background, the July announcement that both countries had agreed to the renegotiated treaty was greeted with widespread cheer—not so much for the changes to the treaty per se, which were mostly on expected lines and mirrored the new Mauritius treaty, but because it talked of retroactively withdrawing the notification of Cyprus as a non-cooperative jurisdiction. After a long wait, finally, the new treaty was signed on November 18 and both sides issued a press release. Worryingly, the Indian side of the release makes no mention of the retroactive withdrawal of the notification, and if that were to be something that fell between the cracks, it would be a classic case of missing the woods for the trees. Investors remain edgy, waiting for the fine print.

The attention now shifts squarely to Singapore. Admittedly, that is perhaps a tougher negotiation because, unlike some of the other jurisdictions that could be accused of being conduits for investors from other countries, there has been significant investment from Singaporean companies itself. There is also the added angle of the Comprehensive Economic Cooperation Agreement that both countries had signed. While it is a clear expectation that the outcome will not be any different from what has been provided for Mauritius, the ask is clearly for something more. More in the form of a longer grace period for the capital gains exemption, and for a lowering of the withholding tax rate on interest to 5% from the current 15%. More than anything, it is the timing of the change that is now causing anxiety and, to some extent, annoyance to investors. Owing to the change in the Mauritius treaty, the capital gains exemption under the Singapore treaty automatically falls away on April 1, 2017, and hence, any more delay in laying down a path on how the new treaty will pan out only goes contrary to the stated position of the Government of providing clarity and doing it with time to spare.

All these developments are a strong signal of India’s position on bilateral tax conventions, emphasising transparency and exchange of information, grandfathering and providing status quo on existing investments and making treaty-shopping a thing of the past, entirely consistent with the global BEPS narrative. While we remain snowed under the weight of the massive GST reform, these changes to the treaty framework are equally landmark and will change forever the direction of foreign investment into India.

The author is partner (direct tax), PwC India. Views are personal

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