With GAAR gone, tax treaty recasts in focus

Written by Sunny Verma | Bijay Shankar Patel | New Delhi | Updated: May 9 2012, 09:29am hrs
With the contentious general anti-avoidance rules (GAAR) out of the way for a year, the government will likely step up pressure on Mauritius to amend the treaty that allows firms claiming to be based in the island nation to escape capital gains tax in India.

Government officials and analysts said New Delhi will also make a serious attempt to nullify similar benefits accorded to investors from two other countries, Singapore and Cyprus. The government is aware that once the Mauritius treaty is whittled down, FIIs may start routing funds through Singapore or Cyprus.

A review of double taxation avoidance agreements (DTAAs) with Mauritius, Singapore and Cyprus is being seen as an alternative to the GAAR plan, which has been deferred following intense pressure from foreign institutional investors.

The finance ministry has already initiated a review of the tax treaty with Mauritius. Once the Mauritius treaty is amended, investors will possibly look to other countries enjoying similar benefits for investing in India, said Radhakishan Rawal, director, PwC.

Investors from Singapore and Cyprus enjoy tax exemption roughly on par with those from Mauritius, market sources said.

There have been concerns over round-tripping or routing of illicit money from India back into the country through Mauritius. India wants any company based in Mauritius and operating in India to pay tax on the capital gains they make here.

The government might tighten tax norms with countries like Cyprus so that funds are not routed from there. Currently, there is full capital gains tax exemption with Mauritius and Cyprus and there is some exemption benefit with Singapore and the Netherlands, Ernst & Young Tax market leader Sudhir Kapadia said.

Sunil Jain, tax partner at law firm J Sagar Associates, said the Singapore DTAA can be amended only after completing the Mauritius treaty review. According to Jain, when Singapore negotiated a comprehensive economic cooperation agreement with India, they also moved an amendment protocol to the Singapore-India tax avoidance treaty, which said that as long as the beneficial tax treatment is available in the India-Mauritius treaty, it will be available to Singapore as well.

So the fortunes of the Singapore treaty is tied up with the India-Mauritius treaty. After the negotiations with Mauritius are complete, the government can immediately go after negotiating with Singapore, he added.

Foreign investors based in these countries get unqualified tax exemption on short-term capital gains made in India, despite the fact the these countries are low-tax jurisdictions. On the contrary, domestic equity investors have to pay short-term capital gains tax of 15%, putting them at a disadvantage vis-a-vis FIIs while at the same time encouraging round-tripping.

The agreement between India and Singapore says: Articles 1, 2, 3 and 5 of this Protocol shall remain in force so long as any Convention or Agreement for the Avoidance of Double Taxation between the Government of the Republic of India and the Government of Mauritius provides that any gains from the alienation of shares in any company which is a resident of a Contracting State shall be taxable only in the Contracting State in which the alienator is a resident.

Even though is India is keen on reviewing the treaty with Mauritius, the latter is unwilling to cooperate in addressing tax evasion, minister of state for finance SS Palanimanickam said in the Lok Sabha last Friday. The government suspects the Mauritius route is misused by investors from third countries and also by many Indians firms to reinvest in India. The DTAA between the two countries is in force since 1983.