MUMBAI: Foreign direct investors using Mauritius to bet on Indian stocks are already beginning to feel the end of a zero-tax regime. The tax office has started questioning the claims of their nominees -- special purpose vehicles and entities floated in the tax haven -- for tax benefit, reports The Economic Times of India
In the course of recent arguments before the authority of advance ruling (AAR), the counsels of the tax department have challenged the Mauritius structures of at last four foreign private equity and strategic investors.
What has surprised these investors and their legal advisors is the aggressive stance of the Income tax department even though the General Anti-Avoidance Rule (GAAR) comes into effect next April, three persons familiar with the development told ET.
Now, here are the new rules and the provisions of the changed treaty between India and Mauritius: capital gains on equity shares bought after April 2017 will be taxed while tax benefits can be claimed on earnings like interest and gains on bonds if the investment vehicle in Mauritius (as per GAAR) has a `substance'. However, stocks sold after April 2017 would not be taxed if these are either held today or bought prior to that date.
But since lawyers representing the IT department are already questioning the lack of substance in the Mauritius entities, investors fear that the department may move the High Court in pursuing their stand in cases where rulings go in favour of the tax payer.
"It is legally not tenable to apply GAAR provisions pre- GAAR in effect and if applied could lead to loss of trust by foreign investors, " said Bijal Ajinkya, partner at law firm Khaitan & Co which is arguing on behalf of some of the offshore investors.
These investors who had bought shares of unlisted companies some years ago, approached the AAR to reconfirm the tax benefit. Some have either sold their shares or are about to strike a deal to book capital gains.
Recently, the AAR ruled that Mahindra-BT Investment (Mauritius) wasn't liable to pay tax in India in respect of transfer of shares in Tech Mahindra Ltd ('TML') to AT&T International USA that was done in 2010. In this ruling, the AAR dealt with the issue of residential status of the company, Mahindra-BT. The revenue authorities had argued that the control and management of the company was situated in India and this was the sole reason why the company was transferring shares of the Indian company to a US Company
"In the advance rulings in some cases, including one case we have recently dealt with, it was clear that for Mauritius based investors investing in India through Mauritius, it doesn't attract capital gains tax in India under India-Mauritius tax treaty. Also an advance ruling can only be challenged by filing a writ petition in High Court either showing that the reasoning of the law in the ruling was patently wrong or that the ruling is otherwise perverse on facts, to persuade High Courts to exercise its writ jurisdiction," said said Sanjay Sanghvi, Tax Partner, Khaitan & Co.
The widely shared perception is that a tax residency certificate is the conclusive test for the availability of India-Mauritius tax treaty benefit?. "Thus, by challenging this position, the tax department will needlessly create uncertainty in the minds of the PE investors... The position, of course, may need to be revisited once GAAR provisions come into being with effect from April 1, 2017," said Punit Shah, Partner at Dhruva Advisors.
But sensing trouble, some investors are putting their house in order. Mitil Chokshi, senior partner at audit firm Chokshi & Chokshi LLP. "Many of them have set up physical presence in Mauritius or Singapore or the Netherlands by using shared service centres and hiring one or two employees. This is ensure management and control in these jurisdictions. This would mitigate permanent establishment tax risk for these companies in India," he said