In the uncoiling of India's post reform stock market history, the small island of Mauritius always pops up. More often than not there is a lot of negativity attached to the island, typically considered an offshore tax haven. In the past, most Indian financial scams have tailed back to Mauritius. From Ketan Parekh's K 10 to the 2G spectrum scam and even the more recent Agusta Westland chopper scam, there has always been a Mauritius link. A large dosage of portfolio investment comes in through Mauritius and hence the suspicion that Participatory Notes masking the identity of the actual investor have been using the tax dodge to round trip money into India always abounds.
At the same, what needs to be considered is that a lot of Foreign Direct Investment into India is also routed through Mauritius. From the time India unfettered its stock markets seeking foreign investment from institutional investors, the Double Taxation agreement between the two nations has been viewed with misgivings and scepticism. And every time when there has been a whiff of shenanigans, the first impression is that there is a Mauritius connection. More often than not, it is true. Hence the inherent distrust. Between April-December 2015-16, FDI of ₹39, 506 crore came through Mauritius, while ₹71,195 crore came from Singapore. However, in the previous full year, April-March 2014-15, Mauritius was in pole position with ₹55,172 crore, followed by Singapore with ₹41,350 crore.
Even the routing of FII money through Mauritius is overstated and overplayed. Of the top Mauritius based India dedicated funds, Copthall Mauritius Investment Fund has a $1.7 billion exposure to Indian equities followed by HSBC Global Investment Fund with a $1 billion and Citibank Global Markets Mauritius Fund with 4409.5 million. This pales into insignificance against Singapore FII investments where Temasek Holdings has a $99.1 billion exposure to Indian equities while GIC Pvt has a $44.2 billion exposure followed by Morgan Stanley Asia with a $1.2 billion. In any case, let me explain why FIIs using the Mauritius route are unlikely to abandon India and its great long-term buys just because of a new clause added to the DTAA. So, the worries on the same clause being added to the treaty with Singapore or other tax-havens are also not a big concern. It’s the pedigree of the company, rather than the tax structure of the home country, which makes a business a strong investment proposition. Obviously, it will be a deterrent to hot money and 'fairweather friends' which is a good thing for it will mean that 'Treaty Abuse' cases will lessen.
So, when India finally decided to amend a few key clauses in the nearly 30-year-old Double Taxation Avoidance Agreement (DTAA), there was no temblor whatsoever. Tax avoidance is something that most governments worry about. The amendments will now allow India to tax capital gains earned by Mauritius based entities. These entities will now have to pay capital gains tax for investments in India made from < data-term="goog_1010839165">April 1, 2017. However, investments made before < data-term="goog_1010839166">April 1, 2017 have been grand-fathered and will not be subject to taxation in India. This in a way is good news, for it means that prima facie all things being equal, till < data-term="goog_1010839167">March 31, 2017, FIIs using the M route will continue to buy aggressively — something that has already begun to happen post the amendments.
From < data-term="goog_1010839168">April 1, 2017 to March 31, 2019, these firms will have to pay capital gains tax at 50% of the tax rate that is paid by domestic entities. Currently, Indian investors are levied 15% tax on short-term capital gains (holding period less than 12 months) of listed companies on payment of security transaction tax (STT). According to Centrum Wealth Research, long-term capital gains are exempt from tax. According to the Limitation of Benefit (LoB) clause, the 50% concession rate can be availed by those entities which spend more than ₹27 lakh or Mauritian Rupees 15 lakh on operations in the African island nation in the 12 months immediately preceding the alienation of shares. After < data-term="goog_1010839169">April 1, 2019, the full domestic tax rate will be applicable to all Mauritius based firms. The latest amendments does not change the life of long-term investors because long-term capital gains are exempt from tax. Again a huge plus.
While the move is aimed towards significantly reducing instances of treaty abuse, round tripping of funds and curb tax evasion, it could change investment flows between the two nations. Mauritius has been a source of one of the highest foreign inflows into India for a very long time now, because of its tax haven status. The earlier treaty allowed capital gains on Indian shares owned by a Mauritius company to be exempted from Indian tax. A Mauritius-based company was simply taxed as per Mauritius tax laws that are extremely favourable.
In the immediate term, India could see increase in FII investments as FIIs may want to take the tax advantage and invest in Indian securities before the sunset date of < data-term="goog_1010839170">April 1, 2017. But, post that, can this taxation result in slowdown in foreign money flows into India? Theoretically, may be yes, but practically, looking at the potential of returns offered by the Indian market, this clarity on taxation is likely to lead to higher inflows of longer term money, thus bringing in stability in flows. The new India-Mauritius treaty is likely to impact hot money, which comes into India with an investment horizon of less than a year. Though these short-term FII flows add to the corpus of foreign money in the country, these come from investors who make a quick exit once their money is made. Hot money tends to increase volatility in equity markets, although it does inject liquidity into the market which leads to higher depth.
India’s capital market has some great stories playing out, which deserve attention and global investment. Global investors will not be deterred by a 7.5% or 15% tax (only on short-term capital gains) from investing into names which have the potential to offer great returns in the future. If we look at the companies with high FII holdings, most of them are names which have solid fundamentals and managements and have given fantastic returns in the past. HDFC, India Bulls Housing Finance, ICICI Bank, KPIT, Indus Ind Bank, Zee Telefilms, UPL, IDFC, Apollo Hospitals, HDIL, Hathaway Cable, Axis Bank, Mindtree, Yes Bank and Infosys already have FII holding in excess of 40 percent. Many of these scrips have seen a huge spurt in the last few days ever since the new amendments were listed out. Others where the FII holding is in the high 30s — Hero Moto Corp, M & M, City Union Bank, Tech Mahindra and Glenmark — there has been frenetic activity. It is clear that the long term investor has nothing to worry about as the changes will actually clean the system.
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