If anyone had suggested back in 2013, that India could rework its tax treaties with Mauritius, Cyprus and Singapore, giving it the right to tax capital gains – all in a span of three years – the idea would have been met with derision. Yet, India has managed to do just that, and nobody seems surprised.
Getting Mauritius And Singapore To The Negotiating Table
Making an example of Cyprus by notifying it as a non-cooperative jurisdiction – effectively a blacklisting exercise – India brought it, as well as other countries, to the negotiating table. The three renegotiated treaties give India the right to collect tax income on capital gains, arising in India, on the sale of shares of an Indian company. The mechanics of the treaties are such that
- All three treaties contain grandfathering provisions for investments made up to March 31, 2017. Essentially, this means that any investment made prior to this cut-off date will continue to enjoy zero capital gains tax in India;
- Mauritius and Singapore will enjoy a concessional tax regime for investments made between April 1, 2017 and March 31, 2019. Under this arrangement, investments made during this period will enjoy a reduced tax rate of 50 percent of the applicable domestic rate. This arrangement has not been extended to Cyprus and hence puts Cypriots at a disadvantage.
- The Mauritius and Cyprus treaties now include a Limitation of Benefits (LOB) clause (Singapore treaty had an LOB clause since 2005). This means that the taxpayers will be deemed to be shell/conduit companies and denied treaty benefits if they do not meet a monetary threshold of expenditure having been incurred in the country of residence.
Since it’s January already, the sand’s running out for foreign investors and they must quickly decide whether it makes sense for them to stay quiescent or seek newer pastures. Savvy investors always look for ways to maximise their returns on investments. A tax levy adds to costs, which investors will mitigate, if they can
Will FPIs Now Seek European Shores?
Against this backdrop, it is natural that foreign investors will look at other foreign jurisdictions which may offer a more beneficial tax structure. One such jurisdiction is Europe, with the Netherlands at the forefront.
The Netherlands offers considerable advantages given that under Dutch law, it is easy to migrate the effective place of management to the Netherlands and thereby become a tax resident of the country. The India-Netherlands tax treaty further provides that capital gains derived by Dutch residents from the sale of shares in an Indian company will be taxable only in the Netherlands so long as (a) the shares are not sold to an Indian resident; and (b) the shares do not derive value principally from immovable property in India. Coupled with other favorable aspects such as low withholding tax on dividend and lack of a LOB clause, Netherlands may offer considerable tax efficiencies to foreign taxpayers.
Tax treaties India has with other European jurisdictions such as France and Spain provide India the right to tax capital gains on the sale of shares only if the holding in the Indian company is at least 10 percent.
The question however remains whether such tax migrations will be effective and sustainable over the long term and this makes the decision a difficult one.
The Looming Specter Of GAAR
The Indian Government has made it clear that the General Anti-Avoidance Rules (GAAR) will not be postponed any further and will come into force from April 1, 2017. GAAR provides for sweeping powers to Indian tax authorities to (a) disregard any tax structure or transaction; or (b) make a unilateral override of tax treaties. GAAR can be invoked in situations where there is lack of substance and the structure is devised with the objective of obtaining a tax benefit. Accordingly, if foreign investors carry out a restructuring exercise so as to avail the benefits of the European tax treaties but are unable to satisfy the commercial substance test, they risk the wrath of the Indian taxman who may deny treaty benefits while also restructuring the transactions to his best judgment.
It may be interesting to note that the Indian tax administration has already made noises that GAAR will not be used to scrutinize transactions made under tax treaties which have LOB clauses in them. So, while Mauritius, Cyprus and Singapore now have the LOB clauses, most European treaties, including the Netherlands do not. If a business structure runs afoul with GAAR, the fact that it was done with a foreign jurisdiction with which India has a tax treaty sans the LOB clause, there could be considerable problems for the taxpayer in India.
In a nutshell, moving to a different tax jurisdiction to avail the benefits of a more favorable tax treaty may not be effective given the looming specter of GAAR
Will Migration To Tax Friendly Jurisdictions Be Sustainable?
The Indian Government has been constantly on the move to renegotiate its tax treaties with the dual objective of (a) plugging what it believes are loopholes in the treaties; and (b) beefing up the exchange of information arrangements.
Renegotiation of the Netherlands tax treaty is also on the agenda for the Indian Government for some time now. The countries had initiated talks in 2013 but were unable to make headway. Post the amendments to the other treaties, India may ramp up its efforts to make changes to the Netherlands tax treaty as well. If only by way of an indicator of the mood of the Indian Government, it may be of note that India unilaterally terminated the bilateral investment protection treaties with all European nations on November 30, 2016.
Additionally, the Base Erosion and Profit Sharing (BEPS) framework has seen a lot of traction lately. BEPS is a framework to tax multinational companies who exploit loopholes and shift profits from high tax jurisdictions to low or no tax jurisdictions. India is already considering opting for the multilateral agreement under BEPS which will enable it to agree to a common tax treaty which will be applicable for multiple countries. Renegotiation of each individual treaty which has a loophole will therefore be obviated. Speculation is rife that India could start work on the multilateral instruments from January 2017 so as to adopt the same by July 2017.
As the world tries to tidy up the mess created by tax treaties that were signed decades ago, it makes sense for a foreign investor to be proactive and stay ahead of the curve. However, in the present instance there is just too much uncertainty involved since the tax landscape is changing at an unprecedented manner. If due care is not taken, it may just turn out to be a classic case of jumping from the frying pan into the fire
Suraj Nangia
Partner – Nangia & Co