The Indian government renegotiated tax treaties with Singapore and Mauritius in 2016 to tackle their abuse and to prevent double non-taxation.
India shall now have, among others, the right to tax capital gains arising from alienation of shares acquired on or after 1 April 2017, by a Singapore or Mauritius resident, which were the most preferred jurisdictions for FDI into India.
As per the protocol, investment in shares made before 1 April, 2017, have been grandfathered and will continue to enjoy the treaty benefits, whereby any capital gains arising on such shares would be subject to tax in Singapore/Mauritius (where the domestic capital gain tax rate is NIL) upon complying with the Limitation of Benefit (LoB) clause. The protocol amending the treaties also provided for a reduced tax rate of 50% of the domestic tax rate in India until 31 March, 2019, and the gains from the sale of shares acquired from 1 April, 2019, are now subject to tax at full applicable rates in India.
Whilst the protocol provides for the aforesaid grandfathering provisions, it does not specifically cover transfer of shares allotted pursuant to group reorganisations, conversion of convertible instruments (preference shares/debentures) and bonus shares and stock splits, where the original shares/instruments are issued/acquired prior to 31 March, 2017, which should have ideally been grandfathered.
Lack of clarity on their taxability is prompting buyers of such shares to adopt a conservative approach and comply with the withholding obligations in India leading to tax uncertainties in deals.
Further, many investors are looking to invest through instruments other than shares, such as CCD’s, bonds and other hybrid instruments, on the argument that the gains arising out of the alienation of such instruments continue to remain exempt in the absence of a specific mention in the treaty amendment.
However, one must be conscious of the interplay between the General Anti-Avoidance Rules (GAAR) provisions in India and the overriding effect of the same over the tax treaties, while structuring investments through such instruments. For example, it remains to be seen if CCDs/CCPS can be recharacterized as shares by invoking the GAAR. Also, the introduction of Place of Effective Management (POEM) guidelines under Indian law places greater emphasis on demonstration of substance in claiming such treaty benefits.
The impact of the renegotiation is that from 1 April, 2019, long-term capital gains earned by foreign investors including FIIs/FPIs would be taxable at the rate of 10%, thereby bringing the taxability of both listed and unlisted shares at par after the amendment in Indian law in 2018, which seeks to impose 10% LTCG tax on the earlier exempt sale of listed shares. Similarly, short-term capital gains will be taxable at 15% in case of stock exchange transactions and at 40% (30% for FPIs) in case of unlisted shares.
The amendment has also prompted a change in the investor preference to alternate jurisdictions such as the Netherlands and France for investment into India, wherein the capital gains tax on sale of shares continue to remain exempt. However, considering the intent of the government, one cannot rule out a renegotiation of these treaties for similar tax treatment.
To summarize, the treaty amendments signal India’s shift to moderate tax investment regime, instead of a potential tax- free investment regime. It would be only fair that the government irons out the open issues arising out of the amendments to provide certainty to investors as India continues to attract global investments.
Girish Vanvari and Krishnan T.A. are founder and director, respectively, at Transaction Square LLP.