Taxing developments: India and Mauritius

The Indian government has never made a secret of its dissatisfaction with the double-taxation agreement (DTA) it signed in the 1980s with Mauritius. Though it fulfilled the original purpose of encouraging inbound investment - Mauritius accounted for about third of foreign direct investment in India over the last 15 years - the agreement's zero levy on capital gains is seen as having contributed to tax avoidance.

Last week's announcement that the DTA had been amended therefore came as no surprise, though industry players had hoped for a significantly different modification than that which was agreed to.

"The expectation or hope we had was that the Indian government would say, ‘Come directly to India, and we won't tax you on capital gains; it's a clean structure, you'll have the same benefit you had whether you were in Mauritius or Singapore,'" says Ash Lilani, co-founder and managing partner at Saama Capital.

Instead, it went in the other direction, announcing that investors based in Mauritius will have to pay the same capital gains tax rate as domestic investors. The change will be phased in over three years, with the current arrangement in effect until April 1, 2017. Investments made after that will be taxed at 50% of the domestic rate, with the full rate taking effect in regard to investments made after March 31, 2019.

Cause of optimism

Nevertheless, PE investors are not wholly downbeat on the impact to Mauritius - and Singapore, since that country's DTA links capital gains tax treatment to the Mauritius agreement. As is often the case with Indian regulatory announcements, the DTA changes were not aimed at private equity. Instead, the focus was on preventing tax avoidance through practices such as "round tripping," whereby wealthy individuals use Mauritius companies to route money into the country from overseas accounts.

"The government wants to make a shift, it wants to prevent any kind of hot money coming into India," says Sanjeev Krishan, executive director for private equity at PwC. "That's not to say that anything that comes out of Mauritius is hot money, but if the government has the feeling that some of it is, it will want to do something about it."

The government has long wanted to crack down on tax avoidance - the General Anti-Avoidance Rule (GAAR), which was passed in 2012 but has yet to go into effect, was designed to rein in the practice. That law also has attracted criticism due to potential unanticipated results for the private equity industry, and concerns that its provisions will be applied retroactively.

Given this regulatory history, a number of PE players see the DTA change as a welcome development - not necessarily because of the content of the measure, but because of its clarity.

"The regulations at times will seem a little harsh, but it's always better to have a provision of identity and a provision to say there is no ambiguity, and therefore one knows the difference between black and white, and the gray areas are reduced that much more," says Vinayak Burman, founding partner at Vertices Partners. "A lot of industry players should appreciate that."

The precise definitions in the DTA amendment - it also provides clear guidelines for separating actual resident Mauritius firms from shell companies, which cannot benefit from the reduced tax rate - stand in contrast to other legislative efforts, which have been marked by complaints about ambiguous language and inconsistent enforcement. Industry participants believe that this clarity is consistent with regulators' approach in recent years, and should help to ease concerns about GAAR.

Unwanted impact

At the same time, there is concern among PE players about possible deterrent effects of the tax changes on LPs. They feel groups might be less likely to invest in India-focused GPs if their future projected profits must be reduced in order to compensate for the higher tax burden.

Some ambiguity still persists in this regard. LPs that pay capital gains tax in their home countries can often take a deduction on tax paid overseas; these investors may not see a significant change here. But those that are tax-exempt - for instance, university endowments in the US - could end up with a significantly higher burden.

The nature of the exit also affects the tax rate that a selling shareholder has to pay. Long-term exits - defined as a sale after two years for unlisted shares and one year for listed shares - are taxed at a relatively low 10%. Sales made before that time limit may face a rate of 15% for listed shares, or as much as 40% for an unlisted company.

However, GPs see this factor, at least, as having relatively little impact on them. While theoretically a firm might reduce its tax liability by choosing a different time or avenue to exit, that level of control is rarely available. Noting that one exit took nearly a year to complete, Srikrishna Dwaram, a partner at India Value Fund Advisors, says his firm needs to take the opportunities it finds rather than wait to engineer a perfect situation. "The fact that we are able to exit is always a good thing. Whenever we can exit we will," says Dwaram.

Investors also downplay the impact of the waiting period before the DTA amendment takes effect; while a slight acceleration of investments, to take advantage of the April 2017 deadline, is possible, this presents problems of its own. Significantly speeding up an investment timeline could give a firm less time to complete its pre-deal checklist and introduce unwanted risk.

With similar changes expected for Singapore and other offshore domiciles, some industry participants look forward to a simplified future in which no geography is advantaged over any other.

"If you take a step back, you actually start to realize that after 2019, Mauritius becomes irrelevant," says Saama's Lilani. "We all went to Mauritius to take advantage of the tax benefit, but if there is no tax benefit by going through Mauritius, funds will have to look at their own structures and decide what is appropriate in the future for the new funds."

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• Topics
• South Asia
• Regulation
• India
• tax
• Singapore
• Mauritius