PE firms wary of India’s proposed tax law changes

Under the General Anti-Avoidance Rule (GAAR), transactions would be presumed to have been structured to obtain tax benefits unless the taxpayer proves this is not the main objective.

In 2010-2011, 35% of foreign direct investment came via Mauritius. The country has a double taxation agreement (DTA) with India, which means any company in possession of a tax residency certificate issued by the Mauritius authorities isn't levied on capital gains arising from investments in India. This is conditional on a company incorporating in the jurisdiction, locating its primary banks accounts and books there, being audited locally and appointing two local directors.

The GAAR could override these provisions. Although the Indian tax authorities are primarily interested in targeting wealthy Indians who leverage DTA benefits as they bring money onshore, private equity firms are affected. Some are already relocating to Singapore, which offers similar tax advantages and where it is easier to set up sufficient business operations to convince the authorities that tax is not the key factor.

It is also feared that the GAAR may target participatory notes (P-notes). These instruments are sold by Indian brokerages to foreign investors not permitted to invest directly in domestic securities. The P-note reflects changes in the value of the underlying security and, if held by a fund based in a jurisdiction like Mauritius, avoids taxes on direct or indirect investments.

CLSA has stopped selling P-notes due to uncertainty over the tax situation. "CLSA has taken the position not to increase its current Indian P-Note book as a way of minimizing the possible tax exposure," the brokerage said in an e-mail to clients, seen by Reuters. "For CLSA or any other P-Note issue, the tax liability must rest with the end ODI investor, the end beneficiary of the economic gain."

The Asia Securities Industry and Financial Markets Association this week warned India's finance minister that the tax proposals could inhibit the efficient operation of domestic debt and equity markets, The Wall Street Journal reported.

A further area of concern in the budget is a proposal to tax transactions between offshore-based entities that involve the transfer of Indian assets - and implement it retroactively. It comes after India missed out on more than $2 billion in tax revenue arising from the sale of Hutchison Whampoa's local assets to Vodafone.

Private equity firms are already adapting to the introduction of similar legislation in China. In 2010, an offshore fund controlled by The Carlyle Group was asked to pay $25 million in tax on capital gains generated by the sale of a 49% stake in Jiangsu-based Yangzhou Chengde Steel Tube to a strategic investor in the US.

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• Topics
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• tax
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