As the general anti-avoidance rules (GAAR) proposal made in the Budget presented in March has been postponed for a year, foreign institutional investors (FIIs) are using this period to correct their practices, and started setting up offices or strengthening their offices in countries that have signed double tax avoidance treaties with India to show permanent establishment .
The finance ministry had said for claiming treaty benefits, non-resident taxpayers would be required to obtain a tax residency certificate containing specific particulars as may be prescribed.
In the absence of clarity, several FIIs had sold investments in India after the Budget presentation, fearing Indian tax authorities may not allow the tax benefits they were claiming so far under double tax avoidance treaties.
According to information from investment banking circles, Citigroup and couple of other US-based FIIs have started strengthening their offices, employing personnel in Mauritius. CLSA is understood to have strengthened its office in Singapore for India security market investments. There are hundreds of other smaller FIIs and hedge funds that are increasingly establishing offices in treaty countries like Mauritius and Singapore.
An official from a US-based FII said: “More and more funds and investors are in the process of having their functional offices in tax havens from where they are routing their investments in India. This will become a trend.”
Even so-called tax havens require this. A senior official from a leading Asian FII said: “Authorities from countries that have signed treaties with countries like India also insist that investors registered in their countries should have properly functional offices there to claim tax benefits in other countries.”
After the GAAR proposal announced, there were fears that Indian tax authorities would reopen cases of entities investing in the Indian market through treaty countries. Investors from treaty countries’ have to have a permanent establishment in countries from where they are routing their investments to claim tax benefits.
It was found that several investors were having just an office address and no permanent establishments. There were cases of numerous investors having common office addresses without having anything else in common. Indian tax authorities have objected to such arrangements.
Sidharth Shah, partner, funds practice at Nishith Desai Associates, said: “Following the announcement of GAAR provisions in the Budget, with a view to demonstrate commercial substance in the treaty jurisdiction, several FIIs and hedge funds have accelerated their effort in establishing proper offices with manpower. While it is unclear today in the absence of the rules related to GAAR, which are yet to be notified as to what and how much substance would suffice, we do advise clients to create as much substance as practically possible, both in the entity and the jurisdiction.”
After the budget proposals on GAAR and opening tax returns of the past FIIs came together to oppose this and wanted clarity and comfort on business done in the past. Several FIIs have discontinued issuing participatory-notes (P-note) as tax treatment of P-note holders was not clear.
As a result, P-notes as a percentage of total FII investments in India had fallen from 15 to 11.9 per cent In April.
Shah added: “Tax authorities are more likely to challenge structures, where entities claiming treaty benefit have no commercial substance in the entity and jurisdiction where they are located, as compared to entities with some substance in the jurisdiction in terms of office, reasonably senior employees, etc.
Also, as implementation of GAAR proposals have been deferred till next year, most FIIs, whether issuing P-notes or not and their clients have got some breather to carefully evaluate their structures and strengthen these where possible by establishing proper operations in such places.”