Mauritius party may go on through instruments other than shares

The fine print of the new Mauritius tax protocol released on Thursday suggested that the changes brought in earlier this week would be applicable only to shares - sparing other instruments.

Other forms of securities such as compulsorily convertible debentures (CCDs), optionally convertible debentures (OCDs) and some derivatives could remain out of the scope of the amendments, according to consultants who have gone through the fine print.

These and other such structured products could qualify as 'securities' under the Securities Regulations (Contract) Act and the transactions on these could still qualify as capital gains under the Indian law. The text of the protocol seems inconsistent with some media interviews by government officials published on Thursday, which indicated that the provisions would be applicable on all kinds of instruments and properties.

According to the protocol, Article 13 of the convention, which deals with "Capital Gains" is amended with effect from April 1, 2017 by inserting new paragraphs 3A and 3B: "3A. Gains from the alienation of shares acquired on or after 1 April 2017 in a company which is resident of a Contracting State may be taxed in that State." Paragraph 3B contains the provision for the 50-per cent clause during transition period between 2017 and 2019.

Another key amendment is replacing the existing paragraph 4 with the following: "4. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3 and 3A shall be taxable only in the Contracting State of which the alienator is a resident."

Ravi Mehta, partner, Grant Thornton India LLP, said "This effectively seems to mean that any other securities which are not in form of shares -CCD, OCD, or such other structured products qualifying as 'Securities' under Securities Contract (Regulations) Act, 1956 and held as 'Investment'- may still remain eligible for benefits under Mauritius and Singapore tax treaties. Would this tempt the future foreign investments to use new product structures, including reorganising their existing investments to other hybrid securities, to continue investing from these countries?"

Under the Indian law, some of these securities continue to qualify as FDI under the Indian Exchange Control Regulations. This could tempt the future foreign investments to use new product structures to continue investing from Mauritius and Singapore.

Further, consultants also suggested that the newly specified Conduit threshold of Rs 27 lakh in Limitation of Benefits (LOB) clause may not apply to such securities transactions. The conduit company tests specified in the LOB clause of the treaty, also seem relevant only for availing concessional tax benefit on capital gain transactions for shares during the transition period.

The words still lead to an interpretation that these 'conduit/shell' company tests may not mandatorily apply in case the securities involved are not shares.

In an interview to the Economic Times, Revenue Secretary Hasmukh Adhia said, "This would apply on capital gains made on all assets if the source of such capital gain is India. Whether it is derivative, future or option or any other property, if you are deriving any value in capital gain out of India, then capital gains provision would apply."

While this could become a potential source of litigation, if left unclarified, experts wondered if the scope of the protocol could be expanded in this manner through clarifications. Mehta of Grant Thornton added that "Press interview given by the Revenue Secretary indicated that the capital gains taxation would be made applicable on all assets if the source of such capital gain is in India. This again could lead a cloud of doubt in the minds of the Foreign Investors as the wordings of the Treaty Protocol do not seem to match with the intent of the framers. Hence, a suitable clarification to this effect would become essential to avoid any future controversies."

DEVIL IN THE DETAILS

• Paragraph 1 deals with immovable properties
   
• Paragraph 2 deals with immovable properties of permanent establishments in India
   
• Paragraph 3 deals with ships and aircraft
   
• Paragraph 3A introduced through protocol mentions only shares
   
• A combined reading suggests instruments other than shares will fall under para 4 and hence Mauritius will have right to tax these