New checks on FPIs' tax shift plans

The country's General Anti Avoidance Rules (GAAR) on tax payments and the government's recent signing of the Multilateral Instrument (MLI) in this regard, as part of measures to prevent base erosion and profit shifting (BEPS), has already had some effects.

These appear to have dissuaded foreign portfolio investors (FPIs) from shifting to European jurisdictions such as France, Spain and the Netherlands as envisaged earlier.

Until April 1, FPIs took the Mauritius, Singapore or Cyprus routes to pool money from investors across the globe and invest in India. The earlier treaties we signed, amended in 2016, allowed for taxation of capital gains earned in India to be subject to tax only in the other country. Since these countries did not charge tax on capital gains, FPIs remained out of the net.

Short-term capital gains in India are taxed at 15 per cent; long-term gains are exempt.
 

FPIs that did not want their returns to get impacted from these treaty amendments were actively scouting for other jurisdictions, especially European ones. That shift has not quite worked out, say experts. "Many FPIs are concerned that if they don't have foot on the ground and adequate commercial reasons for investing into India from these European jurisdictions, they could be challenged under the MLI and, more important, under India's GAAR," said Rajesh Gandhi, partner, Deloitte Haskins & Sells.

BEPS is the term for tax avoidance strategies - these exploit gaps and mismatches in tax rules to shift profit to low or no-tax locations. Under the newly inclusive framework, a little over 100 countries and jurisdictions are collaborating to implement the BEPS measures.

"The current reading of MLI suggests it is more stringent than GAAR; the global tax trend is also discouraging treaty shopping," said Suresh Swamy, partner for tax and regulatory services at consultants PwC India.

India has been an active participant in the BEPS project. And, has introduced key changes in legislation, in response to some of the BEPS action plans. India has also signed the MLI; this would mean the amendment of several bilateral tax treaties, specifically targeting treaty abuse and bringing in the concept of Principal Purpose Test (PPT).

"PPT provides that no benefit under the covered tax agreement would be granted if it is reasonable to conclude that obtaining the benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit. Once the treaties start getting amended, the loopholes would also start getting plugged," said Amit Maheshwari, partner, Ashok Maheshwary & Associates.

At present, some of India's tax treaties exempt gains from sale of derivatives and debt; others exempt all types of capital gains. For example, the Double Taxation Avoidance Agreement with Netherlands exempts tax on capital gains in India when shares of an Indian entity are transferred between non-resident shareholders or in cases where the seller owns less than 10 per cent of the shareholding of the Indian entity.

Despite the benefits, FPIs have to consider the domestic tax treatment in these countries and the regulatory restrictions on redemptions, as well as the cost of setting up and maintaining presence before shifting base.

"Investors have to consider the overall credibility of the jurisdiction to attract foreign funds, disclosure requirements and the local taxation, book keeping and auditing requirements. The ease of moving funds, treaty networks and the exchange of information agreements with other countries also have to be borne in mind," explained Swamy.