Centre to Tax Investments from Mauritius


From 2017, the Centre will tax capital gains on investments from Mauritius, the tiny island from where India has received nearly a third of its total foreign direct investment (FDI) inflows since 2000. In a two-year transition phase, from April 1, 2017 to March 31, 2019, the capital gains will be taxed at a concessional tax rate of 50 per cent of the domestic rate, according to the statement. Capital gains on investments made before April 1, 2017, will not be taxed in India.

The source of the leak in tax revenue was plugged after the two countries signed a protocol in May 2016 at Port Louis, Mauritius. The protocol amends the convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains.

However, following the agreement, Mauritius could cease to be the preferred route for FDI and portfolio investments into India.

The amendment will tackle long-pending issues of treaty abuse and round-tripping of funds, attributed to the India-Mauritius treaty, curb revenue loss, prevent double non-taxation, streamline the flow of investment and stimulate the flow of exchange of information between India and Mauritius, according to an official statement. It will improve transparency in tax matters and will help curb tax evasion and tax avoidance.

Signed in 1983, the Double Taxation Avoidance treaty between the two countries made Mauritius, which taxes capital gains at near-zero rates, an attractive “post box address” for foreign investors to route investments into India. In addition, regulators in India suspect that Indians avoiding taxes set up shell companies in Mauritius, concealing identities and channeling cash or stock market investments through “round tripping” and “participatory notes”.

Those companies will be exempt from paying tax on capital gains in India that can prove they spent at least Rs. 2,700,000 in Mauritius during the immediately preceding 12 months, it said.

Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5 per cent in respect of debt claims or loans made after March, 31, 2017. However, interest income of Mauritian resident banks in respect of debt-claims will be exempt from tax in India.

Round-tripping of Funds

The term ‘round-tripping’ is self-explanatory. It denotes a trip where a person or thing returns to the place from where the journey began. In the context of black money, it leaves the country through various channels such as inflated invoices, payments to shell companies overseas, the hawala route and so on. After cooling its heels overseas for a while, this money returns in a freshly laundered form; thus completing a round-trip.

This route is far from simple or straightforward. Those indulging in this game are past masters who make the money flow through multiple layers consisting of many entities and companies.
How does the money return to India? It could be invested in offshore funds that in turn invest in Indian assets. The Global Depository Receipts (GDR) and Participatory Notes (P-Notes) are some of the other routes that have been used in the past.

We need to take note of such fund movement since many listed companies appear to be involved in these activities. SEBI had recently issued a notice against listed firms including United Spirits, GMR, Unitech and Sterlite for investing in group companies through a foreign account held with UBS. The companies are alleged to have indulged in stock price manipulation and insider trading through this route.

Another high-profile case in 2009 involved the Reliance ADAG group that was alleged to have manipulated the shares of Reliance Communication through a multi-layered transaction involving shell companies, P-Notes and prominent international investment banks.

Participatory Notes (P-Notes)

Participatory notes also called P-Notes are offshore derivative instruments with Indian shares as underlying assets. These instruments are used for making investments in the stock markets. However, they are not used within the country. They are used outside India for making investments in shares listed in the Indian stock market. That is why they are also called offshore derivative instruments.
Participatory notes are issued by brokers and FIIs registered with SEBI. The investment is made on behalf of these foreign investors by the already registered brokers in India. For example, Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors.
The brokers that issue these notes or trades in Indian securities have to mandatorily report their PN issuance status to SEBI for each quarter. These notes allow foreign high networth individuals, hedge funds and other investors to put money in Indian markets without being registered with SEBI, thus making their participation easy and smooth. P-Notes also aid in saving time and costs associated with direct registrations.
Why are participatory notes used?
Investing through P-Notes is very simple and hence very popular amongst FIIs. Overseas investors who are not registered with SEBI have to go through a lot of scrutiny, such as know-your-customer norms, before investing in Indian shares. To avoid these hurdles, foreign investors take this route. Also, since the end beneficiary of these notes is not disclosed, many investors who want to remain anonymous use it. These instruments aid investors who do not want to register with SEBI and reveal their identities to take positions in the Indian market.
Advantages of participatory notes
Anonymity: Any entity investing in participatory notes is not required to register with SEBI, whereas all FIIs have to compulsorily get registered. It enables large hedge funds to carry out their operations without disclosing their identity.
Ease of trading: Trading through participatory notes is easy because they are like contract notes transferable by endorsement and delivery.
Tax saving: Some of the entities route their investment through participatory notes to take advantage of the tax laws of certain preferred countries.

Why Participatory Notes are dangerous

Indian regulators are not very happy about participatory notes because they have no way to know who owns the underlying securities. Regulators fear that hedge funds acting through participatory notes will cause economic volatility in India's exchanges.

Hedge funds were largely blamed for the sudden sharp falls in indices. Unlike FIIs, hedge funds are not directly registered with Sebi, but they can operate through sub-accounts with FIIs. These funds are also said to operate through the issuance of participatory notes.

The PNs are a slap on the face of every citizen who is an investor. For a person to invest even in one share, several KYC (know your customer) forms have to be filled up, and PAN numbers and proof of address, etc., provided. For the PN investor the system is totally silent on even elementary information. The FIIs issue PNs to funds/companies whose identity is not known to the Indian authorities. Hence, the PN system is blatantly discriminatory and seems to favour ghost investors. 

The terror financiers could find this route attractive and simple. 

Wednesday, 11th May 2016, 06:52:56 PM

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