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Mauritius: the sun and sand are safe but |
The island of Mauritius is a key outpost for driving foreign investment into India, thanks to an obscure double-tax treaty signed between the two countries almost 20 years ago. Under the treaty foreign investors based in Mauritius do not have to pay tax on capital gains in India or on dividends paid them by Indian companies. So about a third of the $11 billion foreign portfolio investment and a large chunk of foreign direct investment into India is routed through Mauritius.
Two years back Indian tax officials slapped notices on five such foreign funds, sparking a market sell-off by panicked foreign investors that eventually forced the government to backtrack. The Central Board of Direct Taxes (CBDT), the Indian tax authority, ruled that a certificate of residence issued by the Mauritius revenue authorities was a sufficient basis for foreign investors in India to enjoy tax breaks under the treaty.
However, a non-government organization, among others, challenged the tax authority’s ruling in a Delhi court, which in May this year quashed that CBDT circular, saying it curtailed the rights of Indian tax officials to check misuse of tax benefits and encouraged treaty-shopping by foreign investors.
Foreign investors heaved a sigh of relief when on November 18 the Supreme Court stayed the Delhi court’s order, in response to a petition filed by the Indian government. The hearing of the petition will begin in January. The stay protects foreign funds based in Mauritius from any tax liability under Indian law – for now.
The uncertainty over their tax status in recent months has once more sparked selling by foreign investors in India, says Brian Brown, head of Salomon Smith Barney, a broker for several foreign institutional investors in India. “The court stay is mildly positive in the short term but not something that will trigger buying by foreign investors,” he adds.
Market sources say a few funds, including one US college employees retirement fund, pulled out of India in May but cannot put a figure to how much it sold. Open-ended funds are wary of being hit with a tax liability. Some sources say that new investment projects into India are on hold while the uncertainty persists.
Figures from market regulator the Securities Exchange Board of India show a mixed trend. Net foreign portfolio investment was negative in May this year but turned positive by July, well before the Supreme Court stay. Portfolio investment of about $468 million until November 20 this year is lower than last year. But there may be other reasons why foreign investors are reluctant to invest right now. Chetan Saigal, a fund manager with Templeton Emerging Markets group, which has some investments in India, says that the steady appreciation of the rupee this year has dulled the appetite of foreign investors for Indian stocks.
About a third of the 496 foreign institutional investors in India are based in Mauritius, and they hope a final verdict by the Supreme Court will clarify their tax status. “We hope the court will arrive at their verdict soon and put an end to the uncertainty,” says a foreign fund manager.
Dinesh Kanabar, an international tax consultant at RSM & Co, says a verdict could be out in six months if the government is able to convince the court that the case is sensitive and should be settled quickly. Others are less optimistic; Ernst & Young said in June that it could take two to three years for the court to hear the petition.
The Indian government needs to take a stand on whether it wants foreign investment, says Kanabar, or “whether it sees tax as a substantive issue that makes that investment worthless.” Last time around, in April 2000, finance minister Yashwant Sinha intervened to calm foreign investors after HSBC, Robert Fleming and Guinness Flight suspended dealings in the India funds managed by them after they received notices asking them to cough up taxes.
This time the government faces a new challenge. A parliamentary panel inquiring into the stock market crash in March last year is probing allegations of money-laundering against a few Indian companies and brokers who channelled money into Indian stocks through Mauritius. The government must plug holes, if any are found, but avoid driving off legitimate foreign investors.
Officials in both countries began discreet talks about ways to monitor funds flowing into India. Sushil Khushiram, Mauritius minister of economic development, financial services and corporate affairs, led a high-level delegation to India in December last year that met officials of the Securities Exchange Board of India to discuss gaps in regulation.
Uncomfortable with the risks of seeking tax protection under bilateral treaties such as the Indo-Mauritius DTAT, some large foreign funds invest directly in India. But they advocate reforming tax laws that make the country unattractive to foreign investors. Templeton’s Saigal has little doubt that “India would get a larger share of the pie if it did away with the 30% tax on short-term capital gains. Our funds invest directly in India and we factor the cost of tax into the price when we trade Indian stocks.” A tax on turnover might work better because it is easier to distribute, he adds.
Meanwhile, Saigal says that just $250 million of the $6.5 billion managed by fund manager Mark Mobius under Templeton’s emerging markets group is invested in India. Similarly, foreign direct investors, including private-equity investors, have 21% of the dividends earned from Indian companies axed under a withholding tax.
A report submitted to the government recently by a tax reform panel, suggests doing away with tax on company dividends and capital gains. The government might do well to heed its advice.
