Capital gains arising out of derivatives and debt instruments like debentures would not be taxed in India under the amended India-Mauritius Double Taxation Avoidance Agreement (DTAA) unless the General Anti-avoidance Rules (GAAR) are invoked, revenue secretary Hasmukh Adhia told FE on Friday. The recent amendment, which aligned the DTAA with the dominant global pattern and India’s own 92 similar pacts, only lets New Delhi phase out the capital gains exemption for sale or transfer of shares of an Indian company acquired by a Mauritius tax resident, the official clarified, removing the ambiguity over the scope of the recent changes in the DTAA.
“I have looked at the whole legal position again. In most of our (bilateral tax treaties), derivatives are treated as part of ‘other assets’ and and so are debt instruments. So the capital gains in such cases necessarily come from ‘other assets’, not equity assets… I mean this was already the position in case of our 95-odd tax treaties. As a general rule, the right of taxation for immovable properties (other than equity shares) is given to the resident state and not to the source country. That being so, the only difference in the case of Mauritius is that as a resident state, it is not taxing gains from these assets.”
Adhia said that the objective of the recent modifications in the India-Mauritius DTAA won’t be underachieved by continuing to exempt gains attributable to trading in derivatives as well as convertible/non-convertible debentures from tax. Although derivatives account for the bulk of equity trading in India and are commonly employed by foreign portfolio investors (FPIs) as well, the capital gains arising from these instruments of short durations are not very big, he said. Also, only 12% of the FPI investments via Mauritius goes to debt where the returns too are comparatively small.
The revenue secretary explained how the ambiguity over the tax treatment of derivatives/debentures under the India-Mauritius DTAA occurred in the first place.
“When I was actually negotiating with Mauritius, my understanding was that profit out of derivatives would fall under the head ‘business profits’. But thanks to a lot of confusion among income tax officers on whether to consider profits from exchange-traded derivatives as a business profit or capital gain, an amendment was made to the I-T Act in 2015, which said in case of FIIs (foreign institutional investors), it will be considered as a capital gain. But any other country (with which we have tax treaties) is free to consider such gains as a business income and tax the same accordingly.”
In the case of equity shares, the position in as many as 92 bilateral tax treaties has been that capital gains are taxed in the source country. The exceptions have been the treaties with Mauritius, Cyprus and Netherlands, to some extent. “So we are trying to reverse that position now in case of these countries and so Mauritius (treaty) has been brought at par with other countries,” Adhia said.
While amending the Mauritius DTAA to tax capital gains from the sale or transfer of shares of an Indian company acquired by a Mauritius tax-resident, the two countries retained the exemption for investments made until March 31, 2017. Also, shares acquired in the next two years would attract capital gains tax at a 50% discount — meaning, at 7.5% for listed equities and 20% for unlisted ones. These relaxations, it is hoped, would any sudden drying up of Mauritius investments in the country. The island country, which has recently lost its top slot on India’s FDI chart to Singapore, accounted for $94 billion or 34% of the cumulative FDI inflows into the country between April 2000 and December 2015; over 19% of the FPI investments — asset under custody — in the country are also traceable to Mauritius.
Adhia iterated that the overriding nature of GAAR on tax treaties would prevail. “It (GAAR) comes into play when it is proved that a treaty is misused for the purpose of tax avoidance,” he said.