This article gives an overview of Mauritius and Singapore as jusrisdictions that are competing to emerge as a preferred gateway for international investment into India.
Entering the Tiger’s Den: Foreign Investment in India Through Mauritius or Singapore
Introduction
In the modern era of international tax practice, choice of tax treaties are often perceived as having been reduced to a commoditised service to international investors by international tax practitioners. The well advised transnational investor probably has access to tax planning software or simple tabulations that help identify the treaty offering the most beneficial avenue for investment into the investee country. Entities are readily established in countries completely alien to the investor or the target country purely because they present a tax efficient channel through which the investment can be made.1 The approach of the Indian tax department, particularly in the recent past, clearly suggests that the choice is not quite so simple when it comes to investing in India.
For an international investor looking to invest in India, data on Foreign Direct Investment (“FDI”) indicates that Mauritius is a clear favourite with 41 per cent of FDI in India being channelled through Mauritius. At second place is Singapore with 10 per cent of the FDI pie having overtaken the USA in 2008-2009, which now holds third place with 7 per cent of the FDI inflow. A closer look at the statistics shows an increase in FDI from Singapore from 2009-2010 and a decrease of FDI from Mauritius.2
In tandem with emerging trends relating to FDI and other forms of foreign investment into India, this article seeks to provide an overview of Mauritius and Singapore as jurisdictions that are competing to emerge as a preferred gateway for international investment into India.
The Mauritius Route: Increasing Challenges
India and Mauritius entered into a double taxation avoidance agreement (Mauritius Treaty) in April 1, 1983 with the objective of avoidance of double taxation and the prevention of fiscal evasion. The most important provision by far being that the capital gains earned by a Mauritius resident on disposal of shares of an Indian company is tax exempt in India (exempt from tax of up to 42 per cent) and being chargeable to effectively no tax in Mauritius (due to deemed tax credits). As a consequence, Mauritius enjoys a prominent place in tax treaty planning of private equity players, MNCs and global fund houses investing into India. The “Mauritius route” has faced many challenges since the Mauritius Treaty was entered into in 1983.
The allegations by Indian authorities against the Mauritius Treaty have historically been, and continue to be, primarily on two counts: (i) offshore investors setting up “conduits” in Mauritius solely to avail of Mauritius Treaty benefits without having any actual commercial purpose for setting up such entities; and (ii) politically more sensitive – Indian residents using Mauritius for "round tripping" funds back into India, tax avoidance and money laundering. Amidst these allegations, the following are key developments over the past two decades in relation to the Mauritius Treaty:
1.The Central Board for Direct Taxes (“CBDT”) issued Circular 682 (March 30, 1994) clarifying that capital gains derived by residents of Mauritius by alienating shares of Indian companies shall be taxable only in Mauritius according to Mauritius tax law.
2.In 1994, the Indian Income Tax Department (“Tax Department”) challenged this circular pursuant to a ruling of the Authority of Advance Rulings (“AAR”).3 This ruling was, however, overturned in another AAR ruling where commercial justification was used as a differentiating factor.4
3.In 2000, the Tax Department denied Mauritius Treaty benefits on the ground that the sole reason for investing in India through Mauritius was tax avoidance. CBDT issued Circular 789 (April 13, 2000) stating that the Tax Residency Certificate (“TRC”) issued by the Mauritius Revenue Authorities was sufficient proof of residency of a Mauritius company to avail of Mauritius Treaty benefits.
4.Public Interest Litigations were filed in the Delhi High Court challenging the constitutional validity of the circulars, alleging that “treaty shopping” was being undertaken using “shell” companies in Mauritius. The Delhi High Court upheld the circulars as illegal. On an appeal to the Supreme Court of India, the Delhi High Court order was quashed.
The aforesaid Supreme Court ruling in Union of Indiav Azadi Bachao Andolan and Anr.5 (“Azadi”) paved the way for Mauritius being reaffirmed as the “go-to” jurisdiction with most entities established in Mauritius seeking to avail of Mauritius Treaty benefits solely on the basis of a TRC. However, recent cases and rulings indicate that the Tax Department is applying a number of criteria (beyond just a TRC) when determining whether a foreign entity is eligible to the benefit of the provisions of a tax treaty, amongst which are the place of management of the foreign resident company and the level of substance in the jurisdiction in which it is incorporated. A snap shot of recent cases in this behalf is presented in the table below:
The earlier interim ruling by the Indian Courts in the Vodafone case seems to have led to a more aggressive approach by the Tax Department in denying treaty benefits under the Mauritius Treaty. The uncertainty created by the same has been conclusively ended by the landmark decision by the Supreme Court in the Vodafone case on January 20, 2012. On the facts of the case, the Supreme Court held that Indian tax authorities have no jurisdiction over the transaction which was an outright sale between two non-residents of capital assets outside India. On Azadi, which was effectively reviewed despite not being an issue in the case, the Supreme Court observed that tax planning is not illegal or illegitimate or impermissible and effectively upheld the use of holding structures in Mauritius (or other jurisdictions) to invest into India. The Supreme Court held that FDI in India must be seen in a holistic manner keeping in mind various factors like the duration of time for which the holding structures exists, the period of business operations in India, the generation of taxable revenues in India, the timing of exit, continuity of business upon exit and most importantly, the corporate business purpose of the holding structure. The onus of proof to establish that the structure is a colourable or artificial device is squarely on the Tax Department and such structures can only be ignored if devoid of any commercial substance or if used for abuse or fraudulent purposes such as “round tripping”, tax fraud or other illegal activities.
With a view to address “round tripping” concerns, India and Mauritius signed a Memorandum of Understanding in 2002 in order to improve the exchange of information between the Mauritius Financial Services Commission (“FSC”) and the Securities and Exchange Board of India. The Mauritius Government also took steps to tighten norms for issuance of TRCs by enacting more stringent KYC regulations and anti money laundering laws. The Reserve Bank of India (“RBI”) prohibited Indian nationals from remitting money to Mauritius (amongst other jurisdictions) under the Liberalised Remittance Scheme route.6 Most recently, the Mauritius route was questioned in the 2G spectrum allocation scam where an extensive probe was carried out by the Central Bureau of Investigation together with Mauritius Authorities to obtain all information (shareholding pattern, bank statements etc) of companies that acted as a front for routing money into India in the 2G scam.
India is not the only country with concerns in relation to Mauritius. In 2005, Indonesia terminated its tax treaty with Mauritius on the basis that its government treasury was under assault from round tripping of Indonesian black money. Even China has implemented measures to shield itself from “round tripping” of FDI from Mauritius when it signed a Protocol with Mauritius which amended the Capital Gains and Exchange of Information Articles of their bi-lateral tax treaty, making it harder for Mauritius based companies investing in China to get a capital-gains tax exemption.7 In December 2009, China’s State Administration of Taxation (“SAT”) issued Circular 698 which requires the seller in an indirect transfer of equity interest of a Chinese resident entity to report the transfer to the SAT if the effective tax rate to the seller of a company in the offshore holding jurisdiction is less than 12.5 per cent or offshore income is tax-exempt in that jurisdiction. If the SAT finds the structure lacks business substance or commercial purpose, the seller may then be deemed to have a Chinese-sourced capital gain taxable at 10 per cent, and withholding tax will apply.
Whilst the Supreme Court decision in the Vodafone case ends uncertainty in relation to availability of Mauritius Treaty benefits for past and existing cases, provisions in the proposed Direct Taxes Code (“DTC”) will enable the taxation in India of transactions like the one in the Vodafone case and also through general anti-avoidance rules (“GAAR”), enable the Tax Department to “look beyond” the TRC for substance in the treaty jurisdiction. The decision itself clarifies that it relates to current law and that it will change with the enactment of the DTC.
Going the Singapore Way
The double taxation avoidance agreement between India and Singapore was signed in 1994 (Singapore Treaty). Thereafter in 2005, a Protocol was signed between the two nations with a view to establish Singapore as a hub for foreign investment in India. Pursuant to the Protocol, the Singapore Treaty provides the same capital gains exemption (for gains arising from the sale of shares of an Indian company by a Singaporean resident as contained in the Mauritius Treaty, but with a limitation of benefits clause requiring annual expenditure over S$200,000 (in each of the two years preceding the year in which the gains are realised) to not be classified as a shell/conduit company and avail of Singapore Treaty benefits. Further, the Protocol provides that investors from Singapore will lose the capital gains exemption under the Singapore Treaty if the Mauritius Treaty is amended to take away the corresponding exemption. Very recently, there has been an amendment to the Singapore Treaty to permit effective exchange of information in line with the OECD Model Article on “Exchange of Information” with both countries recognising that exchange of information without regard to domestic law interest requirement and bank secrecy will go a long way in tackling international tax avoidance and evasion.
Whilst the Indian government has done its part to promote Singapore, Singapore has also made changes to its domestic laws to cater to India’s growing appetite for investment. Singapore, in its budget of 2009, introduced the new Enhanced-Tier Fund Management Incentive Scheme (“E-TFMI”). A fund incorporated and resident in Singapore is exempt from tax for the entire life in respect of specified income where the funds are managed by a specified investment manager in Singapore in respect of Designated Investments.8 To avail the exemptions, the fund ought to fulfil certain prescribed conditions and apply to the Monetary Authority of Singapore (“MAS”) before March 31, 2014.9 A fund management company may apply to the MAS for the Financial Sector Incentive – Fund Management Award (“FSI-FM”). Under the award the fee income derived from the services provided to the fund approved under the E-TFMI scheme would be subject to concessionary tax rate of 10 per cent if management/advisory services were being provided to an Enhanced Tier Fund that qualifies for exemption under the E-TFMI scheme.
Importantly, the aforesaid tax exemption is only available for funds set up in Singapore and not to special purpose vehicles or subsidiaries set up in Singapore for making investments in India, whose income from the same may be subject to tax in Singapore (unlike in Mauritius).
Singapore and Mauritius: A Comparative
Some key pros and cons in relation to each jurisdiction are set out in the table below:
A Bi-polar Contest
The choice of jurisdiction for routing investment into India is increasingly a two-way choice between Mauritius and Singapore. Other jurisdictions are not quite as attractive for a variety of reasons, some of which are: (i) Cyprus, which also has the same capital gains exemption as Mauritius and Singapore and more favourable taxation of interest income (only 10 per cent tax in India), does not have a deeming provision (unlike Mauritius and Singapore) to establish “residence” in Cyprus, and is, therefore, under greater threat for denial of treaty benefits; (ii) UAE, which also has a capital gains exemption in its treaty with India, was never a favoured jurisdiction for routing investment in India given ambiguities arising from case law on availability of treaty benefits (on account of there being no tax in the UAE, there is no double tax so the double tax avoidance agreement doesn’t apply). With the protocol entered into 2007, the benefit has now been limited to specified state entities in the UAE and is not generally available; and (iii) other jurisdictions such as Jersey, Luxembourg and Guernsey have recently negotiated/are negotiating double taxation avoidance agreements with India, but none are likely to have provisions as favourable as those contained in the Mauritius and Singapore treaties.
Concluding Remarks
Given both the legislative changes proposed (through the DTC) and the emphasis on the need for corporate business purpose for availing of treaty benefits in judicial decisions, going forward, international tax structuring for investment into India will clearly have to ensure substance and commercial purpose in the treaty jurisdiction to avail of treaty benefits. Whilst it is clearly easier to establish substance in Singapore itself (similar to those available) in Mauritius, some investors (especially those not looking to establish a regional “hub” in a financial centre) may opt to put in place measures to ensure necessary substance in Mauritius rather than shift to Singapore.
► Ashwath Rau *
E-mail: ashwath.rau@amarchand.com
► Pallabi Ghosal
Amarchand & Mangaldas & Suresh A. Shroff & Co
E-mail: pallabi.ghosal@amarchand.com
* Ashwath Rau is a Partner at the firm and also the Deputy Practice Head of its General Corporate Practice (Mumbai Region) and Head of the Funds Team. Pallabi Ghosal is an Associate of Amarchand & Mangaldas & Suresh A. Shroff & Co.
Notes
1 Stefan van Weeghel, “The Improper Use of Tax Treaties”, Series on International Taxation: 19(Kluwer Law International Limited, London, 1998).
2 http://dipp.nic.in/English/Publications/FDI_Statistics/2011/india_FDI_September2011.pdf.
3 In RE: Advance Ruling No. P-9 of 1995.
4 In RE: Advance Ruling No. P-9 of 1996.
5 263 ITR 706.
6 The RBI had announced a Liberalised Remittance Scheme in February 2004 as a step towards further simplification and liberalization of the foreign exchange facilities available to resident individuals. As per the scheme, resident individuals may remit up to USD 200,000 per financial year for any permitted capital and current account transactions or a combination of both. The scheme was operationalised vide A.P. (DIR Series) Circular No 64 dated February 4, 2004.
7 http://www.lowtax.net/lowtax/html/jmu2tax.html.
8 “Designated Investments” inter-aliawould include stocks, shares, units, securities (includes bonds, notes, treasury bills etc) issued by foreign companies designated in foreign currency.
9 Key conditions to be satisfied to enjoy E-TFMI Scheme are as follows:
1. The fund has to be a company, trust (other than a trust that is an approved pension or approved provident fund, an approved CPF unit trust or designated unit trust, or a real estate investment trust) or limited partnership;
2. Minimum fund size of SGD 50 million;
3. Managed by a fund management company in Singapore (which itself has to satisfy several criterions such as having three investment professionals who are earning more than S$3,500 per month and must be engaging substantially in the qualifying activity (such as portfolio managers, research analysts and traders);
4. Incurs at least SGD 200,000 of expenses in each financial year;
5. Should appoint Singapore-based fund administrator;
6. Must not change its investment objectives or strategy after being approved; and
7. Cannot concurrently enjoy tax benefits under other tax incentive scheme.
10 Per the CBDT Circular dated February 10, 2003, if a tax payer is a resident of both countries ie, India and Mauritius, then the Assessing Officer can proceed to treat such tax payer as resident in India provided that the effective management of the tax payer is in India