Indian Economy News

Expert group to guide FIIs on capital gains tax, GAAR rules

New Delhi: The finance ministry is setting up an expert group to work out the modalities of implementing changes in the tax regime stemming from the withdrawal of a capital gains waiver to foreign investors coming through Mauritius.

Not only is this expected to pre-empt any potential confusion, it will also assuage foreign investors who are facing twin changes in the tax regime.

From 1 April 2017, the government will withdraw the capital gains benefits under the India-Mauritius tax treaty and implement general anti-avoidance rules (GAAR).

GAAR is a measure that will empower the tax department to closely scrutinize transactions designed to avoid tax.

“We have been in a series of consultations with portfolio investors, private equity and venture capital funds. No one has a problem with GAAR or with the tax treaties being changed. Their concern is more on compliance,” said Jayant Sinha, minister of state for finance, in a recent interview.

Changes in the tax treaty with Mauritius will mean that foreign portfolio investors (FPIs) will now have to pay short-term capital gains tax in India on investments held for less than one year. Due to the linkage between India’s treaties with Mauritius and Singapore, this would also apply to investors coming in from Singapore.

To ensure a smooth transition, the government has decided to bring together all stakeholders to ensure clarity on how short-term capital gains tax will be levied and accounted for.

“Earlier, there was no short-term capital gains tax. Now there will be short-term capital gains tax. How will the taxes flow through the system? How do they account for it? How do they book it? How do they distribute it back to their shareholders? That is really their concern,” Sinha said.

“We are going to create a working group where we will bring together all the stakeholders—the accounting firms, the custodians, the investment managers, the tax authorities—who can work through all the details to make sure that all of this is done in a smooth and efficient manner,” he added.

As per the revised India-Mauritius tax treaty, India has got the right to levy tax on capital gains arising from transfer of shares in Indian resident companies. Though the long-term capital gains tax on transfer of listed securities is 0%, the short-term capital gains tax is 15%. This means that FPIs who sell their shares within 12 months will be taxed in India.

To be sure, investors have been given a two-year transitionary period wherein only 50% of the capital gains tax will be levied in India till 2019.

Sinha added that investors need clarity on how they can claim tax credit in their resident country for taxes paid in India.

“There will be a short-term capital gains tax in India. It then goes through the fund to a taxpayer in the US or UK. What statement has to be created so that they show that they have paid this tax in India so that they can get a tax credit for it in the US or UK on account of the double taxation avoidance treaty?” he said.

Sinha said the government does not expect any impact on foreign investment flows into India because of changes in the India-Mauritius tax treaty or the implementation of GAAR.

“GAAR is becoming a global movement... Mauritius, Singapore, Cyprus and all these jurisdictions are falling in line with GAAR. What that is doing is squeezing out the unchecked opaque capital flows that no country wants. That is what is going to be impacted. But as far as India is concerned, it is such a minimal portion of the total capital flows that India gets, I think we should be able to move forward quite smoothly,” he said.

Around 50% of foreign direct investment into India comes from Mauritius and Singapore, as per data available with the government. Also, according to data available with National Securities Depository Ltd, almost 31% of the total assets under the custody of FPIs is with investors from Mauritius and Singapore.

“A consultative process to limit the confusion and the tax leakage is a good idea. Investors will be fine in paying the short-term capital gains tax in India as long as they can claim the full tax credit in the resident country,” said Rahul Garg, leader of direct tax practice at PricewaterhouseCoopers, a consulting firm.

Disclaimer: This information has been collected through secondary research and IBEF is not responsible for any errors in the same.

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