India-Mauritius treaty: Now, quasi-equity likely to be taxed

Private equity (PE) investors and venture capital (VC) funds from Mauritius might have to negotiate terms to advance the dates of conversion of their instruments into equity before April 1, 2017, if they don’t want to draw capital gains tax. This is so, because the government is likely to tax quasi-equity instruments, if these are converted into equity after April 1, 2017, under the revised India-Mauritius double taxation avoidance agreement (DTAA).

“The government’s view is what the protocol clearly states. Securities converted into equity after April 1, 2017, will be taxed. We will come out with a clarification on this through a circular,” said a government official, who did not wish to be named.

Quasi-equity is a category of debt taken by a company that has some traits of equity, such as being non-secured by any collateral.

A committee comprising officials from the Central Board of Direct Taxes (CBDT), the Securities and Exchange Board of India (Sebi), Franklin Templeton and HSBC has been deliberating on key concerns of investors regarding the revised treaty, including conversion of quasi-equity securities such as compulsorily convertible preference shares (CCPS) or compulsorily convertible debentures (CCD).

The circular will be issued, once the committee gives its views to the finance ministry by September, the official said, adding the issue was raised at the committee meeting.

CBDT chairperson Rani Singh Nair told Business Standard in an interview that the government would give out a clarification on concerns raised on tax treatment under the Mauritius-India tax protocol. “It will bring a certain amount of clarity and certainty.”

India amended the DTAA with Mauritius in April, allowing it to impose capital gains tax on shares. Companies routing funds into India through Mauritius from the next financial year will have to pay short-term capital gains tax at 50 per cent of the prevailing rate during a two-year transition period beginning April 2017. The short-term capital gains tax rate in listed securities is 15 per cent at the moment. This means that for a two-year transition from April 1, 2017, the capital gains tax will be levied at 7.5 per cent. The full rate of 15 per cent will be imposed from April 1, 2019 onwards. There is no long-term capital gains tax on listed securities.

Several Mauritius-based entities, especially PE and VC funds, use instruments such as CCPS and CCD for their investments in Indian entities.

The same tax treatment would apply to these instruments.

However, PE and VC funds from Mauritius are generally into unlisted securities, though many of them are also into private investment in public enterprises (PIPE). To cite an example of PIPE, in May, listed firm PC Jeweller raised Rs 427 crore from DVI Fund Mauritius. “The board of directors of the company allotted 4.27 million compulsorily convertible debentures having a face value of Rs 1,000 to DVI Fund (Mauritius) Ltd for an aggregate amount of Rs 427 crore,” PC Jeweller had told BSE.

Unlisted shares draw long-term capital gains tax at 20 per cent, if these are indexed to cost inflation and, 10 per cent, if these are not indexed.

So, those converted into shares would draw a tax rate at 10 per cent or five per cent in the transition period and 20 and 10 per cent after April 1, 2019, depending on whether the instruments are indexed or not in the long-term.

According to Bloomberg data, some prominent Mauritius-based vehicles that have invested in India this year include Apollo India Private Equity, Intel Capital (Mauritius) Ltd, Norwest Venture Partners, SAIF Partners FII Holdings, Standard Chartered Bank (Mauritius), QVT Mauritius Fund - FCCB, FIL Investment (Mauritius). Even Singapore's Temasek Holdings has a Mauritius vehicle called Aranda Investments Mauritius Ltd, which it uses to invest in the Indian market.

The US tops the list of PE and VC firms with over 500, and Mauritius takes the ninth place with 19 such firms, according to Prime Database data. However, out of 147 funds or vehicles, which these firms use for investment for which domicile data was available, 145 were based in Mauritius. Only two funds were registered in Singapore.

Investors are concerned about quasi-equity instruments purchased before April 1, 2017, but converted and sold after that.

"Yes, there are concerns related to convertibility and the tax treatment that were raised during the meeting. But, we can't go beyond what the protocol states. It can only be clarificatory in nature," said the official.

Amit Maheshwari, partner of Ashok Maheshwary & Associates LLP, said: "We were hoping that tax would kick in on those quasi-equity instruments acquired after April 1, 2017."

But, since the government is going to tax even those instruments which were acquired before April 1, 2017 but converted after this date, those holding these instruments would rush in to revise the terms of instruments to advance conversion of these into equity before April 1, 2017.

Revision of terms is not easy as these are made based on certain parameters, he said. But, even then, holders of these instruments would try their best to do so as not to draw capital gains tax.

It would not affect foreign fund flows as the money has already come into India from the instruments acquired and there is clarity regarding tax structure after April 1, 2017, Maheshwari said.

Some of these entities might shift to other jurisdictions, he added.

Investors such as PE and VC funds had put in almost $20 billion in India in 2015.

The concessional rate of 50 per cent for a two-year transition period from April 1, 2017 would be subject to fulfilment of conditions in newly-inserted Limitation of Benefit clause in the treaty. This would apply to those entities which will incur an expenditure of at least Rs 27 lakh in Mauritius in the previous financial year.

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel