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Investment pipeline charts a different course on its way to India

Indian industry’s top league has begun to get large investments from abroad, changing a trend in which expectations of inflows usually surpassed the actual outcomes. While the over $10 billion raised by Reliance Industries for its Jio Platforms has become the face of this recent flow, there is some serious money raising happening in the infrastructure space as well. Tata Power has joined Larsen & Toubro, Sterlite and Piramal Enterprises to create investment trusts for operational infrastructure assets, all of which have already attracted investments from abroad. This was a space in which investment inflows were most sluggish. 

As the money has begun to pour in, it is also changing the route through which it has begun to arrive. Cayman Islands and British Virgin Islands have registered cricket score like growth rates of 267.29 per cent and 469.3 per cent in money sent to India. And all of this is happening, when India has raised fresh barriers against foreign investment from China. And a lot of companies, fretting global scrutiny are beginning to operate from their home base, without tax arbitrage. 

Island journeys: 

While Singapore and Mauritius remain at number one and two as per data released by the department for promotion of industry and  internal trade last week ($14.6 and $8.2 billion in FY20), growth from there has flattened out. Instead the inflow from Cayman island for FY20 is already close to half that from Mauritius, the most favoured route for putting money into India for two decades. Money from the African island had made up 30 per cent of all FDI into India since the year 2000. The $11 billion Vodafone investment to buy out Hutchison’s investment in the Indian telecom sector that spectacularly blew up as the “retrospective tax case” was through the Mauritius route. 

Girish Vanvari, key founder of Transaction Square, a tax regulatory and business advisory firm agrees with this assessment. “It is a complete sunset point for the flows through Mauritius,” he says adding that there will be future investment from Mauritius but no growth. Data bears him out. In FY20 the total FDI from Mauritius to India grew by just one per cent when aggregate inflow into India from all over the world grew at 12.64 per cent. FDI from Singapore, which accounts for 21 per cent of money into the Indian market, has fallen by close to 10 per cent.

The globe too, it would seem, does not want to finance exposure to India through the Mauritius route any more. This month, the European Commission had announced the inclusion of Mauritius in a new list of countries which, according to the Commission, had strategic deficiencies in their anti-money laundering and counter terrorism financing (AML-CFT) regimes. Port Louis was shocked. “Government is determined to convince the European Union to remove Mauritius from this list”, a release issued by the Prime Minister’s Office of the nation said. 

Once the European Council and the European Parliament adopts the high risk third-country list that would become effective from October 1, 2020, it will be extremely difficult for any European company to put any dollars through Mauritius. Hitesh Gajaria, head of tax practices at KPMG said he was not surprised. He says high net worth families from the UK, for instance, often operate trusts with “impeccable credentials” based in the British crown colony, Jersey island. “For investments into India through those trusts, the favoured route was the Jersey-Mauritius-India route. With the European Commission stricture, it takes the Mauritius route out and we should not be surprised to see the money coming directly from Jersey”. 

Or from the Cayman islands. The UK overseas territory is ranked as the world’s leading centre for hedge funds and investment trusts. As a Deloitte note puts it, “The Cayman Islands is the recognised leading jurisdiction for fund formation.” While it too has been blacklisted as a tax haven by the European Union this year, just months after the UK’s Brexit came into force, yet given its huge role in the world of finance, it is inevitable that more money will come into India from it now. 

Multinationals like a Facebook or a sovereign wealth fund like Saudi Aramco would not need to discover advantageous tax entities when they deploy money across the globe. They have established favourites. For smaller investors however the tax havens provide immense service, globally. They provide pooling mechanisms for investors and scour good recipient countries, services that the investors value. This is where the financial markets of Hong Kong, Singapore, Mauritius or Cayman islands score. However the inclusion of Mauritius on its caution list by the European Commission could be costly for the island. In its rebuttal, the Mauritius release notes “Placing Mauritius on the blacklist will cause irreversible damage to our reputation. This will undermine investor confidence, reduce cross-border investment flows and lead to a severe disruption of our banking system. As a result, further harm will be caused to our economy”.

Mauritius had climbed in importance as a financial centre once India gradually opened its economy to foreign money since 1991. The India-Mauritius double taxation avoidance agreement of 1982 meant any money from the island invested into the Indian stock market was exempted from capital gains tax, unlike domestic investors. Since 2000 Mauritius remained synonymous with inflow of foreign money into India and led to several court cases which sought to clip the act. Almost every stock market rout was often seen as connected to the flow of money from there and had vast political repercussions. The government set up more than one committee to examine the issue including one headed by former CEA, Ashok Lahiri. One of the issues it examined was whether the flow was “hot money”—of short duration and therefore prone to make the stock markets volatile. The Lahiri report said it found no evidence  of such behaviour but still went on to suggest measures for more disclosure of the source of the money. One of those was there should be more curbs on Participatory Notes or P Notes, the certificate issued by registered portfolio investors to overseas investors who wish to participate in the Indian stock market without registering themselves. Most of the P-Notes were from Mauritius as those could be registered there easily. Those were known as post box entities, just a mailing address in Port Louis, without any substance. At its peak, P-Notes accounted for over 50 per cent of the money flowing into the Indian stock market, some thing that successive Indian governments tried to raise the bar against, but without success.

These measures finally succeeded at the review of the double taxation avoidance agreement in 2017. India decided to charge a capital gains tax on all investments from the island at the same rate as applicable for domestic investors. As Vanvari said “Mauritius immediately began to lose out as it was easier for an investment company to demonstrate it had build a substantive presence in Singapore and so was eligible to get a tax set off”. India had signed a Comprehensive Economic Cooperation Agreement with Singapore in 2005 which gave foreign investors the same advantage as Mauritius but with the necessary safeguards. But this route too has begun to lose steam. Foreign investment from Singapore has dipped 10 per cent in 2019. The share of P-Notes too has shrunk to less than 5 per cent of the total portfolio investment into India.

Does the origin matter for India?

Should the changing flow again be of concern for India? All experts agree there is no reason to be so, even though geographies like Cayman Islands have no tax avoidance treaty with India. Yet, it is also under the watch of the European Commission. 

India’s tax policies have also matured. Between 2014 and 2018, India has sorted out over 600 tax disputes with multinational companies under what is known as the mutual agreement procedure or MAP. There are high profile arbitration cases like Vodafone and Cairn outstanding but the government is showing efforts to resolve tax disputes “within a time frame of 24 months” a  released issued last month by the Central Board of Direct Taxes notes. Vasal says in the new scenario, India’s tax authorities need not be bothered, so far as the Indian tax rules are adhered to, unless there is regulatory violation or its discovered that investments are coming through round tripping (i.e. domestic illegal money taking a circuitous route to come back to Indian stock markets).

“Quite a lot of the rising popularity of Cayman and other nearby territories has to do with Brexit too”, says Amitendu Palit, senior research fellow at the Institute of South Asian Studies at National University of Singapore. Palit who has studied FDI flows for a long time says, till the tax treatment of UK with the European Union settles down, investors would prefer its overseas territories like both Cayman, Jersey or the British Virgin Islands. “In any case foreign money coming into India is usually brownfield. So the tax treatment is of enormous importance”, he said. 

It shows in the data too. The Unctad report on FDI shows of the $49 billion India got in calendar year 2019, the majority went into services industry, especially IT. These were largely investments into existing assets. The major investments expected in 2020 like the ones into RJio and those into investment assets are also for built up assets.  The insurance sector companies have begun to receive money from abroad with quite a bit of it emerging from Bermuda, which is one of the biggest global hub for the sector.  The Association of Bermuda Insurers and Reinsurers have a $100 billion annual turnover, about a third of India’s insurance market. 

Gajaria says these too could be on the wane. The Brexit hiccup, he feels, is a short one. More investors now prefer to operate from their home base than use a tax haven. “It has plenty to do with how they want to be perceived as corporate citizens. For all fresh investments companies are willing to undergo harder scrutiny by the host country. They say, OK let us reconsider everything”. Following the European Commission example, if RBI too decides to raise the red flag on investments not only from Mauritius but also Cayman, the multinationals would not want to be caught off-guard. 

Palit says, the one element of financial flows that would still be drawn to the tax havens would be Chinese money. “The eclipse of Hong Kong could certainly turn this category of investors footloose. Since they cannot come from Shanghai (India has put all investments with Chinese origin under approval instead of automatic clearance), it is quite certain they will prefer Bermuda or Cayman as a base”. India may have to consider this possibility in some years, but it will need to unearth evidence before it can do so. 
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