Investors from Singapore and Cyprus, who have availed an exemption or concessional rate of taxation for investments made before this financial year, may come under scrutiny under a global tax framework that was recently ratified by India.
Last month, the Centre ratified the multilateral instrument (MLI) to prevent base erosion and profit shifting (BEPS). BEPS is the framework by the Organisation for Economic Cooperation and Development (OECD) countries to prevent tax evasion by multinationals, particularly digital companies, which could shift their profit to low tax countries. One of the anti-abuse provisions in the MLI is the Principal Purpose Test (PPT).
Under the domestic General Anti-Avoidance Rules (GAAR) norms, investments before April 1, 2017, are kept out of the tax net. This is after India renegotiated its tax treaties with Mauritius, Singapore and Cyprus in 2016. Based on the new arrangement, Indian equities acquired prior to April 1, 2017, were granted capital gains tax exemption. Shares acquired on or after this period, and sold before April 1, 2019, had concessional tax at 50 per cent of the domestic rate. The MLI, however, does not recognise these exemptions or concessions.
And, since both Singapore and Cyprus are signatories to the MLI framework, any exemption in capital gains or a concessional rate of tax availed by investors from these regions for the said periods could be questioned by the tax authorities. The impact on Singapore investors could be significant, considering the country was India’s top source for foreign direct investment (FDI) in the last financial year. The country put an estimated $16.2 billion in 2018-19 into India via the FDI route compared with $8.1 billion put by Mauritius.
Mauritius is yet to notify its treaty with India as a covered treaty. So, investors coming from the region will not be impacted under the MLI.
“Unlike GAAR, which does not apply to income arising from certain pre-2017 structures, the PPT can be invoked for older structures as well,” said Punit Shah, partner, Dhruva Advisors. Safeguards under GAAR, such as a monetary threshold or access to an approving panel comprising outside experts, will also not be available under the MLI, he added. Provisions of GAAR, for instance, do not apply to arrangements where the tax benefit in the relevant assessment year does not exceed Rs 3 crore. There is no such threshold under the MLI.
“Right now, there is no guidance on the issue from the government. India will have to clarify that grandfathered investments from these jurisdictions will not be additionally subject to the PPT test, once the MLI is enforced,” said a tax expert. MLI could be a game changer and lead to increased litigation between investors and tax authorities owing to its wider applicability than the domestic GAAR.
According to experts, it may be possible that in situations where there is a conflict between GAAR and the MLI, the latter could prevail. This is because GAAR provisions are triggered when the main purpose of an arrangement is to obtain tax benefit. The PPT rule, on the other hand, is applicable even if one of the main purposes is to obtain a tax benefit. Moreover, tax authorities could get a free hand in applying the latter since there is no guidance on how the PPT rule will be applied by them and what constitutes “principal purpose.”