Overseas investors from Mauritius and Singapore may bypass tax treaties

Illustration by Binay Sinha
Overseas investors from Mauritius and Singapore, who realised losses in Indian equities last year, are likely to bypass the treaties in favour of the domestic law for financial year 2019, as the latter will enable them to carry forward their losses. 

While benchmark indices Nifty and Sensex ended in the green, many funds have realised losses in FY19 owing to the acute polarisation of the market. Mid- and small-cap funds, in particular, were on the back foot, losing anywhere from 5-20 per cent, said experts. 

The decision — to come under the treaty or domestic law — is taken every year before tax returns are filed. Funds have an option (but not an obligation) to invoke the treaty, which is provided for under Indian tax laws.

“If the fund opts to avail the treaty, it will have to give up its losses. There are a few judicial precedents that support the view that if income is exempt, the losses cannot be carried forward. However, this will apply only if the funds choose to avail of the treaty benefits,” said a person familiar with the matter.

Funds that evoke the domestic law can carry forward their losses of FY19, and set them off against future capital gains. The tax laws provide for the carry-forward and set-off of losses up to eight years. Funds cannot set off long-term loss against short-term gains. Every other kind of set-off is possible. 

Decisions to alternate between the treaty and domestic law have been challenged by tax authorities in the past. This is a permissible opportunity from a legal standpoint, say market observers, and there have been several judgements from the tribunal upholding the practice. 

“Taxpayers can choose to be governed by the provisions of the domestic tax law or those of the treaty, whichever is more beneficial. To claim a set-off of losses incurred in earlier years, one could choose to be governed by domestic tax law provisions, which the Indian tax law specifically permits,” said Anish Thacker, partner at EY India.

“Some rulings directly deal with the issue of carrying forward losses. The 2017 CBDT circular on GAAR, for instance, says the claim of treaty and domestic law benefits in different years is not a matter to be decided under GAAR. This should provide a level of comfort to taxpayers,” added Rajesh Gandhi, partner, Deloitte India.  

In the past, this strategy was not so helpful as funds that made gains could come under the treaty and not pay taxes on the gains, said experts. “Last year, majority of the funds incurred losses, and coming under the domestic law could prove more beneficial,” said the person quoted above. 

Several funds have also booked losses because of the cost step-up provided in last year’s Budget, with the stock price on January 31, 2018, taken as the cost of acquisition for computing capital gains. 

For instance, let’s say a long-only fund bought shares of company A in 2010 at Rs 10 per share. Assume that the stock price was Rs 150 as of January 31, 2018, and slid to Rs 120 sometime during FY19. If the fund sells these shares at Rs 120, it will technically be considered a loss of Rs 30 (and not a gain of Rs 140) because of the cost step-up. This fund might, then, want to make use of the domestic law to carry forward its losses.

To be sure, funds that have made gains in FY19 may yet evoke the treaty to avail of the grandfathering benefits. India had renegotiated its tax treaties with Mauritius and Singapore in 2016. Based on the new arrangement, Indian equities acquired prior to April 1, 2017, were grandfathered and granted capital gains tax exemption. Shares acquired on or after this period, and sold before April 1, 2019, had to pay concessional tax at 50 per cent of the domestic rate.

Equity investments on or after April 1, 2019, will be taxed 10 per cent for investments greater than one year, and at 15 per cent for those below a year. Foreign portfolio investors were net sellers in seven of the 12 months in FY19, with net investment totalling Rs 170 crore.

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