A Protocol amending the long established Mauritius-India double taxation avoidance treaty (“Treaty”) was signed on 10 May 2016 between the Government of Mauritius and the Government of the Republic of India. A number of amendments are expected to become effective under the revised Treaty, one of which relates to Article 11 on Interest.
As from 1 April 2017, withholding tax on interest arising in India and paid to a Mauritius resident company will be limited to 7.5%, compared to the existing provision under which the Indian domestic rate of 20% (plus surcharges) applies.
As far as capital gains are concerned, a gain arising on a sale of debt investments held by a Mauritius resident company in an Indian resident company remain unaffected under the Protocol, and will continue to be exempted from tax in India.
Following the above amendment, debt structuring through Mauritius is likely to become an attractive proposition for foreign investors seeking to invest in India.
The returns to foreign investors from India may be structured as capital gains or interest income, which should substantially reduce the effective tax liability.
Offshore debt funding
There are various ways that an investor could contemplate providing debt into India (other than external commercial borrowing). These include the following routes:
Instruments which are not fully convertible are considered external commercial borrowings and are governed by the ECB regime. Currently, the withholding tax on interest payments in respect of such instruments is 5%. The ECB regime however, requires RBI approval.
Using Mauritius as an intermediate jurisdiction
The use of Mauritius as an intermediate jurisdiction for investment into India may enable foreign investors to minimize tax leakage on the investment whilst also satisfying the commercial requirements of the envisaged transaction.
Illustrative scenario for using Mauritius as an intermediate jurisdiction:
One of the key benefits of debt structuring from a tax perspective, is that the interest accruing on the debt should be tax deductible by the Indian company (at the standard Indian corporate income tax rate of 30%), provided the local thin capitalization rules (ratio of debt to equity), if any, are satisfied.
This benefit may also be impacted by other tax leakages that may apply when interest expense is repatriated to the lender. In the present case of an Indian borrower and a Mauritian lender, the tax implications of a debt funding into India via Mauritius should result in a net benefit of 19.5%, as illustrated below :
Common types of debt investment opportunities:
a) Non-Convertible Debentures
In order to raise finance, the Indian Target company may issue Non-Convertible Debentures (“NCD”) listed on the Indian Stock Exchange. The NCD is governed by the FPI route, as indicated above. Listing of non-convertible debentures on the wholesale debt market of the Bombay Stock Exchange and the appointment of required intermediaries (Debenture trustee, Rating agency and Registrar/transfer agent) is a fairly simple and straightforward process (may take about three weeks).
In order to undertake this investment, the foreign investors may pool funds together in a Mauritius SPV vehicle, which in turn, will purchase the listed NCD on the Indian stock market.
From a tax perspective, the interest expense should be tax deductible in India although a withholding tax rate of 7.5% will apply when interest payments are made to the Mauritius SPV. From a Mauritian tax perspective, the interest income will be taxed at an effective rate of 3% only. On an exit, the NCD may be sold on the floor of the stock exchange. Under the Protocol, if there is disposal of any property other than shares, the capital gains will only be taxed in the resident state i.e. any gains arising on the sale of the NCD will be taxable in Mauritius only. As there is no capital gains tax in Mauritius, the investor will benefit from a tax free exit.
Debt investments could also be structured via Compulsorily Convertible Debentures (CCDs). Such instruments could be converted into equity prior to an IPO process or sold directly to third party buyers upon a private sale. In these scenarios, a tax free exit should continue to be available to the investors.
b) Distressed debt opportunities
Based on recent statistics from the Reserve Bank of India, there has been a sharp rise of Non-Performing Loans (“NPLs”) held by Indian debtors and this is expected to continue in the foreseeable future. In order to boost foreign investment in this sector, the Government of India brought recent changes to facilitate foreign investment in Asset Reconstruction Companies ("ARC") which is a mechanism that may be used by foreign investors to acquire distressed debts in India.
In order to undertake this investment, a foreign investor may set up a fund company in Mauritius, the sole purpose of which will be to take over distressed debts in India at price below the face value of the NPLs via an ARC. Until the company affairs are settled, the Mauritius Fund may continue to derive interest from India during the life of the investment and benefit from the low withholding tax rate of 7.5%. Depending on how the ARC is structured in India and the applicable regulatory regime, Investors may be able to benefit from a tax free exit in the event that a gain is realised upon maturity of the NPLs.*
c) Exchange Traded Funds (“ETFs”)
Foreign investors may also consider investing into the Indian debt market via Exchange Traded Funds which are listed and traded on the Indian Stock Exchange. Globally, ETFs have opened a whole new spectrum of investment opportunities for retail as well as institutional money managers. ETFs enable investors to gain broad exposure to entire stock markets in different countries and specific sectors with relative ease, on a real-time basis and at a lower cost than many other forms of investing.
In order to undertake such investments, foreign investors may consider setting up an ETF vehicle in Mauritius which would invest in the bond market in India. Any interest payments made to the Mauritius ETF vehicle would be subject to a withholding tax at a rate of 7.5%. As above, no capital gains tax should arise on an exit.
The impact of GAAR
With the introduction of GAAR, investors have to be mindful of the need to build adequate substance in the Mauritius structure to demonstrate the commercial rationale of investing through Mauritius. There are a plethora of reasons which support this rationale:
How can Cim Global Business assist?
Cim Global Business has more than 20 years of experience in corporate and fund establishment and administration. We regularly advise global corporations and private equity funds on international tax structuring matters in respect of a wide range of cross-border investments.
We also provide various services which help investors build adequate substance in the Mauritius structure whilst also supporting the commercial rationale of investing through Mauritius.
Some of the key services offered by Cim Global Business in this respect include:
For any additional information, feel free to contact:
Head of Business Development
Cim Global Business
Head of Structuring
Cim Tax Services
* Appropriate legal advice should be obtained by Investors prior to implementing the ARC structure to ensure the commercial objectives of the transaction may be incorporated into a tax efficient acquisition structure within the applicable regulatory framework.
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