Opportunity for debt structuring through Mauritius

Background

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:

  • Through fully and compulsory convertible debentures under the Foreign Direct Investment (“FDI”) route;
  • Through purchase of Non-Convertible Debentures (“NCD”) of an Indian company  on the stock exchange under the Foreign Portfolio Investment (“FPI”) route;
  • Through purchase of NCD and /or optionally convertible debentures (“OCD”) of an Indian venture capital undertaking or a venture capital fund under the Foreign Venture Capital Investment (“FVCI”) route.

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:

dept structuring
 

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 :

dept struturing 2
 
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:

  • Rule of law in Mauritius; the ultimate court of appeal is the Judicial Committee of the Privy Council in United Kingdom and this adds substantial confidence around the legal parameters of a transaction. In addition, Mauritius is already positioning itself as an International Arbitration Centre for resolution of conflicts between commercial parties;
  • Contracts certainty; there is a modern legal and regulatory framework in place in accordance with international standards;
  •  Mauritius is an established, tried, tested and trusted jurisdiction with lower administration costs and skillsets compared to other competitor jurisdictions:
    • a) Young, talented and qualified workforce that carries out legal, secretarial, and accounting tasks associated with companies;
    • b) Adopted international financial reporting  standards, but can also adapt to report under internationally acceptable accounting standards such as US GAAP, UK GAAP, SA GAAP, etc.
  • Mauritius enjoys a favourable time-zone with India which aligns with market activity
  • An Investment Promotion and Protection Agreement (“IPPA”) is in place to give investment protection against expropriation and nationalization;
  • No foreign exchange control to allow redeployment of capital to other projects without RBI intervention;
  • Mauritius is a participant in the OECD initiative on BEPS, which demonstrates the country’s willingness to adhere to international standards;
  • Signatory to tax exchange information agreements which allows for transparency
  • The Mauritius Revenue Authority entertains information exchange requests from the competent authority in India and these are being discharged to the satisfaction of the Indian authorities
  • Financial Services Commission of Mauritius has signed MoU;
    • a) With Securities Exchange Board of India that allows exchange of information between the two regulators;
    • b) With European Securities and Monetary Authorities for the implementation of the Alternative Investment Fund Managers Directive.
       

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:

  • Management/operations – provision of administration services at a low cost, including preparation of financial statements in accordance with the applicable accounting standards.
  • Legal and compliance – provide the necessary support to ensure compliance with the Mauritius regulatory framework
  • Directorship services – provision of Mauritian resident directors having appropriate experience and skills to fulfil director duties.
  • Meetings – organise regular board meetings with a majority of Mauritian resident directors being physically present in Mauritius.
  • Rental of office spaces – provision of office space in Mauritius along with the necessary infrastructure to support the office.
     

For any additional information, feel free to contact:

Shamima Mallam-Hassam
Head of Business Development
Cim Global Business
Email: Shamima.Mallam@cimglobalbusiness.com


Gary Gowrea
Head of Structuring
Cim Tax Services
Email:Gary.Gowrea@cimglobalbusiness.com

* 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.

 

Disclaimer:
This document is a copyright of Cim Global Business. No reader should act on the basis of any statement contained herein without seeking professional advice. Cim Global Business and its officers expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.