Top FPIs Raise Concerns with Sebi Over Mauritius Treaty, GAAR and Participatory Notes

Officials of more than 20 offshore asset managers, belonging to top banking groups and fund houses, met Sebi chairman UK Sinha and other senior officials of the regulatory body here on Wednesday to get a sense of the ongoing talks with Mauritius, the future of General Anti-Avoidance Rule (GAAR) which would come into force in 2017, and the proposed restrictions on transfer of participatory notes (P-notes) among other things, two persons who attended the meeting told ET.

Overseas investors coming through Mauritius and trading on Indian stock exchanges are spared of the 15% tax on shortterm capital gains. Their worries have been stoked by a recent statement by the former finance minister of Mauritius that stock market gains could be taxed in India under the revised treaty.

Scrapping the tax benefit could have ripple effects as foreign investors coming from Singapore would also find their short-term capital gains taxed in India. The tax treaty that India signed with Singapore is categorical that if investors coming from Mauritius are taxed in India, so will be ones coming from Singapore.

"The regulator assured that the views would be conveyed to the government. It also said that any change in P-note rules would be made after considering all the feedbacks and views," said a person representing one of the global investors. FPIs are also looking for some clarity on GAAR as "2017 is not that far off ", he said. 

According to GAAR, a rule to curb treaty shopping, Mauritius investment vehicles lacking commercial substance would be challenged by the Indian tax office. Since GAAR did not specify what constitutes "substance" it rattled offshore investors when the rule was proposed in 2012.

Security law experts and fund managers are hoping that the renegotiated treaty with Mauritius would specify the conditions that remained unstated in GAAR rather than entirely doing away with the tax exemption to investors from Mauritius.

"The revised treaty could introduce certain limitation of benefit (LoB) clauses that would require overseas investors to fulfil certain conditions like spending a minimum amount annually in Mauritius, setting up office, hiring local employees for claiming tax benefit. This could be similar to the LoB conditions in the Singapore treaty, though the amount that may have to be spent in Mauritius would have to be lower that annual expenditure required in Singapore," said a senior securities lawyer.

Some believe that the revised treaty could even lower the withholding tax - the tax that is deducted from interest income before the money is remitted to foreign investors - for foreign investors holding Indian bonds and debt instruments.

After GAAR was announced, many foreign institutional investors moved their investment vehicle from Mauritius to Singapore, fearing that investment structures in Mauritius could be questioned by the Indian tax authorities while clear cut LoB conditions defined in the treaty with Singapore would enable them to avoid capital gains tax in India.