India Changes The Rules For Taxation Of Investments From Mauritius

by Mandy Robinson, Tax-news.com, London

24 April 2001

The Indian Taxation Department's Authority for Advance Rulings (AAR) has ruled that gains on the sale of shares in an Indian company generated by a Mauritius-based private equity fund will be viewed as business profits and not as capital gains. Presumably the AAR's logic is that the activity being carried on in India is one of investment, which constitutes the trade of the fund in question. It might have reached a different conclusion if the holding had been in the hands of a trading rather than an investment company. The AAR also ruled that since the private equity fund's presence in India consisted only of an Investment Adviser and a Custodian, this did not amount to a Permanent Establishment - hence the business profits in question would not be taxed in India.

The effect of this ruling, on the surface, would appear to be that there is no advantage to holding an interest in an Indian company through Mauritius, if the eventual gains on sale are going to be repatriated to a high-tax country where they will be taxed on the same basis as if they had been held direct. In practice, we are talking about the USA here, since a high proportion of the Mauritian holding companies which have invested in India have done so with US capital.

The key benefit of investing through Mauritius was that capital gains tax exemption applied under the Indian-Mauritius tax treaty. But now that gains on shares will be regarded as business profits, funds will now be regulated - by default - as if they were under the US treaty. Thus it is expected that the new ruling will attract other foreign-based venture capital funds to India particularly those from the United States because funds can now be eligible for exemption of business profits if they do not have a permanent establishment in India.

However, some tax experts have argued that the practice of routing investments through subsidiaries in Mauritius could continue because the Indian tax authorities may eventually insist that there is a permanent establishment even if there is just one investment advisor in India - only time will tell.

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