Experts & Views
India is shutting down its tax havens: Why this may be a good thing.
Much has been written over the past few years about the "Mauritius route" and the "Singapore route", and how these offshore island jurisdictions are in use for avoiding tax by foreign investors as well as misuse by Indian residents who route money back into India through "round-tripping", thus curtailing the true source of funds and evading taxes. The revenue loss over the past few years has increasingly jarred the Government of India, and contributed to the chorus for renegotiating India's tax treaties with Mauritius (and Singapore).
Mauritius, a relatively small African island nation has been one of India's largest foreign investors with a disproportionate amount of investment being channeled through its companies and funds. To enable this, Mauritius has over the years developed and marketed its legal and judicial system, rule of law and ease of doing business as contributors to its place as an offshore financial center, worthy of routing large investments through into India.
India also has a protocol with Singapore that provides for the same treaty exemptions as Mauritius, and which benefits fall away at the same time as Mauritius. This way, the Indian government had over the years quite intentionally opened up Singapore and Mauritius as jurisdictions that are attractive to channel funds into India.
The necessity of routing money through Singapore or Mauritius
In the context of startups and venture funded companies with long gestation periods where investors make money when the companies (or their shares in the companies) are sold, routing investments through Singapore and Mauritius made sense given that these countries do not tax capital gains. In India, long terms capital gains due to sale of shares in private companies are chargeable at 20% of the gains. Therefore, it was prudent and absolutely necessary for responsible legal and tax advisors to recommend that foreign investments into India are channelled through Mauritius or Singapore as this would impact gains by 20%, which would have otherwise been taxable in India.
The circus Indian businesses had to engage in:
Given the necessity of providing foreign investors a tax efficient way to invest in Indian companies, any reasonably sized or growing Indian company was required to set up shop in Singapore, and subject its Indian business to holding relationship with a Singapore company, i.e. restructure the business to have a Singapore company hold shares in the Indian company. In some cases, while this entity would be used to solely reflect foreign shareholding, in other cases, the Indian investors and promoters would hold their interest in Indian businesses out of the Singapore holding company.
This created an industry of India-Singapore/ India-Mauritius structuring and advisory work, and booming industry of legal, tax and secretarial professionals in India, Singapore and Mauritius who specialise in creating tax friendly structures to channel money into India. More importantly, it also made the best and most promising of Indian businesses have to subject themselves to Singapore shareholder arrangements and exposed their businesses to Singapore laws, regulatory and the judicial system. More the merrier for Singapore (and Mauritius) professionals, government and economies.
So much so, that even though these are Indian businesses generating revenues in India and with their costs being incurred in India, Singapore touted their presence in Singapore as a part of Singapore's startup story and attractiveness as a financial centre. This is for most part untrue and largely untested, as opposed to India's considerably mature legal and regulatory system which is the result of a democratic feedback process (though with its own share of frustrations) .
The cost of "externalising" startup businesses to Singapore and exposing your business to Singapore laws, lawyers and accounting professionals can not only be frustrating but prohibitively expensive. Over the past few years, a large amount of corporate and tax work relating to Singapore companies in being done onshore and Indian legal, tax and accounting firms have focused on ensuring that the Singapore/Mauritius structure is handled as much as possible by deploying Indian talent and expertise, ably and cost effectively in India. This does not however mean that misadventures do not cost money, or that English barristers do not have to be flown in for a Singapore arbitration. The distortions introduced by "externalisation" the idea seemed to be, would eventually be offset by the capital gains tax exemption available to the investors.
The Singapore and Mauritius routes are complete unnecessary
If the Government of India created tax avoidance windows that benefit foreign investors in general to attract foreign investments, it seems incongruous that domestic investors who are usually the first investors and Indian promoters feel compelled to invest in Indian business without the available tax exemptions. That is to say, if the fundamentals of the business and its growth are attracting domestic capital (subject to capital gains tax), there is no reason to believe that foreign investors will not likewise be compelled.
In many cases, the structure lent itself to Indian resident promoters and investors moving their shareholding to Singapore or Mauritius, sometimes in a compliant manner, say by not taking money out of India (and being accused of round-tripping) but merely holding their shares out of Singapore or Mauritius, i.e., by transferring shares in offshore entities to themselves by way of gift after having invested in the India entity. This has taken out shareholder wealth in Indian businesses out of the purview of Indian tax and legal supervision, and given the opacity of Singapore companies, reduced the amount of information available to Indian regulators, professionals and media. In addition to tax avoidance, new windows are being created for irresponsible corporate governance and inability of small shareholders to exercise oversight. Most of all, despite an active and exciting startup ecosystem, companies were by and large moving to Singapore - thus affecting India's vision to be perceived as an entrepreneurship and innovation hub (which it is).
The Indian backlash
The alarm bells seemed to have started ringing over the years. In 2010, India introduced the "general anti avoidance rule" (GAAR) which forbid any and every sort of tax avoidance structuring, legal or illegal. This has been put in abeyance, though it is widely expected to kick-in in 2018/19 as recently declared by the Finance Minister (Government of India). One good reason to put GAAR in abeyance has been its conflict with tax exemptions agreed by India under its treaties with Singapore and Mauritius to which India is bound by international law.
India also commenced other legal and regulatory measures. Through amendments to foreign exchange notifications, India made it impermissible to take money from India directly or indirectly to Mauritius towards investments. Companies with Mauritius connections or investments have been subject to greater tax and regulatory scrutuny. For a while, India has thus been indirectly looking to do what cant be achieved directly - strangulating round-tripping opportunities along with legally permissible tax avoidance involving Mauritius (and sometimes Singapore).
The tax exemption windows are shutting. And its a good thing.
It appears now that the tax exemptions available under both of the tax treaties will partially cease starting from the financial year 2017/18 and completely 2 (two) years thereafter. This implies that the Singapore and Mauritius routes will soon be dead. The approach of the Government of India appears to be to ensure that tax avoidance routes are closed to investors, and capital gains must be taxable in India for Indian businesses. The introduction of GAAR will provide (questionably) wide ranging powers to the Indian tax authorities to go behind structures that result in the avoidance of tax and routing of money through offshore jurisdictions and to tax transactions using the test of substance over form.
As someone who works with foreign investors, one may ask why I feel this is good news. Is this going to affect foreign investment in India? I don't think so, as it is a highly questionable argument that the decision to invest in India is driven by capital gain tax exemptions in offshore tax havens. Foreign investment in India rides on the back of Indian entrepreneurship, domestic investment, opportunity of India's market and its growth story. If the 20% tax on long term capital gains isn't swinging it for other shareholders in Indian companies, I don't see why foreign investors would see it any other way (not commenting on hedge funds or speculators which are not in the scope of this article and should not impact long term policy measures).
As a corporate lawyer, I am delighted that Indian businesses will return to Indian shores lock, stock and barrel, and rid themselves of the unnecessary burdens, costs and uncertainties of opening themselves up to Singapore (or Mauritius) legal systems. It is fair that shareholders in an Indian business are taxed on their gains in the same manner, irrespective of whether they are resident or non-resident investors. A large leak in the tax revenues of the Indian government has been plugged, i.e., of tax revenues that are in principle owed by an Indian business for the growth of its business in India. The rules of the game will be simple. Indian innovators won't be forced to go treaty shopping and focus on their businesses instead. Indian courts, legal and tax professionals will refocus their energies on ensuring that they are able to service Indian companies well, to deploy their professional expertise in making India a predictable and business friendly jurisdiction. No overpriced Singapore legal opinions will be required, and no English barristers need to be flown into Singapore.
Welcome to innocence again, and looks like we can all now be spared the hoops.
By Suhas Baliga
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Tax levels in India today are moderate and in line with global norms - India is not an outlier and India's tax rates don't render it uncompetitive. Frankly, a capital gains tax exemption is only a cherry on the cake for a substantial investor - it isn't the driving force. So, as long as India has good market opportunities and entrepreneurs coupled with sensible governance, investors will be attracted to it. Ease of doing business, infrastructure enhancement, lower levels of corruption, tax certainty and rule of law are much more important factors than a capital gains exemption - and that's what India should focus on to enhance investment.
Cheap labor is not India's main attraction - for us, we invest here because of the quality of the talent, innovation and ideas. India actually has a good play in enabling industrial automation, and many Indian service providers and startups have opportunities in that domain. Sweat shops making cheap sneakers are not going to get India to the next level and that's not what most foreign investors look to put their money in anyway.
Nice article Suhas!
Well, while I agree with you on some of points the comment above, your organisation may be one in a many, which chooses to adopt a simpler structure over a complex one (which reduces the tax burden significantly). As much as you may give your own example, the fact of the matter is that your organisation is the exception to the norm and not the general norm in itself. Foreign Investments can be segregated into two categories; one which is specifically used as a investment vehicle by investment funds and the other multinationals who investment into India either because they envisage India as potential market or in order to achieve synergies at a significantly lesser cost.
For, most of investment companies, that operate in India, have foreign investments in them, routed through these tax havens; which is why most of these funds today are either Mauritius/Singapore/Cayman Islands based. In fact any of these AIFs or FVCIs that you see today, have vehicles routed either, through Mauritius or any other treaty shopping nations. Examples may be taken for The Zephypr Peacock Fund, the SBI Macquarie Fund, the IDFC Fund, which have all their investment vehicles routed through, either Mauritius or Bermuda or the Cayman Islands. Therefore, the argument above may be right when he says that it may be a plot spoiler for foreign investors. If two countries provide the same returns and profits on its investments, the only thing that puts one country over the other as the favoured investment hub will be the tax incidence. I am assuming that by investors he/she meant financial investors, whose goal is centre around earning greater returns on their investment. This includes tax holidays earned through thought out investment structures.
While the same may not be true for all corporates which look at India as a potential market or a favourable hub for their expansion plans, there are a lot of corporates that prefer taking the benefit of these treaty shopping nations to earn them a better return. Take Maxis as an example. Because the company has been reported about, so much, it is a public knowledge how the company was structured. Maxis, which is actually a Malaysia based company, routed its investments through vehicles which were based out of these treaty shopping nations. Vodafone is another example. So to say that the driving force for the corporates to choose India as an investment hub depends on fundamentals such as market opportunity, quality of the idea, management team is not accurate; though is a virtue which is ideally desirable and audible.
I agree that with you when you say that good market opportunities and entrepreneurs coupled with sensible governance infrastructure enhancement, lower levels of corruption, tax certainty and rule of law are much more important factors than a capital gains exemption - and that's what India should focus on to enhance investment, the fact of the matter is that these reforms, so to say will still take time to be achieved and implemented. Pragmatically speaking, the infrastructure that India currently has, does not make it a favoured choice.
Delve a bit deep and you will find corporates who will tell you that they have burnt their fingers while dealing with Indian authorities or promoters. Do you think that is going to go away in a day. I doubt it. As regards on your bit on automation, while you are mostly right, when you say India has had a good play in enabling industrial automation, that argument stands true for only some of the sectors and the service industry and not the entire industrial scenario as a whole. I would however like to point out, one such sector i.e. the E-Commerce which was riding on the hype of computerisation and digitalisation, have actually done disastrously and have been burning money. Flipkart and Snapdeal have had their valuations devalued, TinyOwl shut shop, FoodPanda and Askme Bazaar laid down about 4000 employees cumulatively. These trends do not depict a positive picture in terms of performance of the management or innovativeness of the idea.
So somewhere down the line one needs to strike a fine balance between realism and idealism. By supporting governments move, what Suhas paints through his article is an ideal scenario that Indian government should aim to achieve (which also goes onto show his strong character and grit and love for his nation) by bringing about these changes, but whether that will actually bring about the desired result has to be ascertained. As of now, the sense is it is only going to be a deterrent thereby putting other countries in the sweetspot over India as the preferred investment hub.
Tax savings is only one of several considerations that drive foreign investors to route through Singapore. India's reputation for corruption, opacity and unpredictability is a large driver. It's a particularly Indian analysis to suggest that saving money is the biggest consideration, from tax avoidance to "flying in English barristers." These costs are largely rounding errors for such investors.
Sure, a low cap gains tax is a big incentive. So is ease of opening and closing a business, a predictable tax regime, a corruption-free judiciary and a long track record of respecting IPR. Consider how many of those factors inarguably weigh in India's favour.
Foreign investors don't care, and should not care, how much India has "improved" over the last 20 years. Such investors are agnostic and choose based on current conditions and the likeliest future. Singapore has a vastly better elevator pitch than India. Deal with that reality effectively rather than banging out an ultimately blinkered and jingoistic "analysis."
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