Mauritius route: Funds investing in debt may face ‘beneficial ownership’ scrutiny

MUMBAI: Several overseas funds betting on Indian bonds and debt securities from their outfits in Mauritius will have to put their house in order to enjoy the low tax regime. If they don’t, these funds could suffer the same as their counterparts from Cyprus – the tax haven that was once the favoured gateway for foreign investors in Indian debts.

Tax authorities in India are learnt to have denied many Cyprus funds the benefit of a lower withholding tax — which is deducted from interest earnings from debt papers invested in India — for not being “beneficial owners” of these investments.

It’s a test that not all funds entering India through Mauritius would pass. At a time when a large number of foreign funds are using investment vehicles in Mauritius to pour money into Indian debts — far more that they have done in equity — the Income Tax department will take a close look at the nature of their operations to figure out whether the entities in Mauritius enjoy the real benefits of ownership.

“The term beneficial ownership is not defined in the IT Act, hence it would depend on the facts of and documentation in each case, such as board of directors, constitution and actions, cash flows, shareholders agreements etc,” said Punit Shah, partner, Dhruva Advisors.

One of the ways for a fund to demonstrate “beneficial ownership” is by using Mauritius as a destination to pool money from investors across the world. Mauritius has become an attractive jurisdiction for debt investments in India after the amendment of the tax treaty that provides for a lower withholding tax of 7.5 per cent on interest payments from 1 April 2017.

“Not all funds pool money in Mauritius....Indeed, the benefit of reduced tax rate would be subject to beneficial ownership condition being met by the Mauritius entity, which would be difficult to substantiate if there is no substance and commercial rationale for existence of such entities in that tax friendly jurisdiction,” said Shah.

On May 10, 2016, the governments of India and Mauritius signed a protocol to amend the 34-year old treaty between the two countries. While the treaty imposed shortterm capital gains tax (that investors from Mauritius will have to pay from sale of shares in India), a low withholding tax made the island in the Indian Ocean a highly attractive base for offshore investors of Indian debts.

Between May 2016 and now, foreign investors have purchased Rs 1.13 lakh crore of debt instruments in India compared with Rs 67,600 crore of equity. Since April 1, 2017, there has been Rs 1.26 lakh crore of inflow into debts as against Rs 17,464 crore into equity. A bulk of this is from Mauritius.

According to Subramaniam Krishnan, partner, Ernst & Young, “The controversy involving the denial of treaty benefits on interest income to a number of Cypriot tax residents brings to fore the critical condition of “beneficial ownership” enshrined in tax treaties for availing treaty benefits on interest, dividend, fees for technical services and royalty income. Considering the evolving landscape on tax treaty access and domestic anti avoidance rules, investment and funding structures will need to be carefully evaluated to ensure that the legal owner of the income is able to also assert beneficial ownership over such income.”

In completing the tax assessments (which became timebarred on December 31, 2017), the tax office is understood to have questioned the structure of more funds from Cyprus on the grounds that they were not beneficial owners.

“The term ‘beneficial owner’ is not clearly defined and has been the subject matter of interpretation and commentary, including from the OECD. The Mauritius treaty provides for income tax to be levied at 7.5 per cent on gross interest earned from India, subject to the condition that the beneficial owner of the interest is resident in Mauritius. This is similar to the condition laid down in other treaties on taxation of interest,” said Gautam Mehra, partner, PwC.