Taxing Time Ahead For India-Focused Mauritius Funds

After the amendment to the India-Mauritius tax treaty in 2016, Mauritius investors earning capital gains from disposal of shares of Indian companies (acquired on or after April 1, 2017) would be required to pay tax in India. The burden of taxation would be reduced by half for gains arising from April 1, 2017, to March 31, 2019, if the investor meets the substance requirements prescribed under the Limitation of Benefits (LoB) clause under the amended tax treaty. One condition of the amended treaty is that a Mauritius investor should incur an expenditure of at least Mauritian Rupee 1.5 million (approximately $40,000) in the preceding twelve months from the date of sale).

The deal was sweeter on account of the fact that such capital gains were exempt from income tax in Mauritius under the Income Tax Act, 1995. Accordingly, in effect, the Mauritius investors were enjoying double non-taxation of the same income in both the country of residence and the country of source.

Further, the expenses incurred by the Mauritian company were also claimed as a tax deduction from taxable Mauritius income such dividend, etc. As a result, the overall effective tax rate for Mauritian company was significantly lower.

This is because in January 2017, the Supreme Court of Mauritius in the case of JP Morgan Sicav Investment Company (Mauritius) Limited, held that a portion of common/administrative expenses (such as fees paid to custodians and sub-custodians for holding investment) towards earning exempt capital gains were to be disallowed as tax deductible expenditure in Mauritius. The rationale for this judgement is similar to that of Section 14A of the Indian Income Tax Act, 1961 which provides for disallowance of expenditure, if the same is incurred in connection with earning exempt income.

To understand the rationale and impact of this judgement on Mauritius investors, the facts and contentions of the case are summarised below:

Facts Of the Case

• The taxpayer company is a Mauritian investment company holding a Category 1 Global Business License. It derived income in the nature of dividend, interest and capital gains from shares and securities of Indian companies.
• The capital gains earned by the company were exempt from income tax in Mauritius under the 1995 Act. However, the income in nature of dividend and interest were liable to income-tax in Mauritius.
• The company claimed a full deduction of sundry expenses and custodian and sub-custodian fees which were incurred for earning income in nature of exempt capital gains and taxable dividend.
• However, the Mauritius Revenue Authorities (MRA) applied the following formula for proportionate disallowance of expenditure, which is drawn from another section of the Act: [Capital Gains / (Income + Capital Gains)] X Allowable Expenses.
• This disallowance was made on the grounds that expenditure attributable to the earning exempt capital gain could not be reduced from taxable dividend income.
• Before the Mauritius Supreme Court, the taxpayer contended that the section of the Act applied by the MRA did not provide for such proportionate disallowance for exempt capital gains.

Mauritius SC Ruling

• The Supreme Court held that the provisions of the Act in substance permit such disallowance of proportionate expenditure.
• While ruling against the taxpayer, the SC stated that allowance of entire expenditure would otherwise result in double-benefit for the taxpayer i.e. capital gain income would be exempt and allocable expenditure to such income would be reduced from taxable Mauritian income.

Consequential Impact On Foreign Portfolio Investors

• As mentioned above, many Mauritius funds which are India-focussed typically derive their main income from capital gains arising from Indian securities. In such cases, the dividend and interest income tend to be incidental. Where the portion of capital gains income is significantly larger than the dividend and interest income, it is possible that a majority of expenditure incurred by such funds (in nature of fees paid to custodians and sub custodians for holding investment, etc.) for earning this income could be subject to disallowance by relying on the Mauritius SC judgment.
• The impact of the potential disallowance of expenditure could get amplified on account of the fact that under the LoB clause of the amended tax treaty, the Mauritius funds would have to incur minimum expenditure of Mauritian Rupee 1.5 million to avail concessional tax rate (7.5 percent) in India for the period April 1, 2017 to March 31, 2019. Despite incurring this expenditure, the investor may not get a deduction for expenses and hence, would be a sunk cost.
• Naturally, a higher tax cost in Mauritius would result in lower returns for the investors of such funds. This is because even though the effective corporate tax rate in Mauritius can be structured to be only 3 percent, any increase in tax cost would have to be passed to the investors of such funds who are already burdened with the tax cost to be incurred in India.
• Lastly, this SC ruling also has the potential to impact Indian outbound investors which have traditionally used Mauritius as a holding company jurisdiction for further investments across the globe (especially Africa). Since the capital gains derived by such Mauritius holding vehicles from the disposal of overseas assets would also be exempt under the Act, such vehicles could also end up paying higher corporate tax in Mauritius.

Conclusion

In light of the above implications, it would be advisable that all groups using Mauritius as a jurisdiction for holding investments (whether inbound into India or outbound from India) analyse the impact of this ruling on their corporate tax liability in Mauritius and suitably factor such tax cost in their expected rates of return on investment.

Maulik Doshi is a partner at SKP Business Consulting.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.