Round Tripping: The Bane of Indian Tax Treaties
Mauritius and Singapore are both examples of countries with Double Taxation Avoidance Agreements (DTAAs) with India, meaning dividends from corporations that are paid out to shareholders are not taxed further, having already been taxed at the corporate level. This legislation has meant that such countries have been used to “round-trip” India and avoid the Minimum Alternative Tax (MAT) to a great extent by foreign funds.
As a result of such, somewhat shocking statistics emerge: between April 2000 and February 2012, Mauritius accounted for 39 per cent of total Foreign Direct Investment (FDI) in India – more than the next six investing countries put together. Given the fact that India’s Gross Domestic Product is over 200 times larger than that of Mauritius, it seems likely that there is an external factor responsible for this anomaly, namely the existence of round-tripping.
Recently, there has been conflict over taxation legislation in India – many foreign investment funds have been subject to tax demands despite the existence of the MAT, which was introduced in the mid-1990s to ensure tax payments (typically 20% of profits) by domestic Indian firms. India’s finance minister, Arun Jaitley, told India’s NDTV news that tax demands on foreign investors are set to raise up to Rs.400bn ($6.4bn). Mr Jaitley did not explain how the $6.4bn had been calculated, but argued that Indian tax authorities had strong legal backing to seek to apply “overdue” MAT.
Though this may seem unreasonable, the lesser-known factor of tax avoidance treaties certainly comes into play. Arguably, the Indian economy is still benefitting from FDI in terms of job creation, infrastructure investment and higher overall output. The government possess the power to increase their tax revenue significantly through imposing MAT on Foreign Institutional Investors (FIIs). Arun Jaitley revealed the government’s intended plans to use the increased revenue to fund higher public spending in the agricultural sector on initiatives such as irrigation – a technology that would highly benefit India’s efficiency in a sector, which currently accounts for 13.9% of total GDP.
However, it is important to consider that MAT has not traditionally been levied on foreign institutional investors, who are naturally unhappy about the claims given the dramatic effect it would have on their own profit margin. This conflict follows a period of strong investment in India, with FIIs investing a record $43bn into Indian debt and equity last year. Foreign investment funds hold a record 20% of Indian equities and 40% of freely floated shares (in the hands of public investors). Consequently, the claims could potentially harm the markets if investors decide to leave India, as well as tarnishing its reputation as a destination for FDI in future, as a result of the so called “tax terrorism”.
Aberdeen Asset Management was the first foreign institution to confirm having been asked for a payment.
“The fact that we suddenly get a tax demand like this is new . . . It certainly doesn’t fill one with warm cuddly feelings towards India . . . [and] this must make India a less attractive place to invest” Hugh Young, Managing Director, Aberdeen Asset Management Asia
But how much of an effect does or will this proceed to have on India’s economy? Jaitley emphasised the fact that the legislation had been introduced to ensure that foreign firms would not pay tax after April 1st 2015. Yet, India’s Authority for Advance Rulings have stated that a 2012 ruling enables claims to be issued for years preceding 2012. There has been speculation that the Indian government are now looking to override tax avoidance treaties, which could cause FIIs to appeal and consequently open a floodgate of litigation, inviting potentially damaging consequences.
It seems that India’s attempt to regain the revenue it could have been claiming until now may be more costly than anticipated, and the outcome remains to be seen over the next year or so, which will almost undoubtedly be rough for India’s foreign investment flows.