Is Cayman Islands the new Mauritius when it comes to flow of foreign direct investments (FDI) to India? After Mauritius and Singapore lost their tax advantage due to change in tax treaties, Cayman Island has emerged as the new hotspot to route FDI into India.
FDI inflows worth $2.1 billion were made through Cayman Islands in first half of the current financial year. Only Singapore ($8.3 billion) and US (7.12 billion) were ahead. Mauritius, which till last year contributed the second highest FDI inflows to India, was behind Cayman Islands. This British overseas territory is now the third most preferred source of investments into India - it was 7th in FY19 and 5th in FY20.
FDI inflows from Cayman Island almost quadrupled from $1.01 billion in 2018-19 to $3.7 billion in 2019-20. Based on cumulative inflows between April 2000 and September 2020, it is the 10th largest contributor with a 2 per cent share in total FDI flows.
So, why is Cayman Islands turning into a big source of FDI inflows to India? Is there any tax 'arbitrage' that investors are exploiting? "Unlike most countries, the Cayman Islands doesn't have corporate tax, making it an ideal place for multinational corporations to base subsidiary entities to shield some or all of their incomes from taxation. In addition to having no corporate tax, the Cayman Islands impose no direct taxes, whatsoever on residents. They have no income tax, no property taxes, no capital gains taxes, no payroll taxes, and no withholding tax," said Amit Jindal, co-founder, Felix advisory.
Also, India does not have a double taxation avoidance agreement (DTAA) with Cayman Islands. It only has Tax Information Exchange Agreement.
According to tax experts, India's domestic laws tax indirect capital gains only when a specific threshold is met and when the company derives more than 50 per cent of its value from Indian assets. Hence, global funds with substantial non-India portfolio can route their investments through Cayman Islands with zero tax impact.
Further, Cayman Islands' economic substance law also prescribes only carrying out certain activities to substantiate economic presence without any monetary thresholds. How long will these tax 'advantages' last? Rajesh Narain Gupta, managing partner, SNG & Partners, says they may not last long after Indian tax authorities plug the loopholes if they find regulatory issues like direct substance issues.
However, experts say that Cayman Island's emergence is not purely because of tax arbitrage. Easier rules for setting up of fund structure, lower cost of operations and lower compliances also make Cayman Island investment funds hub.
"The lower cost of operations and lower compliance requirements makes Cayman Islands more attractive. There has been dip in FDI inflows from Mauritius & Singapore and Cayman Islands with lower operating cost is increasingly replacing the same. Increasing regulations and cost of operations in Singapore and grey listing of Mauritius is an additional factor leading to investments being routed through Cayman Islands. Increase by nearly 300 per cent of FDI from Cayman Islands would keep the taxman in India on their toes," says Divakar Vijayasarathy, Founder and Managing Partner, DVS Advisors LLP.
Meanwhile, India attracted total FDI of $28,102 million during the second quarter of FY21, out of which FDI equity inflows were $23,441 million or Rs 1,74,793 crore. This takes the FDI equity inflows during the financial year (upto September 2020) to $30,004 million which was 15 per cent more than the corresponding period of the previous fiscal. August 2020 saw $17,487 million FDI equity inflows in the country.