Even as reports say that foreign portfolio investors, or FPIs, are setting up shop in the Netherlands and France after India plugged loopholes in tax treaties with Mauritius, Singapore and Cyprus, tax experts and officials are confident that the trend will be short-lived. The reason: the government is working on renegotiating and plugging the gaps in tax treaties with other countries as well. Several of these treaties have 'beneficial' provisions for companies and foreign investors that help them avoid paying capital gains tax in India. Before India reworked its treaties with them, Mauritius, Singapore and Cyprus used to be the three major tax jurisdictions used by companies to avoid paying tax in India.
However, after this, for companies and investors looking for places from where they could continue to enjoy the tax benefits, the Netherlands was the first option, and so was France - treaties with both provide for exemption from short-term capitals gains tax. The Netherlands treaty exempts sale of shares of an Indian company by a Dutch-based company if it holds less than 10 per cent shares in the Indian company from short-term capital gains tax. In fact, even if the Dutch company holds more than 10 per cent in the Indian company, it can sell to a non-resident without attracting short-term capital gains tax.
This may soon be history. For instance, with the changes in Mauritius, Singapore and Cyprus treaties, India got the right to tax short-term capital gains made by investors based in these jurisdictions on sale of shares of Indian companies after April 1, 2017. For the first two years, the tax rate will be 7.5 per cent (or 50 per cent of existing short-term capital gains tax). From April 1, 2019, India will be able to fully tax such gains. Negotiations are under way to change the tax treaty with the Netherlands for the past three-four years, and according to CBDT officials, the changes could be finalised anytime soon. After that, the government may look at other treaties with similar provisions.
"There are some treaties with capital gains provisions in India but with conditions attached. The Netherlands has some different conditions and France has some different conditions. What the government will be looking at is whether these 'conditions' are hampering India's right to tax capital gains in India. The policy is that all such gains should be taxed in India. If the provisions and conditions are making a material difference, the government may look at renegotiating those treaties," says Akhilesh Ranjan, Principal Chief Commissioner, Income Tax (International Taxation).
Besides, with the General Anti-Avoidance Agreement, or GAAR, in place from April 1, 2017, any attempt to avoid paying tax in India might meet with failure. GAAR can override treaty provisions that do not have the limitation of benefit, or LoB, clause, which says that beneficial treaty provisions can be used only by companies with genuine business operations in the treaty country. The Netherlands treaty does not have the LoB clause. In all, there are few treaties left that can be used by investors/companies to evade tax.