Foreign investors betting on India by putting money into private equity (PE) funds here are taken aback by a recent observation by the Mauritius Revenue Authority (MRA), raising a hitherto ignored angle on tax – and in the process questioning investment structures that have been in vogue for years.
According to a private ruling by MRA, investment vehicles in Mauritius, used by global investors to enter India, will have to pay tax in Mauritius on ‘capital gains’ they receive from a PE or debt fund in India when the latter exits an investment. Till now, a Mauritius entity paid tax to the Mauritius government only on ‘income flows’, like dividends and interest distributed by funds in India — but not on capital gains booked in India.
However, MRA, in a matter related to a global investor, has ruled that “all income distribution” made by AIF (alternative investment funds) Category II and III “will be treated as dividend income and therefore not retain their initial characteristics”.
AIFs are privately pooled vehicles incorporated in India, like a PE fund, collecting money from savvy Indian and offshore investors. Category II AIFs are usually PE funds while Category III funds are allowed leverage and employ complex trading strategies.
The MRA ruling boils down to a position where capital gains would be taxed in Mauritius, just as income distributions like dividends. It has taken experts by surprise.
Bijal Ajinkya, partner at law firm Khaitan & Co, said it can put off foreign investors who typically invest in a Mauritius entity which further invests into an Indian AIF that is formed as a trust in India.
“The characterisation of income received from a trust as dividend income, subject to a levy of tax in Mauritius, irrespective of its underlying character has shocked fund managers who have set up such structures,” she said. “The fact that such a position would lead to unavailability of a capital gains tax exemption in Mauritius and treat such income as dividends is something which fund managers may not have accounted for in their fund returns. Further, funds which have already wound up and have distributed proceeds to investors would find it difficult to collect such taxes. Another question crops up: Would this encourage foreign investors to directly invest into a GIFT AIF so as to avoid the costs?”
An investment entity in Mauritius has to pay 10% tax in India on long-term gains (for stocks held over two years) when an AIF (where the investor has put money) books capital gains. For short-term gains, the tax in India could be 40% or 30% depending on whether the entity in Mauritius is a company or a partnership. Now, over and above this tax paid on capital gains to the Indian government, foreign investors would have to fork out at least an extra 3% tax in Mauritius.
Since the Mauritius tax law concerns distribution from a trust, this will apply particularly if a PE fund in India is set up as a trust. Most funds are set up as trusts as investors in a fund prefer not to disclose their identities, which they have to if the PE is formed as a limited liability partnership (or, LLP).
The MRA ruling, posted on its website, does not disclose the identity of the foreign investor whose query seeking a clarification to revenue authority has opened a Pandora’s box. Interestingly, though such a stand always existed in the Mauritian tax laws, fund managers somehow interpreted that capital gains in India would not be taxed in Mauritius – a position that was never questioned by authorities in Mauritius. Till now.
“This ruling is set to impact the investment to India as today the established rule is that AIF category 2 is a pass through while dividend is tax free under category 3. The ruling would put a question mark on how the credit mechanism will work in case of foreign investments through Mauritius,” said Girish Vanvari, founder of tax advisory firm Transaction Square.
The Mauritius vehicle in question has a global business licence and a collective investment scheme licence with the country’s Financial Services Commission. Its investment manager is a Singapore company regulated by the Monetary Authority of Singapore. The question it posted before MRA was: Whether capital gains accrued by the AIF trust and distributed to L will be considered as capital gains for income tax purpose?
Tax professionals and service providers in the tax haven are unsure about what could be the outcome of MRA’s response.