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How VCs are impacted by the change in the India-Mauritius tax treaty – Deepak Shenoy, Capital Mind

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by Deepak Shenoy, Capital Mind 

Mauritius based entities that Invest in India – from Private Equity investors, VC funds, and investment pass-through vehicles (which issue participatory notes) will start to see taxation apply to them from April 1, 2017. This is due to a treaty change between India and Mauritius.

Here’s the full text of the treaty change.

How it used to work

Currently, if you are a foreign investor, you can invest in Indian companies – both listed and unlisted. When you sell them, you would pay capital gains taxes in India (as many NRIs do) and some of those gains are withheld before you get the money.

But till now, there were Double Taxation Avoidance Agreements (DTAAs) which are treaties between India and certain countries, that allowed a certain type of gain – Capital Gain on the sale of shares or property – to be untaxed in India. This applied to entities coming from Mauritius, Cyprus and Singapore. So if you brought the money in “through” a Singapore, Mauritius and Cyprus entity, then the sale of shares would not be taxed at all, since none of these countries charged any capital gains taxes.

Leave Cyprus out of it for now. The government there tried to remove money from bank accounts and will suffer from investor fear for a while.

Mauritius was the easiest.

All you had to do to get zero tax on your investments – both listed and unlisted – was simply to set up a shell entity in Mauritius. The tax treaty didn’t differentiate between a company that was actually operating in Mauritius versus a company that was only set up there to get tax benefits. So for a few thousand dollars, you could get a Mauritius entity and invest through it into Indian stocks and shares, and never pay capital gains taxes anywhere…

So How Does It Affect The Market?
Well, it shouldn’t, but it usually does. Remember all past investments have been grandfathered and if sold, those shares pay no tax no matter when they are sold…

And VC Investments?
Many VCs don’t buy shares in private unlisted companies in India. They buy preference shares, which are converted to “common” shares at a certain ratio, typically just before sale. Unfortunately, a conversion to common will entail capital gains taxes after April 1, 2017. So such investments too will have to be restructured, and in many such cases, there are serious restrictions on conversion or other complex clauses which will generate, at the very least, a lot of revenue for lawyers.

***

This excerpt was crossposted with permission from the author. Read the full story here.

About Deepak Shenoy: Deepak Founded Capital Mind, which mines financial data and provides analytics. Deepak is part of the core team that helps build, grow and keep our data platform up to date. He lives in Bangalore. Connect with him at deepakshenoy@capitalmind.in.

Image Credit: Phillip Ingham under CC BY ND 2.0

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