India is one of the largest and fastest growing economies in
the world. It harbours enormous opportunities for domestic and
foreign investments because of its highly skilled manpower,
huge domestic market and natural resources. Foreign investors
have found India to be a very attractive investment
destination, leading to enormous growth in the economy.
Significant and expanding cross-border trade has led to the
Indian government increasing its efforts in providing an
investor friendly tax regime, without losing major revenue. As
a result, India has signed agreements with a large number of
countries for the avoidance of double taxation (
DTAs). Besides preventing income from being taxed twice,
the treaties also promote trade and commerce.
However, in certain cases, effective DTAs have also resulted
in double non-taxation. This has led to a large number of
investors routing their investments through jurisdictions that
have a favourable DTA with India, such as Mauritius, Singapore,
and to a certain extent, the Netherlands and Cyprus.
While the DTA provisions allowed investments to be steered
into India from a tax efficient intermediate jurisdiction, the
issue has also led to an increased amount of litigation because
of 'treaty shopping’, among other issues. Time and
time again, the legislature made attempts to eliminate grey
areas and doubts over the application of DTA provisions, while
the judiciary made substantial developments with landmark
An example of this is the case of the Union of India v
Azadi Bachao Andolan (2003) 263 ITR 706 (SC). In this
case, the Supreme Court of India (SC) said the Indian
government had power under Section 90 of the Income-tax Act (IT
Act) to enter into an agreement to avoid potential double
taxation by demarcating the respective areas of each
jurisdiction’s taxation – even if no
tax is presently levied in the other country. It also upheld
the validity of Circular No. 789, which stated that the tax
residency certificate issued by Mauritian tax authorities is
enough proof of residency.
In a step towards substance-based taxation, the Indian tax
laws have undergone some significant changes that have
inter alia directly impacted the conventional ways in
which foreign investments are structured.
To name a few, these changes include:
- The taxation of offshore indirect transfers of Indian
- The notification of Cyprus as a non-cooperative
jurisdiction (see below);
- The recent amendments to the India-Mauritius DTA and the
consequential impact it has on the India-Singapore DTA;
- The introduction of the
General Anti Avoidance Rules (GAAR);
- The change in corporate residency tests that are now
based on the place of effective management of a foreign
- The mandatory disclosures of foreign assets, including
Some of these changes are discussed below, followed by how
the amendments are making some conventional structures
Cyprus was originally one of the preferred jurisdictions for
routing investments into India.
Its low tax regime for offshore and resident companies, as
well as its identity protection for investors was highly sought
after by institutions.
However, Cyprus failed to share information on tax avoiders
and the Indian government declared Cyprus as a non-cooperative
jurisdiction in November 2013 and imposed a 30% withholding tax
on any payment to a Cyprus entity by Indian residents
— effectively suspending the tax benefits otherwise
available under the India-Cyprus DTA.
A recent press release issued by the Indian Ministry of
Finance said the notification may be withdrawn following
negotiations between the two countries. The press release also
stated that India and Cyprus may soon sign a revised DTA under
which, among other changes, the capital gains will be taxable
at source, rather than on a residence basis (the latter
resulting in a double non-taxation of capital gains where a
Cypriot resident sells shares of an Indian company).
Amendment to India-Mauritius DTA
India-Mauritius DTA, capital gains were exempt from tax in
India and could be taxed only in Mauritius. However, Mauritian
tax laws meant
capital gains were not taxable in Mauritius either. This
double non-taxation made Mauritius a favourite jurisdiction for
foreign investors to route their investments into India.
Due to this provision, the government lost a substantial
amount of tax revenue, resulting in India renegotiating some
terms of the DTA with Mauritius. A
protocol signed by the authorities on May 10 2016 plugged
the double non-taxation loophole.
Under the revised DTA, capital gains tax will be charged on
the sale of shares of Indian companies from April 1 2017.
However, the protocol provides a grandfathering period for
investments made in Indian companies before April 1 2017.
Impact on India-Singapore DTA
Like the original India-Mauritius DTA, India’s
DTA with Singapore provides a similar capital gains tax
exemption on alienation of shares in an Indian company by a
The revised measures in the India–Mauritius DTA
will impact this exemption in the India-Singapore DTA. The protocol to the
India–Singapore DTA provides that the said exemption
will remain in force so long as the DTA between India and
Mauritius provides exemption from capital gains tax in the
source state in case the sale of shares of a company (for
instance, in India when the shares of an Indian company are
sold by a Mauritian resident). There is lack of clarity on
aspects such as:
a) Whether the protocol to the
India–Mauritius DTA would automatically result in the
withdrawal of the exemption or would require re-negotiation of
the India–Singapore tax treaty itself;
b) Whether there would be any
grandfathering provision; and
c) Whether the exemption
under the India–Singapore DTA would only be withdrawn
for equity instruments and not for debt, among other
instruments. Finance Minister Arun Jaitley has confirmed that
India will renegotiate the DTA with Singapore soon.
Indirect transfer of assets
The tax landscape of indirect asset transfers has also
changed in recent years.
In 2012, the Indian legislator introduced a provision to
levy tax on capital gains earned by a
non-resident’s transfer of shares or interest into
a foreign company that derived "substantial value" from
underlying Indian assets. The SC ruling in the
Vodafone dispute case had been sought to be overruled
by the retrospective amendment.
In 2015, a number of important amendments were made to the
criteria, including the definition of "substantial value" for
taxing income attributable to Indian assets. The changes also
introduced a reporting requirement for Indian entities.
In June 2016, the government released rules relating to the
method of computing the fair market value of Indian and global
assets and other compliances. The underlying Indian entities,
as part of their reporting obligation, must maintain extensive
information regarding multi-level and multi-jurisdictional
Introduction of GAAR
The Indian government’s primary focus has been
to revise its laws to eliminate double non-taxation and
discourage illegitimate tax planning. As part of this plan,
GAAR will enter into effect from the next financial year,
commencing on April 1 2017.
The rule will empower the Indian tax authorities to
scrutinise investment structures and other transactions that
have been made only to achieve a tax benefit and do not have
any commercial substance. Hence, investments made in India
through a third country may need to pass the test of GAAR
before receiving a tax benefit under a DTA.
The principle of substance over form
Looking at the recent changes made by the Indian government
in its taxation policies and the decisions made by the Indian
judiciary, it is evident that the tax authorities will look
into the 'commercial substance’ of an arrangement
rather than the 'form’.
Tax authorities will scrutinise transactions and will deny
tax benefits to any such transaction or arrangement that could
be a tool to evade tax or that is lacking any commercial
Even in the amended India-Mauritius DTA, a Limitation of
Benefits (LoB) clause has been introduced. The provision, which
is similar to the LoB clause in the India-Singapore DTA, does
not allow a shell company in Mauritius to be entitled to claim
benefits of the reduced tax of half the applicable rate during
the two year transition period between April 2017 and March
India has adopted
Place of Effective Management (POEM) as the basis for
determining corporate residency of a foreign company.
POEM means a place where key management and commercial
decisions that are necessary for the conduct of business of an
entity as a whole are made.
Accordingly, a foreign company could be considered an Indian
tax resident if its POEM is for the relevant year is considered
to be in India.
On December 23 2015, the government issued draft guiding
principles for the determination of the POEM of a company (POEM
Guidelines). These guidelines emphasise that:
(a) The determination of POEM is based on
all relevant facts related to the management and control of the
(b) The POEM concept is one of substance over
(c) The POEM determination is an annual
exercise, i.e. the POEM of a company is to be determined on a
year to year basis.
Once the POEM of a foreign company for a particular
financial year is in India, its global income for that
particular financial year is exposed to Indian taxation unless
the applicable DTA resolves the tax residence of the taxpayer
in favour of the other jurisdiction.
These changes have led multinational enterprises and the
investor community to re-think their methods for investing in
India or divesting from their existing Indian investments.
Traditional structures becoming
Given the more evolved tax law in India, below we briefly
discuss some of the conventional structures for investing in
India that may no longer be used.
SPV structures that use an intermediary holding company in a
tax friendly or tax neutral jurisdiction for routing investment
to India would be exposed to a greater level of scrutiny under
GAAR when the rule enters into effect. With the recent DTA
amendments influencing the attractiveness of Cyprus, Mauritius
and Singapore (for the time being), investors may have a
limited choice in how they structure investments into India
from the perspective of achieving a tax efficient exit.
With the indirect transfer tax provisions being part of law,
using an intermediary entity to indirectly transfer underlying
Indian assets/ business would be subject to tax in India. Also,
the Indian tax law has strict disclosure requirements on the
Indian companies to disclose such offshore transactions. The
obligations ensure the Indian tax authorities are aware of such
Tightening of disclosures of foreign assets, including
offshore bank accounts and trusts, discourages the use of
structures set up to accumulate the wealth of Indian residents
outside India to avoid residence-based taxation, as well as
those structures where Indian funds are routed back into India
through structures, which are able to achieve a no tax outcome.
Tougher disclosure rules also give the tax authorities more
tools to track down such structures.
Based on the POEM, a foreign company that has its
intelligence in India would be considered to be an Indian
resident. While POEM based taxation would be more relevant for
outbound investment structures, it may potentially also impact
fund structures where the fund managers or advisers are in
India and are providing advice regarding the Indian investment
market on which investment vehicles are being used to invest
into the country. In such structures, factors such as
independent decision making of the investment vehicle,
substance in the investment vehicle in terms of its 'head and
brain’, location of the real decision makers and
the nature of advice provided by the Indian teams, both on
paper and in conduct, would be critical. Note that the POEM
Guidelines do recognise the electronic/ virtual modes of
attending meetings and thus, use of technology to flout rules
may not be an option for taxpayers.
ALL is not lost
Given all these recent significant developments concerning
taxation in India, the 'substance’ in structuring
is going to be critical and that will be the biggest challenge
in terms of structuring foreign investments into India in a tax
This may require a change in mind set from the first step.
The structuring exercise would need to consider and build a
commercial and non-tax justification supported by the
underlying documents and actual conduct.
Investments made prior to April 1 2017 will be grandfathered
from a GAAR perspective whereby taxability of income from the
transfer of such investments will not be tested under GAAR.
Similarly, April 1 2017 is a critical date for investments
from Mauritius. The amendments to the India-Mauritius DTA only
shuts the equity investment route as the capital gains arising
from the sale of shares would no longer be exempt from Indian
taxes. However, capital gains from the transfer of other
capital assets situated in India, such as units,
non-convertible debentures, debt securities, etc. will continue
to enjoy exemption from capital gain taxes under the amended
India-Mauritius DTA, but they may be susceptible to GAAR.
Therefore, the debt route may still be tax efficient under the
amended India-Mauritius DTA with a 7.5% withholding tax rate on
interest arising to a Mauritian beneficial owner of such debt
from India. Thus, going forward, Mauritius could be the most
preferred jurisdiction for debt investments into India.
Furthermore, based on this changed scenario, the Netherlands
could be an interesting jurisdiction worth exploring for the
purposes of investing into India. Under the India-Netherlands
DTA, when a resident of the Netherlands transfers its
investments in an Indian company to another
foreign/non-resident buyer, its capital gains would be exempt
from tax in India.
Also, in relation to indirect transfer taxation, the
transferor’s jurisdiction of tax residence and the
applicable tax treaty with India are also relevant as there are
several tax treaties under which there is a favourable
provision in this regard whereby only the residence country
gets the right to tax the transaction.
Thus, all is not lost and there are structuring
opportunities which could be considered while ensuring that the
structures have adequate substance.