FII traffic to face diversion

Fri, 26 Mar Pre-Open

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Most of us know of Mauritius as a great holiday destination. It also has a sizeable population with roots tracing back to India. In financial circles though, it is famous as a tax haven for foreign funds investing in India. It has a double taxation treaty with India. Capital gains on Indian equity investments in the hand of a Mauritian company do not attract any tax here. Due to this agreement, almost 90% of the foreign investment into India comes from the African island. In fact, according to Wall Street Journal, total foreign institutional investment into Indian equities of almost US$ 46 bn came through Mauritius during 9mFY10. Compare that with investment routed through Singapore of around US$ 10 bn during the period.

But all that could change with the new Direct Tax Code set to be introduced next year. The main thrust of the new proposals is to simply the maze of tax exemptions. And one of the exemptions to be removed could be the double taxation treaty with Mauritius. That would affect several foreign private-equity players, hedge funds and mutual funds.

There is still some time before the tax proposals become law. In our view, a lot of pressure will be applied on India to keep the double taxation treaty in some form. But there is also the chance that the government sticks to its guns. After all, it is losing out on a chance to tax money flows amounting to several billion dollars. There is also a global trend wherein governments are getting increasing fidgety about tax avoidance. Especially when most of them have to support expensive stimulus packages. In India’s case, regulators also want to exercise greater control on offshore money flowing into the country. The entire episode over foreign institutional investors (FIIs) and P-notes.

If the double taxation treaty is tweaked, foreign institutional investors will have to re-route their investments. Truth be told, we are not big fans of FIIs in their present form. Most of it is short term money chasing incremental returns. They come in hordes crowding good investments out of the reach of individual investors and often leave in hordes trampling everything and everyone that comes in their way. In our view, changes in the double taxation treaty could trigger a correction for reasons other than fundamental merits of companies. That could create a buying opportunity for individual investors to really dig in.