A. SEBI Circular Letter Dated 10 April 2018
On 10 April 2018, the SEBI, issued a circular titled ‘Know Your Client Requirements for Foreign Portfolio Investors (FPIs)’ clarifying its position on the concept of identification and verification of Beneficial Owner of an FPI (BO). The Circular fell as a death knell to NRIs (Non-Resident Indians), PIOs (Persons of Indian Origin) and OCIs (Overseas Citizens of India) who are BOs of FPIs by imposing a blanket restriction on the eligibility of such category of persons to make investments as FPIs. In essence, the Circular retains the concept of controlling ownership interest and control basis for identification of BOs. Hence, in case of a company, the BO is identified as per the materiality threshold of 25%, and in case of other entities such as a partnership firm or trust, the threshold stands at 15%. As for “high-risk jurisdictions,” a lowered materiality threshold of 10% is applicable.
It is now expected that SEBI will review its position on the BO construct by excluding PIOs and OCIs from the Beneficial Ownership restrictions imposed by the April Circular. However, no official confirmation to that effect has been obtained yet. In any event, while the intent of the Circular is to curb the evils of money laundering and round-tripping of funds, NRIs who currently hold significant interest in Indian equities and coming in as FPIs or through offshore funds, may get affected as from 10 October 2018 which is the deadline for existing FPI structures to rejig their operations and comply with the new requirements.
B. Mauritius not a High-Risk Jurisdiction
According to certain media reports, SEBI had requested custodian banks to prepare a list of such high-risk jurisdiction and among the names submitted were China, Cyprus, UAE and more significantly Mauritius. However, pursuant to a high-level discussion between the Mauritius Financial Service Commission and SEBI, it was subsequently confirmed that SEBI is neither working on nor contemplating to produce any list at its level, which will identify Mauritius as a High-Risk jurisdiction. At this meeting, the FSC received the comfort that SEBI acknowledges all initiatives undertaken by Mauritius to ensure full adherence to best international norms and practices with respect to regulatory oversight and enforcement. (vide https://www.fscmauritius.org/media/54904/fsc-issues-communique-high-level-discussions-between-the-financial-services-commission-fsc-and-the-securities-and-exchange-board-of-india-sebi.pdf).
C. Mauritius, still attractive for FPI?
The Mauritian legislations caters for structures which allow domestic funds to invest into another fund established in another jurisdiction. The core traits of such type of structures are to invest in a portfolio that contains different underlying assets instead of investing directly in bonds, stocks and other types of securities.
The prevailing Acts and Regulations contain provisions for the structuring of Fund of Funds where the concept relates to a feeder fund whose main role is to pool funding from worldwide investors and then inject the capital amount into a master-feeder fund domiciled outside Mauritius, for instance, an Alternative Investment Fund (Category 1) established in India. Under such equation, the AIF will be subject to Indian regulations and will ventilate the money received from the Feeder Fund in Mauritius into short-term and/or long-term investments.
The Mauritian framework and regulations also offer the possibility to incorporate a multiclass Fund. Such Fund is well reputed to invest under the FPI route and meet the definition of a broad-based fund under the SEBI regulations. The regulations in Mauritius are flexible enough to formally register a Fund with multiple sub-fund where segregation of assets and liabilities can be done under the creation of sub fund for each type of investors and underlying investments. Provided that some conditions are met, this Fund can apply for FPI license and engaged in investment activities in quoted securities and/or private equity investments.
Investments in securities:
Quoted investments made through the FPI route in India are now subject to tax following the Treaty re-negotiation. It is to be noted that income from the sale of shares is characterized as capital gains and at present, FPIs enjoy the benefits of the capital gains provisions under the India-Mauritius DTAA. While there is a zero percent rate applicable on gains arising out of shares that are listed and sold on a recognized stock exchange if such shares are held for more than 12 months, capital gains arising out of investments are subject to a tax rate of 15% (exclusive of applicable surcharge and cess) if such shares are held for less than 12 months i.e. short-term capital gains. During the Transition Period (1 April 2017 – 31 March 2019), and subject to the satisfaction of the limitation of benefits clause, this rate may be reduced to 7.5%. Hence, while short-term capital gains have been affected by the treaty re-negotiation, long-term investments in shares of listed Indian Companies are not affected by the DTAA amendment and continue to enjoy the treaty benefits. The above should be read in light of recent legislative changes brought to the (Indian) Income Tax Act which extends the scope of capital gains taxation to gains on the transfer of a long-term capital asset with effect from 1 April 2018. While the amendments to the taxation of LTCG would not affect transfers made on or before 31 March 2018, the impact on securities acquired on or after 1 April 2017 and transferred on or after 1 April 2018 would be taxable at the maximum marginal rate of 10.92% of gains arising from the transfer of these securities. In the latter case, gains arising from sale or transfer of long-term equity shares shall be taxable at the rate of the 50% of the prevailing domestic (Indian) tax rate under the DTAA, that is, 5.82% plus applicable charge and cess for shares acquired after 1 April 2017 and sold before 31 March 2019. As for shares sold post 31st March 2019, the full domestic rate will apply.
In a nutshell, it is posited that the modification on capital gains taxation is limited to gains arising on sale of shares. This ensures continuity of benefit to other instruments and also provides much-needed certainty in respect of the position of the India-Mauritius DTAA. Mauritius still retains its attractiveness as far as channeling of foreign portfolio investments is concerned, the more so that other alternative structures are being constantly explored so as to offer wider options to investors.
Mauritius accounts for the highest level (about 16%) of total foreign portfolio inflows in India after the US. It is considered as an inexpensive and a favourite route for many NRI and PIO investment managers. Furthermore, it is not gainsaid that following the re-negotiation of the India-Mauritius DTAA in 2016, Mauritius still remains a competitive jurisdiction for making debt investments through the FPI route in listed securities either on the primary or secondary markets in India.
Essentially, a foreign investor investing in debt instruments could earn the following incomes from investments in India: either (a) gains arising from sale / transfer of securities held in Indian companies or (b) interest income.
It has been clarified that any gains arising to an FPI from the sale of securities (equity or debt) held in Indian companies will be characterized as ‘capital gains.’ Under the India-Mauritius DTAA, if the gain from the alienation of debt instruments (compulsorily, optionally and non-convertible debentures), other than redemption premium, is treated as ‘capital gains’, such instruments shall only be taxable in Mauritius, which is beneficial as Mauritius does not levy a tax on capital gains.
As for interest income, the Protocol provides that all Mauritius entities including banks earning interest income from Indian sources will now be required to pay tax at a rate of not more than 7.5% of the gross amount of interest provided that the Mauritius entities are the beneficial owners of such interest income. Furthermore, in case the domestic (Indian) tax rate is lower than 7.5%, then it is the domestic rate which will be applicable. Based on the above analysis, it can be said that for now, Mauritius is certainly the preferred route for investing in the debt market in India and now emerges as the preferred jurisdiction for debt investments considering the lower withholding tax rates for interest income as well as the capital gains tax exemption, as compared to such other jurisdictions as Singapore (15%) and Netherlands (10%).
D. Benefits of Using Mauritius
Mauritius has built a solid reputation of being a jurisdiction of substance internationally. Supported by its legislative framework and financial services infrastructure, Mauritius offers an ideal platform for investments around the globe with a focus on Africa and Asia including India.
While the current fiscal advantages will play a major role in the choice of jurisdiction for a cross-border investment, they are not the only factors which should be taken into account. Mauritius is considered as one of the most reputable offshore financial centers in the world, for a number of reasons including:
- well established administrative infrastructure for setting up and operating special purpose vehicles;
- a well-established rule of law founded on the Common and civil law;
- its modern and flexible company legislation which is based on the Anglo- Saxon laws;
- compliance with anti-money laundering laws and international standards;
- Mauritius has never been blacklisted internationally by any of the OECD, FATF or UN;
- the long-term commitment and support of the Mauritius government in the development of the financial services sector;
- its political stability and a free market economy;
- several Investment Protection and Promotion Agreements which have been signed in order to safeguard investors business and assets;
- the relatively low cost of services compared to other jurisdiction;
- Unlike such offshore jurisdictions like Singapore which does not have any specific corporate structures that are geared towards investment funds, Mauritius has a variety of corporate structures which can be used to channel foreign portfolio investments, including for example Expert Fund or Professional CIS regulated by the Financial Services Commission;
- an educated and bilingual workforce;
- good international telecommunications services;
- Presence of the Mauritius FSC Representative Office in Mumbai as a key point of contact for SEBI; and
- a convenient time zone location which allows for the conduct of business in the Far East in the morning, Europe during the early afternoon and the United States, later in the day
E. What Next?
Mauritius has been undoubtedly a vibrant International Financial Centre during the last 25 years. Its strategic location, its stable socio-political environment, its business-conducive framework, it’s well-established and yet competitive regulatory framework, and its connectivity and openness to the rest of the word makes Mauritius an attractive hub for financial services and capital raising, linking Asia/Europe/USA to Africa. With more challenges ahead and investors seeking for long-term visibility, new legislative changes have been brought by the Finance (Miscelleneous Provisions) Act 2018 to the global business sector in order to bring more certainty, clarity and harmonisation to the treatment of foreign investors and cross-border investments alike. Mauritius is now gearing itself towards becoming a leader in the African region and beyond. Policy makers are presently in the process of elaborating a 10 year ‘Blueprint’ for the Financial Services sector, which will make significant in-roads into existing and new activities which Mauritius has to offer from its jurisdiction.
This Article is authored by our Mauritius partner Anex Management Services Limited, licensed by Mauritius Financial Services Commission and having more than 20 years of experience in providing incorporation, accounting, compliance and administration services to global business entities in Mauritius.