Setback for foreign investors on Mauritius tax angle on PE funds

Setback for foreign investors on Mauritius tax angle on PE funds

The move of the revenue authority comes as a surprise to the experts

The foreign investors betting on India by putting their money into Private Equity (PE) funds are shocked by a recent observation by the Mauritius Revenue Authority (MRA). The government organization has imposed a tax and, in the process, questioned the investment structures that have been in vogue for years.

As per the new MRA ruling, investment vehicles in Mauritius (used by global investors to enter India), would now have to pay a tax in Mauritius on the ‘capital gains’ received from a PE or debt fund, when the latter exits an investment.

Until now, a Mauritius entity paid tax to the Mauritius government only on ‘income flows’, such as dividends and interest distributed by funds in India. But it was not on capital gains booked in India.

In a matter related to a global investor, the MRA 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. While Category II AIFs are usually PE funds, the Category III funds are allowed leverage and employ complex trading strategies.

As per the MRA ruling, capital gains would now be taxed in Mauritius, just as income distributions like dividends.

Bijal Ajinkya, the Partner at law firm Khaitan & Co, said it could 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.

Ajinkya said, “The characterization 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.”

“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 that 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,” she added.

Ajinkya further questioned, “Would this encourage foreign investors to directly invest in a GIFT AIF so as to avoid the costs?”

Meanwhile, an investment entity in Mauritius pays a 10 percent 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 percent or 30 percent depending on whether the entity 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 percent tax in Mauritius.

Since the Mauritius tax law concerns distribution from a trust, this would apply particularly if a PE fund in India was set up as a trust. In fact, most funds are set up as trusts as investors in a fund prefer not to disclose their identities, which they must if the PE is formed as a limited liability partnership (LLP).

The MRA ruling (posted on its website), does not disclose the identity of the foreign investor whose query seeking clarification to revenue authority has opened 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. This position was never questioned by authorities in Mauritius.

Girish Vanvari, the Founder of tax advisory firm Transaction Square, said, “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 the 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.”

The Mauritius vehicle has a global business licence and a collective investment scheme license with the country’s Financial Services Commission. Its investment manager is a Singaporean company regulated by the Monetary Authority of Singapore.

The MRA was questioned, “Whether capital gains accrued by the AIF trust and distributed to L would be considered as capital gains for income tax purposes?”

Meanwhile, tax professionals and service providers in the tax haven are awaiting the response of MRA.

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