Investing in India through a tax haven

A tax haven is a place of shelter from high income taxes and currency controls. Countries offering more advantageous tax regimes are known as tax havens.

According to the Organization for Economic Cooperation and Development (OECD), tax havens have a number of common features.

They lack effective exchanges of information and transparency. They attract business with no substantial activity and are known as money laundering centres.

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According to the OECD, a harmful preferential tax regime is one that imposes low or zero effective tax rates on income.

The regime is often ring-fenced, that is, it does not offer its domestic tax players the same incentives for the same activity as it offers to foreign players. What’s more, the operation of the regime is opaque.

There is no effective exchange of information with government of other countries.

Situation in India

Capital gains on sales of shares sold through a recognized stock exchange and held for more than one year are currently tax free.

Gains on sales of such shares held for less than one year are taxed at 11.33%. This figure includes a 10% tax rate plus various surcharges and education fees.

Gains on sales of shares in private companies held for more than one year are taxed at the reduced rate of 22.66%. As above, this figure includes a 20% tax plus surcharges and education fees.

Gains on sales of such shares held for more than one year are taxed at the normal corporate tax rate of 33.99%.

Dividends declared by an Indian company are presently not taxed in the hands of the recipient upon payment of a Dividend Distribution Tax (presently 16.995%) by the Indian company that declares the dividend. Thus, foreign investment in India is usually routed through a tax haven.

Two very popular such tax havens to route foreign investment in India are Mauritius or Cyprus.

Corporate tax in Cyprus

Cyprus-resident companies are liable to corporate tax on their worldwide income, including any interest receivable, at a rate of 10%.

However, capital gains on the disposal of shares in non-Cyprus resident companies are exempt from capital gains tax in Cyprus, as are the dividends received from such companies, provided that the Cyprus company has no permanent establishment in that country.

The 1994 double taxation agreement between India and Cyprus confers certain benefits on Cyprus-resident companies which do not have permanent establishment in India.

First, capital gains on the disposal of shares in Indian companies will not be taxed in India, as they are also exempt from capital gains tax in Cyprus.

Second, interest income (if any) from India will be subject to Indian withholding tax at 10% rather than the normal 20% rate.

Finally, dividends from India will be free of Indian withholding tax provided that the Indian company has paid Dividend Distribution Tax at 16.995%.

Balancing liabilities

Half of the interest receivable from Indian companies will be taxed in Cyprus at 10%, but double tax relief should be available in respect of the Indian withholding tax suffered at source. This should be sufficient to extinguish any tax liabilities in  Cyprus.

A Cyprus company will be deemed to be a tax resident only if its management and control is in Cyprus. Companies managed and controlled from outside of Cyprus do not receive any benefits under the Cyprus-India tax treaty.

Whether the effective management of a company is in India or Cyprus or elsewhere is a question of fact.

Investment through Mauritius

In terms of the Double Taxation India-Mauritius tax treaty, the Indian tax on sales of shares of an Indian company can be avoided if the seller is a Mauritius company.

The caveat is that  the Mauritius company cannot have a permanent establishment in India.

Thus, no tax on sales of shares is payable, in the case of the sale of shares of an Indian company by a Mauritius company that does not have a permanent establishment in India, regardless of whether the shares are of a company listed on a stock exchange or of a private company and regardless of the length of the holding period.

Under Mauritius laws, a Global Business Company Category 1 (what was once known as an Offshore Company), has to be created before investmets are made.

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Sumes Dewan is a partner at KR Chawla & Co Advocates & Legal Consultants. The firm is headquartered in New Delhi and has offices in Chennai and Bangalore as well as a representative office in Singapore.